De-dollarisation, or the ongoing efforts by many (if not most) countries to reduce dependence on the United States (US) dollar, is not a new phenomenon. At various points in the past when US government debt threatened to explode, there would be talk of de-dollarisation and efforts to find a substitute — all to no avail. However, the dollar’s share of global reserves has been volatile, falling from nearly 80% in 1970 to below 58% in 1980 and further to an all-time low of 47% in 1990. It rose to 71% in 1999 before falling again, to about 58-59% in 2020.
With the birth of the euro in 1999, there was a period when it was thought that, perhaps, this could provide a reasonable avenue of diversification for central banks, both from an economic and geopolitical perspective. However, it is clear that the euro is but a shadow of what was expected.
Nonetheless, the effort to find an alternative to dollar hegemony continues, accelerating after the G7, under US direction, sanctioned Russia after it invaded Ukraine, by cutting it off from SWIFT, the global settlement system.
In recent years, as China loudly climbed to its position as the second-largest economy, the renminbi (RNB) was seen for a time as a possible alternative to the dollar. However, despite its positives — highest volume of underlying physical trade, increasing trading and settlement volumes, large number of bilateral treaties, and, a remarkably large bond market ($8 trillion versus the much older US market of $30 trillion) — there are major countervailing negatives, primarily that the currency is not convertible and remains in thrall to the Chinese government, which means that no oligarch or corporate titan worth his/her salt would ever think of maintaining any wealth in the RNB. Thus, although the RNB has made significant strides in becoming globalised, it remains a poor relative of the dollar in the larger scheme of things.
However, the discomfort with the dollar continues. In 2022, global central banks bought 1,131 tonnes of gold (worth $70 billion) in an effort to diversify from the dollar, the highest annual purchase since these were first recorded in 1950. And it appears that these purchases have continued to rise in 2024. This, despite the fact that gold has limitations as a store of value since it earns no return and actually entails a storage cost.
In all this, it is important to recognise that, in addition to managing the potential geopolitical threat, there is another critical element that determines the importance and use of global currencies — the cost of short-term borrowings, particularly for trade finance.
Since early 2022 — coincidentally the same time as Russia’s invasion of Ukraine — the US one-year Treasury-Bill yield shot up from near-zero to over 5%; at the same time, Chinese Treasuries yielded around 2%. This has been pushing companies, particularly those trading with China, to prefer RNB-denominated debt (to $-denominated) in trade finance transactions.
The rise in US rates was obviously the result of the Federal Reserve trying to bring inflation, which had scooted away from right beneath its nose, under control. On the other side, the Chinese economy is crying out in pain, pressured by huge liabilities in the real estate sector and anaemic (by its standards) growth, which has kept interest rates subdued.
Another factor that has been pushing against dollar-denominated debt is the extremely strong dollar, which has led to a squeeze in dollar liquidity, particularly in emerging markets. A blog from the Atlantic Council points out that “…higher rates increased the value of dollar-denominated assets, which created strong incentives for global investors to buy dollars to buy those assets. The war amplified this. Investors also increased their dollar holdings as they view the dollar as a “safe haven asset” and expect the currency to retain, or even gain value during periods of global instability and economic downturn.”
With Donald Trump having taken dramatic charge with a flurry of appointments and announcements, it seems quite clear that inflation in the US is more or less certain to remain high. Tariffs are an odds-on bet to lead to higher prices; reducing the number of workers in an economy (albeit illegal ones) will reduce the supply of labour, again increasing prices; and, of course, tax cuts will only serve to increase the deficit, leading to higher inflation (yet again).
Thus, it seems likely that US interest rates are not going to subside sweetly and quietly as many seem to expect. It is possible that Trump may even try to push the Fed into doing his bidding — viz., lowering rates even if they are not ready. But that would have the impact of increasing volatility in the US debt markets and, possibly, a collapse in US equities.
On the other side (again), there are many analysts who fear that China may be heading for a long Japan-style period of low to possibly negative inflation, which means that interest rates there may actually fall from current levels. Thus, the interest rate differential will remain strongly in favour of borrowing in RMB, and the longer it persists, the more the number of companies flocking to this new deal in town. This tail will likely wag the dog as more central banks reduce their dollar holdings in favour of other alternatives.
Of course, none of this means that the dollar will really go out of favour — it’s just that de-dollarisation is an ongoing process as the rest of the world grows up.
Jamal Mecklai is CEO, Mecklai Financial.The views expressed are personal
