Decision Points from Enquire: De-Dollarization?

No. 18

April 20, 2023

Summary:?Many countries are moving to settle their 2-way trade in RMB, without going through the USD settlement route. We examine if this “de-dollarization” is fleeting or if it's going to mark the end of the U.S.’ “exorbitant privilege” and understand the underlying geopolitics of this emergent shift.

A?Shot Across the Bow

Ever since its inception in September 2021, this newsletter has had a single-point agenda: that it will survey the complicated and ever-changing world around us, identify the first shifting of the ground and communicate that with as much contextual information as possible. In doing so, it will try not to predict the future, but merely to answer important questions about where the world might be headed. In that spirit, we start this edition by seeking to answer a question asked by Brazilian President Luiz Inacio Lula da Silva. On a state visit to China, President Silva was speaking at an event hosted at the offices of the New Development Bank, often referred to as the BRICS Bank, and asked, “Why do all countries have to base their trade on the dollar?” He continued, “Why can’t we do trade based on our own currencies?” What he was speaking of was ‘de-dollarization.’

According to reporting from the?Financial Times, which covered the speech, “Lula’s call to shed dollar dependence dovetailed with Beijing’s increasing efforts to promote use of the renminbi in settlement of cross-border commodities trades, as Chinese policymakers seek to strengthen the role of the world’s second-largest economy in the global financial system.” According to the same article, the Chinese economy accounts for approximately 15% of global trade, but the Chinese currency currently accounts for only 4.5% of global trade finance. Policymakers in the People’s Republic have long sought to address this imbalance?—?though more for geopolitical rather than economic reasons. Recently, however, they have had several successes.

Birds of a Feather

First, China pulled off a major diplomatic coup of sorts by bringing together Iran and Saudi Arabia to try and negotiate a mediated settlement to the civil war in Yemen. According to reporting in the?South China Morning Post, the “Chinese-mediated agreement between Iran and Saudi Arabia to resume diplomatic relations after a seven-year hiatus is widely expected to de-escalate conflicts across the Middle East.” According to this analysis, the immediate beneficiary of this deal, apart from the Yemeni people themselves, will be the Islamic Republic of Iran, and its allies in Qatar and Syria. Bringing together the two historic rivals in the Middle East is not only a diplomatic achievement, but also a sign that China is stepping into the gap left by the U.S. as it focuses on rebuilding ties in Europe and East Asia. By any standard metric, this signals a major realignment of regional geopolitics. Where geopolitics leads, business and investment will surely follow.

The second emerging development was the news from the?Wall Street Journal?that Saudi Arabia was planning to price its energy exports to China in renminbi. According to the report, “Saudi officials in favor of the shift have argued that the kingdom could use part of yuan revenues to pay Chinese contractors involved in mega projects domestically, which would help mitigate some of the risks associated with the capital controls over the currency. China could also offer incentives such as multibillion-dollar investments in the kingdom.” Equally, this shift “would dent the U.S. dollar’s dominance of the global petroleum market and mark another shift by the world’s top crude exporter toward Asia.” This decision is not just economic?—?Riyadh has been angered by U.S. criticism of its human rights record and especially rankled by the condemnation following the murder of journalist Jamal Khashoggi.

Up the Garden Path

Developments in the Gulf follow a decision by Russia to settle bilateral trade between itself and China in renminbi. According to a report in the?Financial Times, “Russia has been driven towards the Chinese currency by international sanctions, the freezing of $300bn of its international assets and moves to exclude its main banks from global markets.” Brazil too recently announced that it would trade with China in their own currency, without the U.S. dollar as an intermediary. Per the?AFP, this “deal will enable China, the top rival to U.S. economic hegemony, and Brazil, the biggest economy in Latin America, to conduct their massive trade and financial transactions directly, exchanging yuan for reais and vice versa instead of going through the dollar.” That’s not all that Brazil is doing. Recently Brazil and Argentina announced the creation of a nascent currency union. Later, “officials clarified that the project’s true ambition is to create a new unit of account (a synthetic currency like the International Monetary Fund’s Special Drawing Rights) for denominating bilateral trade and financial flows as an alternative to the U.S. dollar,” says an explainer from Think-Tank?CSIS.

