Financial News Weekly Digest June 2: The Ongoing De-Dollarization

You may have heard a lot of buzz about the US debt ceiling lately, but this week we’ll be changing gears and diving into another related topic: de-dollarization.

During the “South America Summit 2023” held in Brazil on Tuesday, Brazilian President Lula made a statement that caught the world off guard. He expressed his hope that the BRICS nations would come together to establish a unified regional currency akin to the euro in the European Union. This would enable South American countries to develop trade independently of the US dollar, marking a significant step towards “de-dollarization.”

Is this the straw that breaks the camel’s back for de-dollarization? MoneySmart’s Financial News Weekly Digest is going to break down every bit of de-dollarization so you can ride out the storm.

What is de-dollarization? And why does it happen?

De-dollarization refers to the process of countries reducing their dependency on the US dollar and exploring alternative currencies for international trade and finance. In other words, countries are no longer putting all their eggs in the USD basket.

But why is de-dollarization happening? It can be chalked up to the following major factors:

• The US weaponizing the USD
• The US’s financial instability
• The rise of BRICS

Weaponizing USD in US economic sanctions

As the most powerful and widespread currency in the world, the US dollar has the ability to use economic sanctions against countries that the US disagrees with. For example, when the Russian-Ukrainian war broke out, major Russian banks were cut off from SWIFT, and over $1 trillion in US-held assets were frozen and seized by March 2022.

However, there are costs to this sanction. The US dollar’s weaponization can make it difficult for allied countries to trade and finance their economies if they do business with sanctioned countries and rely heavily on the dollar. US allies are suffering economic losses due to US sanctions against Russia, China, and Iran. Plus, it is unclear how long Washington will continue to maintain this approach, which incentivizes other countries to de-risk with another currency.

As a result, there is a growing trend towards de-dollarization, with countries seeking to reduce their reliance on the US dollar and explore alternative currencies for international trade and finance.

US financial instability—the ever-rising debt ceiling

If you’ve been keeping up with our previous Financial News Digest, you’re probably familiar with the worrisome US debt ceiling that’s been causing the world to hold their breath. Despite the slim chance of a US debt default, the ever-increasing US debt ceiling has got US treasuries in hot water and the market rattled. 

Janet Yellen, the US Secretary of the Treasury, testified in Congress in March 2023 that the US government’s debt would grow to a whopping $51 trillion in a decade, hinting at an imminent debt crisis. The uncertainty surrounding the US debt is causing countries to steer clear of using the USD in trade and as a reserve currency.

The rise of the BRICS—new demand for an alternative currency

The BRICS countries, which include Brazil, Russia, India, China, and South Africa, are gaining economic power with a combined GDP of $20 trillion. Plus, being major producers of commodities such as oil, gas, and metals has made these countries increasingly influential in determining which currency to use for international trade and finance, and they may choose to use their own currency or invest in other currencies, such as the euro or the Chinese yuan, instead of relying solely on the US dollar.

The ongoing trend of de-dollarization

The trend towards de-dollarization seems to be gaining momentum, with countries worldwide seeking to decrease their reliance on the US dollar. The rise of BRICS nations, US financial instability, and the weaponization of the USD have all contributed to this unstoppable movement. Countries in the Global South, in particular, are reducing their USD reserves, settling cross-border transactions in non-dollar currencies, and exploring the formation of new multilateral settlement mechanisms.

Central banks holding fewer USD in global reserves

As the de-dollarization wave sweeps across the globe, some countries have reduced their holdings of US treasuries. In 2022, Japan, the world’s largest holder of US debts, had cut its holdings by $224.5 billion and China by $173.2 billion.

For decades, the US dollar has been king in global trade and capital flows. However, its share in global central bank reserves has dropped to less than 60% from roughly 70% 20 years ago, indicating that the de-dollarization trend is gaining steam.

The rising power of RMB

As countries look to diversify their currency holdings, China has been making moves to position its RMB as the new big player in town. It has acted as a safe haven for Russia amidst sanctions, gained ground in the oil settlement market, and become a viable alternative to the USD in South America.

Resort to the US’s sanctions against Russia

In the midst of US sanctions, Russia was compelled to turn to the RMB due to the freezing of $300 billion of its international assets and the US’s moves to exclude major Russian banks from global markets. The Chinese Yuan has served as a resort for Russia to diversify its foreign exchange reserves. Specifically, China has purchased Russian oil using the yuan, while Russia has conducted currency swaps with China.

RMB taking market share in oil settlement

RMB is becoming increasingly important due to its use in oil settlements. Here are the recent events regarding the RMB in oil settlements:

• In Mar 2023, Saudi Arabia considered accepting RMB for oil sales. Chinese and French energy companies finalized the first-ever deal on liquified natural gas (LNG) in the Renminbi yuan currency.
• Recently in South Asia, Bangladesh and Russia have agreed to use Renminbi to settle payment for a nuclear plant being constructed by Russia’s state-owned atomic company Rosatom.
• China and the Arab Gulf nations are working out a deal to use the Shanghai Petroleum and Natural Gas Exchange as a platform for carrying out yuan settlements of oil and gas trades.

RMB is gaining a place in South America

Earlier this year, Brazil reached an agreement with China to use its own currency in trade, becoming the first South American country to “de-dollarize” trade with China. Following Brazil’s lead, Argentina, the second-largest economy in South America, has also announced that it will pay for imports from China in Renminbi.

Stacking gold to back RMB

According to data from the State Administration of Foreign Exchange in May, China raised its gold holdings by about 8.09 tons in April, and the nation’s total stockpiles now sit at about 2,076 tons. If China continues to accumulate gold, it could challenge the USD as a dominant player in the global financial landscape, with RMB linking up to the Chinese gold reserve.

The challenge of RMB internationalization

While the RMB is being widely used, it constitutes less than 3% of global currency reserves, and China’s attempts to expand the currency’s international role have faced roadblocks. There are risks associated with trading in RMB, especially considering China’s tendency for sudden devaluations due to capital controls and standoffs with other countries.

Capital controls—no free flow of capital

The RMB is not quite ready for prime time as an effective means of savings and deposits, as it is still subject to capital controls. 

Russia is another prime example of a country that is feeling the squeeze of capital flow restrictions. First, China’s capital controls pose a challenge to Russia’s ability to move Chinese CNY holdings into other currencies. Second, although the RMB is widely used for trade savings and credit financing in Russia, long-term financing has yet to be offered, leaving the credit market underdeveloped. Additionally, Russia holds almost a third of the world’s renminbi reserves, but this is less impressive as there aren’t many countries using RMB to trade.

Built-up tension—India holds back on RMB settlements

There is a growing concern in India over the use of the Chinese yuan for foreign trade, especially amid ongoing border tensions between India and China. India’s biggest cement producer, UltraTech Cement, used RMB for a cargo of Russian coal last year, drawing attention to the issue. In response, New Delhi has requested that banks and traders use UAE dirhams instead of the RMB, hinting that India may not go along with the RMB settlements.

Conclusion—what now for de-dollarization?

For the time being, the US financial markets are still the big cheese, with more depth, sophistication, and liquidity than any other market. Plus, most global trade is done in dollars, and most central banks around the world hold their reserves in dollars. This just goes to show that the US dollar is still the bee’s knees.

However, the Chinese yuan is giving the US dollar a run for its money, challenging its supremacy as the primary reserve asset of many international organizations. Countries like China, Russia, and several Latin American nations are implementing policies aimed at reducing their dependence on the US dollar.

In a nutshell, de-dollarization may be inevitable, but it won’t happen overnight.

 

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