Beyond the Greenback: Understanding De-Dollarization Dynamics

    • By,
      Aarini Mishra – Student, Kautilya

For over a century, the U.S. dollar has reigned as the world’s dominant reserve currency. From commodities trading to international debt issuance, the greenback has been the go-to currency for facilitating global transactions. However, geopolitical shifts and economic forces may be chipping away at the dollar’s supremacy. The rise of alternative currencies, particularly the Chinese renminbi, has reignited talks of potential de-dollarization.

What is De-Dollarization? De-dollarization refers to the move away from using the U.S. dollar as the primary reserve currency and medium for international transactions. This can involve central banks diversifying their currency reserves, countries settling trade in other currencies like their own rather than dollars, and businesses issuing debt denominated in non-dollar currencies.

While still the preeminent global currency, the dollar’s share of allocated foreign exchange reserves has dropped from over 70% in 2001 to around 59% as of early 2023. Nations are seeking to reduce their dependence on the dollar amidst rising U.S. interest rates, punitive economic sanctions, and general geopolitical tensions. (1)

At the forefront of the de-dollarization movement is China and its renminbi currency. The renminbi currently accounts for only around 2.3% of global payments through the SWIFT system. However, its use has been rapidly expanding, nearly doubling in 2022 as countries aimed to sidestep the dollar in response to sanctions on Russia. (2)

China has been actively promoting the renminbi’s international adoption through policies like renminbi clearing banks, bilateral currency swap lines, and its Cross-Border Interbank Payment System (CIPS). The renminbi’s share of foreign exchange reserves held by many countries has grown. For instance, it accounted for over 5% of Brazil’s reserves by the end of 2022. (3)

The Ukraine conflict served as a catalyst, with countries like Russia and India turning to the renminbi for trade to avoid dollar-based sanctions from the West. Data indicates the renminbi’s use in Russian export and import invoicing climbed significantly in 2022.
While the renminbi’s footprint is spreading, the dollar still utterly dominates global finance and trade. The greenback was involved in around 90% of all foreign exchange transactions in 2022. It remains the most widely traded, liquid, and stable reserve currency. (4)

For the renminbi to be a true alternative, China will likely need to relax its capital controls, further open its markets, and promote greater currency liquidity. The renminbi’s lack of full convertibility, government oversight, and opaque legal system remain barriers. Beyond the renminbi, the potential use of other currencies like the Indian rupee, Brazilian real, and Russian ruble is still relatively limited globally. Volatility, liquidity constraints, and inadequate financial infrastructure currently restrict their widespread adoption.

Most analysts don’t foresee a rapid upheaval but a partial, gradual de-dollarization where multiple reserve currencies co-exist. A more regionally siloed international financial system with distinct spheres of influence could take shape. Within the BRICS bloc of major emerging economies, there are active efforts to facilitate trade using local currencies. However, the dollar remains deeply entrenched even among these nations due to its stability and ubiquity in global markets.

For the U.S., although de-dollarization could increase borrowing costs and drain markets, its effects are difficult to quantify. The dollar’s unmatched global networks, market depth, and use in vital commodities trading underpin its central role.

While unlikely to be dethroned imminently, the U.S. dollar’s dominance faces its most serious challenge in decades. Sustaining its global reserve status will require the U.S. to maintain both economic strength and financial system credibility on the world stage. American policymakers must remain attuned to macro forces encouraging de-dollarization.

Though still a bit player, the renminbi has emerged as the dollar’s principal challenger thanks to China’s economic clout and policies aimed at increasing its currency’s globalization. Whether the renminbi or a multipolar system of reserve currencies takes greater hold remains to be seen. However, the growth of options appears to signal a gradual power redistribution in the making within international finance and monetary affairs. Nonetheless, countries like India and Brazil are actively exploring bilateral agreements and local currency settlement mechanisms to reduce their reliance on the dollar. (5)

Despite the growing calls for de-dollarization, the dollar remains the undisputed king of the global financial system. Data from 2022 revealed that the dollar was involved in a staggering 90% of all foreign exchange transactions globally. The dollar’s dominance is reinforced by its widespread acceptance as a medium of exchange, store of value, and standard of deferred payment. Its liquidity and stability continue to attract central banks, with 59% of disclosed global foreign exchange reserves held in dollar assets in 2022.

While de-dollarization is an ongoing process, experts predict that it will be a gradual shift rather than a rapid upheaval. The advantages of a ubiquitous currency like the dollar, coupled with the U.S.’s global alliances, make a complete dethroning of the greenback unlikely in the near future. A more plausible scenario is “partial de-dollarization,” where alternative currencies like the renminbi assume specific functions, leading to regionalism and distinct economic and financial spheres of influence.

As the battle for currency supremacy rages on, one thing is certain: the global financial landscape is undergoing a seismic shift, and the outcome will have far-reaching implications for economies, markets, and the balance of power among nations.

*The Kautilya School of Public Policy (KSPP) takes no institutional positions. The views and opinions expressed in this article are solely those of the author(s) and do not reflect the views or positions of KSPP.