The swiftness and severity of the Western sanctions against Russia have also made other nations take steps to limit their exposure to the U.S. dollar. According to?WION News, “India has been making consistent efforts to replace the dollar with rupee as global reserve currency. New Delhi is offering countries facing dollar shortage to settle their trade payments in Indian rupee. The country aims to “disaster proof” countries in its immediate neighborhood and the one with which it shares significant trade volumes.” Sri Lanka and Bangladesh have reportedly signed up.

Dangerous Liaisons

Zooming out, a pattern begins to emerge. The dollar’s status as the unchallenged global reserve currency affords Washington a powerful tool with which it can keep recalcitrant allies and would-be antagonists in line. Terrified of being overexposed to a weaponized dollar, rising second-tier powers across the world are taking steps to shore up their defenses. A switch to renminbi-denominated trade would secure China its energy imports, as well as sanction-proof energy and other exports by Russia, Iran, and Saudi Arabia. Similarly, a common unit of currency for Brazil and Argentina, two of Latin America’s biggest economies, where one (Brazil) is settling all its Chinese trade is renminbi, would not only secure the two countries’ agricultural exports to China, but, more importantly, serve as a catalyst for other countries in the continent to lessen their trade dependence on the dollar.

That, at least, is the plan. The difficulty lies in getting it done. Former Goldman Sachs banker, Jim O’Neill – the very man who coined the acronym BRICS – recently wrote about this in an essay for?Project Syndicate. He identified two main challenges. First, “the group’s most important economies are China and India, bitter adversaries that rarely cooperate on anything. Until that changes, it is fanciful to think that the BRICS or even an expanded grouping could mount any serious challenge to the dollar.” Unless both countries agree to work together with the explicit aim of moving away from the dollar, and price their?bilateral trade worth $135.9bn?in?rupees or renminbi, this dream is dead on arrival. But given the geopolitical tensions, and a long-simmering border dispute, that is unlikely to happen. The second is that for any currency, “to pose a strategic challenge to the dollar, it would have to permit – indeed encourage – foreign and domestic savers and investors to decide for themselves when to buy or sell assets denominated in its currency. That means no capital controls of the kind that China has routinely deployed.”

It’s the Economy, Stupid

Perhaps the most prescient take on this came from Fletcher School Professor Daniel Drezner, writing in his?Substack. While enjoying some lighthearted schadenfreude at the travails of Elon Musk at Twitter, Drezner pointed out that while everybody can agree that Twitter’s user experience has worsened, no single alternative has emerged that provides everything that Twitter does. In other words, people, having built and curated their online personas and communities around their Twitter handle, are naturally reluctant to go somewhere else, and start all over again from scratch. This is also true of the U.S. Dollar.

In the decades since the Second World War, and the establishment of the so-called Bretton Woods institutions, central banks and large financial institutions have held large sums in dollar denominated assets, especially U.S. treasuries – mainly for stability. In the decades since the 1990s, the financialization of every aspect of the global economy has increased both these dollar holdings as well as the dependence of many central banks on the U.S. Federal Reserve. In the aftermath of the global financial crisis of 2008, the U.S. Federal Reserve mounted a concerted global operation to safeguard the international financial system – leaving it paradoxically with more power. Indeed, last month, as “Swiss officials wrestled UBS Group AG into acquiring Credit Suisse Group AG, the Federal Reserve beefed up dollar swap arrangements with five other monetary authorities to counter funding strains. This was the Fed showing muscle as a backstop to the world. It drew on statecraft deployed after the collapse of Lehman Brothers and enhanced during the volatile early stages of the pandemic,” according to an opinion piece in?Bloomberg. Given the dollar’s entrenched position as the global reserve currency, any move away would entail a significant disruption to international trade and finance. “Not that the world is necessarily in love with the dollar. It’s the absence of a viable suitor that counts here.”