De-dollarization

Good afternoon from New Economy Brief.

Is ‘de-dollarization’ on the horizon, and what could it mean for the global economy?

The second Trump administration’s erratic economic policies have reignited debates about the future of the US dollar, and whether its role as the international reserve currency – and the enormous power it gives to the US – is under threat.

So, is ‘de-dollarization’ underway? And if so, does it pose a risk to global stability, or could it pave the way for a fairer international economy?

This week’s briefing asks if the dominance of the dollar is really in decline, and what a shifting monetary system might mean for creating a fairer global economy.

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What does it mean to be the global reserve currency? 

The US dollar is central to the workings of the international economy. It’s estimated that dollars are used for almost half of all global trade transactions and a whopping 89% of foreign exchange (buying and selling of currencies). This helps explain why dollars also account for almost 60% of all central banks’ and governments’ foreign exchange reserves – stocks of foreign currencies they hold to ensure countries can keep paying for imports and making debt payments in times of crisis. 

Impacts on the US. Being the issuer of the world’s reserve currency gives the US particular advantages, sometimes termed an ‘exorbitant privilege’. Essentially, demand for dollars lets it run large trade deficits without much risk of its currency dropping in value, while continuing to borrow huge amounts from the rest of the world, cheaply and in its own currency. 

Impacts on the rest of the world. Crucially, the flip side of the privilege the US enjoys from the dollar’s reserve currency status is the financial subordination of developing and emerging economies. Dollar-denominated debts, and the need to pay for essential imports in dollars, leaves many global south countries are vulnerable to exchange rate volatility. Countries also suffer knock-on effects from US monetary policy. If the US Federal Reserve raises interest rates, debt costs rise regardless of a country’s internal economic state, and the value of its currency comes under pressure. 

Meanwhile the need to accumulate dollars limits room for spending on domestic priorities, and contributes to locking countries into extractive export industries. Developing countries spent a record $1.4 trillion on servicing foreign debt in 2023, with severe human costs. In Sri Lanka, spiralling debt costs led the country to default. This left it highly exposed to the ongoing rise in global prices for food and fuel following the US-Israel war on Iran, and led to shortages and rationing.

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Why is the dollar now under threat?

Weaponisation of money and payments. The dollar, and accompanying US-owned international payments system, also give the US a powerful economic weapon. The US exercised this in response to Russia’s invasion of Ukraine in 2022, taking the unprecedented step of freezing the assets of Russia’s Central Bank. Some argued that the move would spark serious efforts from other countries to reduce dollar dependency and so mitigate risks from future US sanctions.

Trust and Trump. Political economists Tobias Pforro, Johannes Petry and Fabian Pape argue, however, that “nothing has been as disorientating to the global role of the dollar as the second Trump administration’s overt attacks on the liberal international economic order”. They argue that tariffs, surging US sovereign debt, and the undermining of economic institutions are threatening the foundation of trust  - crucially, that the US will be the international lender of last resort when crisis hits - that underpins the system. 

Strikingly, even JP Morgan has suggested that increased US political polarization, "jeopardiz[ing] its governance”, is a key risk to the dollar’s status as a reserve currency. It is also possible that some of this is happening on purpose, as influential Trumpworld figures like Stephen Miran and JD Vance have suggested (following Michael Pettis) that reserve currency status is a burden, because a strong dollar harms US exporters.

Currency colonialism. The de-dollarization debate is by no means new. A report from Positive Money describes how the hierarchical international monetary system is a “direct legacy of the colonial era” that reproduces colonial dynamics. Many global south countries have been pursuing strategies to reduce dollar reliance for years. Coordinated efforts through groups such as the BRICS and the ASEAN have become increasingly sophisticated, particularly due to the development of new payment technologies. 

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What are the alternatives? 

As well as heightened politicisation, the rising viability of potential alternatives has contributed to doubts about the dollar’s future being taken increasingly seriously.

Will another currency take the dollar’s place? The euro and China’s renminbi are the two currencies most often posited as potential direct challengers to the dollar. European Central Bank president Christine Lagarde has said there is an opportunity for a “global euro moment”, and the ECB is actively taking steps to make the euro more attractive as a key international currency. China’s Xi Jinping has also expressed ambitions for the renminbi to become a global reserve currency.

Brazilian President Lula championed the idea of a common BRICS currency at the group’s 2023 summit, and the rise of the BRICS states means a shared currency could potentially be a contender– particularly if it were to become the de facto currency for international pricing of oil and gas. However, the deep economic integration required means a shared currency faces major political challenges.

Towards a multipolar monetary system. Perhaps more likely than the wholesale replacement of the dollar is a shift towards a more diverse monetary system. Some have proposed a tokenised unit of account, used for settling international payments. This echoes Keynes’ proposal for an international currency called the ‘bancor’, put forward at Bretton Woods in recognition of the risks and inequities of a single dominant currency. Central Bank Digital Currencies (CBDCs) could also be designed to be ‘interoperable’ between different countries. This would support increased trade in sovereign currencies without the need for a common digital asset, making it politically easier. Project mBridge is one of the most developed examples – a platform enabling cross-border payments using respective countries’ CBDCs. A pilot was developed with the support of the Bank for International Settlements and a commercial launch is expected soon.

Some of these shifts are already appearing in the data. The dollar’s share of foreign reserves has steadily declined over the past two decades, and those of a range of non-traditional reserve currencies have increased. However, even if new tech does turbocharge efforts at de-dollarization, it’s unlikely that dollar hegemony will be toppled quickly. As Adam Tooze recently argued, the dollar’s strength is not solely upheld by other states holding it as foreign exchange reserves. Increasingly, demand for dollars comes from financial markets – private investors buying US assets to reap returns from the profit-driven US economy. The key question, therefore, might be whether Trump will put even that at risk.