Is de-dollarization happening?

Since the conclusion of World War II, the U.S. dollar has held a preeminent position as the world's primary means of exchange.

However, there are concerns about the sustainability of the dollar's dominance as an increasing number of emerging economies are exploring alternatives to conduct trade in currencies other than the dollar, a phenomenon known as de-dollarization. This shift in attitude has been further fueled by events such as the Russian invasion of Ukraine and the far-reaching consequences of the COVID-19 pandemic.

Despite the growing interest in de-dollarization, the emergence of a viable replacement for the dollar as the leading reserve currency appears improbable at present. Few serious contenders have come forward, leaving the greenback's position largely unchallenged for the foreseeable future. Chinese Renminbi, arguably a key rival to dollar contributes only 2.6% of global currency reserve. While the supremacy of the dollar and its sovereign status won’t end anytime soon, its stranglehold on the global financial system is likely to weaken as more countries start seeking or testing alternatives to diversify their reserves away from the dollar.??

As evident from above graph, over time, the share of global foreign exchange reserves held in the U.S. dollar has been steadily declining, as indicated by the IMF's Currency Composition of Official Foreign Exchange Reserves (COFER) data. Its contribution in global exchange reserve has reduced from 71% in 1999 to 59% in 2023. The decline in the dollar's share of exchange reserves does not signify a shift towards the euro, the British pound sterling, or the Japanese yen. Instead, it has been accompanied by a corresponding increase in the share of what we call nontraditional reserve currencies especially Chinese Renminbi.

In terms of currency usage for global payments as per SWIFT Bank, dollar continues to contribute more 40%, and euro continues to enjoy more than 30% share of SWIFT payments. While Chinese Renminbi continues to rise as more countries are looking for alternates to dollars.

Countries like Brazil, Argentina, India, South Africa, the Middle East, and Southeast Asia are increasingly choosing to conduct international settlements in their own national currencies or alternative currencies. This trend is anticipated to gather additional momentum in the future.?

How dollar became world’s reserve currency?

Here are some of the key events that helped the dollar become the world's reserve currency:

• The First World War:?The United States emerged from World War I as the world's leading creditor nation, with a large gold reserve.
• The Bretton Woods Agreement:?In 1944, the Bretton Woods Agreement established the dollar as the official currency of the International Monetary Fund (IMF). This gave the dollar a central role in the global financial system.

In the 1960s, the United States didn't have enough gold to back all the dollars held by other countries. This raised concerns that foreign nations might rush to exchange their dollars for gold, depleting the U.S. gold reserves. Despite attempts to fix the issue, President Richard Nixon stopped allowing the dollar to be exchanged for gold in August 1971. This move marked the start of the breakdown of the Bretton Woods exchange rate system. By 1973, the current system of mostly floating exchange rates was in place.

Factors that contribute to the dollar’s dominance include its stable value, the size of the U.S. economy, and the United States’ geopolitical heft. Major commodities such as oil are primarily bought and sold using U.S. dollars, and some major economies, including Saudi Arabia, still peg their currencies to the dollar. All these factors make dollar a de-facto reserve currency.

Why few countries want de-dollarization?

De-dollarization is the process of reducing the use of the US dollar in international trade and finance. This can be done by using other currencies, such as the euro or the yuan, or by using non-currency assets, such as gold. There are a number of reasons why countries might choose to de-dollarize. These include:

• To reduce their vulnerability to US economic and financial policies:?The US dollar is the most important currency in the world, and the US government has a lot of power over the dollar. This means that countries that rely heavily on the dollar are vulnerable to US economic and financial policies. For example, if the US government were to impose sanctions on a country, it could have a significant impact on that country's economy like that of Russia.
• To protect their economies from inflation:?The US dollar is not always a stable currency. In recent years, the dollar has experienced a period of high inflation. This has made it difficult for countries that rely on the dollar to maintain their own economic stability.
• To promote economic independence:?By using their own currency, countries can gain more control over their own economies. This can make them more resilient to economic shocks and can help them to achieve their own economic goals.

It is still too early to say whether de-dollarization will be a successful trend. However, it is clear that the US dollar is likely to remain the dominant global reserve currency for the foreseeable future.