De-Dollarisation Unlikely Soon As US Dominance, Tariff Threats Keep Dollar As Global Anchor Currency

There has been a lot of talk of de-dollarisation in the context of countries moving away from the use of the dollar for cross-border transactions and settlement. This concept had been spoken of for quite some time now but came actively to the discussion table when the USA put an embargo on all treasury assets held by Russia following the war with Ukraine. The question was that if the US could do it with Russia, the same can be done with any other country. And considering that almost 57% of the world forex assets are held in dollars, there was a need for diversification. This would mean de-dollarisation. In parallel, countries could be using another currency to settle trade transactions as this process caught on.

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While this is an idea worth discussing, it has been observed that the USA holds a position of primacy in the world economy. When the president imposed tariffs last year on Liberation Day, it was widely accepted by all countries, which went back to negotiating deals with the USA. While the rudimentary game theory would have proposed that all nations unite against the USA, the EU, England, and Japan, among others, went on immediately to strike deals. It was a clear win situation for the USA, which got better deals on its exports to these countries besides earning higher revenue on imports, which had a minimum threshold rate of 10%. All these countries have the US as their major export partner, with the share being 18-20%.

The USA has all the time been threatening the world to not move away from the dollar for settling global transactions, as this could lead to higher tariffs being imposed on them. Hence, most transactions continue this way overtly, though there are some covert transactions in other currencies with China attempting to take a slice of the cake. Similarly, sanctions imposed by the USA have been complied with by most nations. Hence, for all practical purposes, the USA calls the shots on the political and economic stages. This is more than evident in the context of the war in Iran, where there has been no chastisement meted out by the world, unlike for Russia when it invaded Ukraine. In such a situation, moving to any other currency looks improbable in the short to medium term.

At present, the euro is the second dominant currency, with a share of 20%, while the UK pound and yen have shares of 5-5.5%. In case of the renminbi, it is a little less than 2%. While China has been negotiating with countries like Iran and those in Africa to deal in the renminbi, which helps them to buy goods from their producers, it is unlikely to substitute the dollar. Russia is also known to be dealing with China using the renminbi to a certain extent, as it has been moved out of SWIFT.

The euro has a high share simply because it is used as the currency for all internal payments as well as trade within the 20 nations. This makes it feasible for other non-euro nations to also hold this currency, as it can be used when dealing with this group. Otherwise, there is universal use of the dollar. There are, hence, advantages of having an anchor currency which is believed in and held by all other nations.

The main issue with having an anchor currency is that there should be enough money in circulation that can be held by central banks. This would essentially be government bonds, or treasuries, as they are called in the USA. For this, the government has to keep running high deficits so that such bonds are issued on a continuous basis. In case the USA hypothetically runs surpluses, there would be no new debt and, hence, the asset would no longer be available to other countries, which would have to look for alternatives. Therefore, ‘benign neglect’ of deficits is required, which also means that the USA can run a high current account deficit, which enables the global economy to accelerate.

The risk is that having high deficits can spur high inflation in the country, which will call for more restrictive monetary policy. This will also require forex intervention, as the currency comes under pressure due to volatile capital flows. Therefore, having an anchor currency does put pressure on central banks.

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There have been talks of having a BRICS currency. However, the main challenge is to choose an acceptable currency. The group is united more in political ideology but not on economic grounds. It is largely felt that the yuan is a managed currency and hence will not be acceptable to others. Countries have been working to settle trade deals in their own domestic currencies. But this would not work, as there is always a deficit that one nation has with the other, and hence the country with a surplus will not accept more local currency from the partner unless it can be used to buy goods from a third country. A way out is for various groups of countries to agree to trade in each other’s currencies to the extent that they can and use dollars or any other reserve currency for the residual transactions. This will reduce the demand for dollars for certain in the market and, hence, lower such holdings as reserves over a period of time.

This is why there is a virtual oligopolistic dominance in the currency market. One thought that has been expressed is having cryptocurrency as a reserve currency. But this will never work, as it is a private currency, which is considered illegal in many countries and has little acceptability at the central bank level. Stable coins tend to get linked mainly to the dollar and also would not work. Therefore, the dollar will stay strong for longer.

The author is Chief Economist, Bank of Baroda and author of ‘Corporate Quirks: The Darker Side of the Sun’. Views are personal.

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