Will the US Dollar be dethroned?

The Dollar wasn't always the most dominant currency in the world. It was the Spanish currency used for trade in the 17th-18th centuries, before being dethroned by the British pound sterling.

The British pound sterling (￡) remained the world's foremost reserve currency from the 18th to early 20th century during the heights of the British Empire, before being surpassed by the U.S. dollar ($).

The Threat to the Dollar's Dominance

We are now in a phase where the dollar's dominance is under threat.

China and other BRICS countries have been offloading U.S. treasuries worth billions since 2022.

The uncontrolled debt of $34.4 trillion and the fear of being sanctioned amid geopolitical tensions are worrisome, making BRICS rely on local currencies instead of the dollar.

European nations are also beginning to distance themselves from the U.S. economy. Belgium, a close ally of the U.S., dumped $22-23 billion worth of treasuries during the same period, although it was BRICS that initiated this attempt towards de-dollarization to uproot the U.S. dollar from the world's reserve currency status.

Russia purchased arms manufactured by India by paying $ 4 Bn entirely in its Local currency and USD was left out of the transaction. In addition, India is also settling trade with Russia using local currencies through Vostro accounts and not the USD.

China's Massive Selloff of U.S. Assets

In just the first quarter of 2024, China sold a record $53.3 billion of Treasuries and agency bonds combined, according to the U.S. Department of the Treasury.

This highlights China's move to diversify away from American assets as trade tensions persist.

But why now? Everyone’s expecting a potential Fed rate-cut cycle which would increase the value of their U.S. holdings......

Unless they anticipate that U.S. interest rates will continue to rise due to persistent fiscal deficits, making it prudent to sell now rather than risk losses or repayment in devalued dollars. Well, only time will tell.

"China's selling of U.S. securities could speed up as the U.S.-China trade war resumes, especially if Trump returns as president," warned Stephen Chiu, Chief Asia Fx and rates strategist.

The Rise of Alternative Assets

With China selling dollar assets, its holdings of gold have risen in the nation's official reserves. The share of gold in the reserves climbed to 4.9% in April, the highest according to central bank data from 2015.

As Gita Gopinath, IMF's First Deputy Managing Director, stated, "China and countries with close ties to it have increased their holdings of gold in foreign-exchange reserves since 2015, while countries in the U.S. bloc have kept them broadly stable. This suggests that concerns about sanctions risk may have driven gold purchases by some central banks."

President Joe Biden has unveiled sweeping tariff hikes on a range of Chinese imports, while his predecessor Donald Trump said he might impose a levy of more than 60% on Chinese goods if elected.

The IMF Confirms the Dollar's Jeopardy

The International Monetary Fund (IMF) confirmed that the U.S. dollar is in jeopardy against BRICS nations and other local currencies.

In her paper titled 'Impact of Geopolitics on International Trade and the Dollar,' Gopinath acknowledged that BRICS is creating a shift in global economic policies.

She revealed that BRICS nations are now conducting business based on their geopolitical alliances with other countries, putting the U.S. dollar on the back foot as local currencies will be used to settle cross-border transactions.

However, Gopinath noted that despite the risk, the U.S. dollar remains the de facto currency for global trade and commerce, "Probably because a large part of commodity trade continues to be invoiced and settled in U.S. dollars."

The Potential Tipping Point

If BRICS captures the oil sector and settles trade in local currencies, the U.S. dollar could decline significantly. The majority of new countries that joined BRICS this year are oil-producing and exporting nations.

The alliance is waiting for Saudi Arabia to join the bloc, which could change the dynamics in the global oil sector and potentially hasten the dollar's?dethroning.

Conclusion

Despite the potential for de-dollarization, it remains an unlikely scenario in the short term, even with the existing challenges to the U.S. dollar's dominance. The Yuan currently lacks the necessary liquidity to serve as a viable replacement for the dollar's global role. It will take much more to dethrone the world's most dominant currency. However, once the first domino falls, it may just be a matter of time.

Sources-

1. Watcher Guru
2. Reuters
3. Mint