Marcel Salikhov: Here’s how the end of the US dollar’s global dominance will play out

By Marcel Salikhov, Director of the Centre for Economic Expertise at the Higher School of Economics, Moscow

The de-dollarization of the global financial system is set to continue. This will be facilitated by the development of new financial technology. Central banks will seek to settle directly with each other without using the currencies of developed countries. In the future, central banks’ digital currencies may also be used for international transactions, reducing costs for economic transactions. However, this process will be rather slow.  

The US dollar has long been the world’s dominant currency. Its use in international transactions has for many decades far exceeded the American share of the global economy, which now stands at around 24%. For example, according to the IMF the dollar accounted for 58.4% of central banks’ international reserves by currency at the end of 2002. According to SWIFT, the Greenback’s share of interbank transfers in April 2023 was 59.7 per cent. This was significantly higher than a year earlier.

Several factors contribute to the active use of the US dollar, even in transactions between third countries: the size of the American economy (the largest and most liquid market for financial instruments, including reliable ones), political influence and the role of US multinationals in global markets. All these aspects interact and are mutually supportive over a long period of time. It’s also worth remembering that the global financial crisis of 2008-2009, which originated in the US economy itself, did not affect the position of the dollar globally.

However, the blocking of the Bank of Russia’s reserves by Western countries, as well as large-scale financial sanctions against Russian banks and companies, have caused many to question whether the advantages of dollarization might not be all they seem. The non-economic risks of US dollar transactions and dollarized assets have become apparent to everyone, especially central banks. In particular, Article 21 of the 2004 UN Convention on Jurisdictional Immunities of States and their Property guarantees immunity for central bank assets. However, this did not protect the assets of the Bank of Russia from being frozen, which has now set a precedent.

Russia’s actions under these conditions were expected and understandable. From the beginning of 2023, the Central Bank began to conduct operations under the budget rule in Chinese yuan. Russian companies are restructuring their foreign-trade operations and how they accumulate foreign assets, preferring to use of the currencies of “friendly” countries. This basically means non-Western.

At the same time, current data does not show a mass abandonment of the use of the US dollar by central banks. The share of the US currency in international reserves has been declining steadily over the past few decades, but at a relatively slow pace. While around 70% of global central bank reserves were held in US dollars in the early 2000s, this figure fell to less than 60% by 2020. There was no radical decline in dollar reserves in 2022. Its share of reserves fell by 0.44 percentage points, while its use in interbank transfers actually rose.

Are there alternatives to the dollar?

The main reason for this, despite obviously increased political risks, is the lack of serious alternatives that can absorb significant amounts of central bank savings.

The traditional role of foreign exchange reserves, both for private actors and governments, is to ensure financial stability and diversify risk. Central bank reserves are one of the instruments that serve this purpose. They are highly liquid and can be used quickly for currency intervention if necessary. The downside is the high vulnerability of such assets in terms of sanctions. Plus low yields.

The Eurozone government bond market is fragmented into individual countries, many of which have low credit ratings. The Chinese yuan is not a freely convertible currency. It is split into internal (offshore) and external (onshore) parts, and is under the strict control of the National Bank of China. Gold as an asset can be a good hedge in times of crisis, but it does not generate interest income and has low liquidity. It is therefore far from obvious to central banks in developing countries which assets –and in what currency– can be an alternative to those held in US dollars.

Storing wealth not only in gold and foreign exchange reserves  

A more important factor than the nominal share of the US dollar in international reserves is the changing approach to the management and accumulation of foreign assets. The same IMF data shows that the total value of central bank reserves has remained virtually unchanged at $11.5-12 trillion over the past decade, even as the global economy has grown. China’s foreign exchange reserves peaked at $4 trillion in 2014 and have been declining ever since. Their current value is $3.2 trillion, down 20% from 2014. Many other developing countries are not increasing their international reserves, if not reducing them.

This does not mean, however, that external assets are not being created. They can be formed in “non-standard” forms, such as assets of sovereign wealth funds, state banks, development institutions and other structures not directly related to central banks. Foreign direct investment by government structures can also be classified as a type of reserve asset. Such a strategy is not aimed at maximising the availability and liquidity of assets, but at securing one’s own economic interests in foreign markets. To some extent, it provides greater protection against the political risks of asset freezes, as their legal status is less transparent.

China’s strategy

A similar strategy is being pursued by China, which is seeking to gradually “internationalize” its currency. Formally, the yuan’s share of central banks’ international reserves is small, amounting to no more than 3%. Moreover, between a third and a half of this demand is provided by the Bank of Russia.

China’s strategy is to secure the international status of the RMB through trade rather than investment. In recent years, China has actively sought to motivate and encourage its partners to trade in RMB rather than other currencies. This is being done in a number of ways, including infrastructure development, its own analogue of the SWIFT system, development of clearing, international lending in the currency and so on. Many people have heard of the term “petroyuan” – an analogue of the petrodollar. In essence, it is the signing of long-term contracts for the supply of oil in yuan in return for a flow of goods and equipment. So, trade is already being conducted in yuan rather than US dollars. This creates demand outside the Chinese economy. At the same time, the Chinese authorities maintain restrictions on capital transactions. 

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The de-dollarization of the global financial system will continue. This will be facilitated in particular by progress in financial technology. The development of automated trading platforms will reduce the cost of exchanging one currency for another. Central banks will seek to directly clear each other’s currencies without directly using the currencies of Western countries. In the future, central banks’ digital currencies may also be used for international transactions, reducing costs for economic agents. However, this process will be slow and we should not expect a fundamental change in the global financial system in the foreseeable future.

This piece was originally published by Valdai Discussion Club and edited by the RT team