The U.S. dollar plays an important role in the global economy, not only as a means of payment to support international trade, but also as an important option for value storage. However, this status of the dollar is not innate. After the severe impact of World War II on global supply and demand, the US dollar gained significant holdings with its stable exchange rate with gold. Subsequently, the United States and the Organization of the Petroleum Exporting Countries reached an agreement to use the us dollar as the sole settlement currency for oil transactions, and the US dollar completed the replacement of the pound's status.
The international status of the dollar will not remain static. The main reason governments, businesses and individuals hold dollar assets comes from trust and confidence in the Fed. If this confidence is hit and credit is damaged, the value represented by the dollar is expected to depreciate.
In 2020, some scholars proposed that the dominance of the us dollar far exceeds the proportion of the United States in global trade, bond issuance, and cross-border lending. Despite the dollar's importance in the international monetary system, much of its dominance stems from the lack of alternative currencies. If other currencies can provide sufficient investment grade government bonds to ensure investment security, this advantage may change with the international environment and situation.
The International Monetary Fund's (IMF) Official Foreign Exchange Reserve Currency Composition (COFER) survey shows that the dollar is declining in the composition of international reserve currencies of governments. From 1999 to 2021, the share of central banks' dollar reserves fell from 71 percent to 59 percent, a drop of 12 percentage points. The IMF notes that while the dollar share is declining, the share of non-traditional reserve currencies other than the dollar, euro, pound and yen has risen almost negligibly from the beginning of the 21st century to 10% in 2021 (worth about $1.2 trillion). A quarter of the dollar's declining share shifted to the renminbi and three-quarters to other non-traditional reserve currencies. Official foreign exchange reserves reflect central banks' security concerns about assets that assume the role of "lender of last resort" and represent their judgments about the future value of various types of assets.
Globally, the decline in the dollar's share of central banks' official foreign exchange reserves is due to two main reasons.
First, the structural evolution of global economic and trade has changed the supply and demand relationship of the US dollar. As a means of international payment, the US dollar plays an important role in international trade. But after a currency leaves the issuing country, its value and acceptance are likely to change even more. Between 1999 and 2021, global trade in dollar terms increased from 35 percent to 45 percent, but the global share of U.S. imports continued to decline from 22 percent to 15 percent. In general, as the native supplier of the dollar, the United States exports dollars to the world through trade imports, and dollar holders use dollars to trade with each other. At market exchange rates, the U.S. economy's share of the global economy fell from 32 percent in 2002 to 25 percent in 2021 (down from 22 percent in 2014), while its share in purchasing power parity terms fell from 21 percent to 17 percent over the same period. The impact of trade relations on the use of currencies is clear, and some countries may use more currencies issued by the central banks of neighboring countries to meet trade needs. Namibia, for example, holds a large number of South African rands, while Kazakhstan and Kyrgyzstan hold a significant share of the Russian ruble. Empirical analysis shows that when the global share of a country's economy shows a downward trend, the structure of money supply and demand serving trading activities may react and adjust. The continuous decline in the proportion of the US economy in the world has exacerbated the contradiction between the supply and demand of the US dollar and the imbalance in the development of the economic market, which has increased the expectation of reducing the use of the US dollar.
The weakening of demand for the dollar, such as financial investment, occurred earlier than in real economic activities such as trade. Developed countries and a growing number of emerging economies have borrowed less and less dollar debt over the past 20 years, forcing their central banks to hold dollar reserves, thereby reducing financial demand for the dollar.
Second, the United States' abuse of dollar hegemony has reduced the attractiveness of the dollar. Essentially, the dollar is a symbol of value guaranteed by the U.S. government and central banks, and its value depends largely on the confidence of the market. But the U.S. government has repeatedly used the dollar as a tool to achieve its political goals. In 2001, the U.S. Treasury Department gained the right to control and act on the Information And Actions of the Global Institute for Interbank Financial Telecommunication (SWIFT) for tracking the financing of terrorist organizations. During the Trump era, after the United States unilaterally withdrew from the Iran nuclear deal, it demanded that Iranian financial institutions be disqualified from using SWIFT and used the US dollar as a tool to pressure the global market. In this regard, the EU, as the seat and regulator of SWIFT, has no say. Britain, France and Germany established INSTEX, a non-dollar cross-border settlement system, to protect EU companies from US sanctions. After the outbreak of the Russian-Ukrainian conflict, the United States once again used the dollar hegemony to pressure Russia, excluding some Russian financial institutions from SWIFT, and using the dollar trading system as a tool to pressure countries to stop trade with Russia. Among them, Russia's advantageous energy has become the focus of pressure from the United States, which uses the US dollar as a tool to suppress Russian energy exports, while trying to create a market for its own energy exports.
Driven by both economic interests and security considerations, the process of de-dollarization has accelerated. In order to ensure its energy supply, India has stepped up its oil imports from Russia and promoted the establishment of an Inr rupee-Russian ruble local currency trade mechanism with Russia to support its trade needs and avoid US sanctions. The abuse of its dollar hegemony by the United States has made many countries feel real pressure and have to bear higher trade costs. Even if it is impossible to get rid of the dollar in the short term, it has begun to increase the holding and use of non-dollar currencies. Due to the stable nature of the reserve structure and market trends, once preferences and trends are adjusted, they will have a lasting impact over a longer period of time.
White House Photo by Xinhua News Agency reporter Liu Jie
Innovation is an important driving force for economic development, and the financial sector is an innovative and active field, which has a direct impact on the supply and demand relationship of the US dollar in international economic and trade activities. The obvious differences in the global economic and trade structure and the structure of currency use have stimulated the demand for financial innovation, and the increase in the use of non-traditional reserve currencies, including the renminbi, has also given market players more choices. The international energy market offers new ideas, and Saudi Arabia and China have negotiated the use of renminbi payments for oil trade, which is also conducive to reducing the value risk of the single currency. The low-carbon economy has gained a broader space for development, and the substitution of renewable energy for traditional fossil energy has increased significantly, reducing the dependence of various regions on energy imports, and helping to change the traditional path and model of the US dollar affecting the global economy through commodity markets. With the advancement of technology, international financial transaction methods are accelerating innovation and upgrading, information technology and blockchain and other innovations have greatly reduced the management costs of cross-border capital flows, but also increased the share of non-bank financial institutions in the global financial market, these institutions rely on SWIFT, a centralized clearing network, significantly reduced, but also make countries in the face of the United States abuse of dollar hegemony, the possibility of achieving the goal of de-dollarization significantly increased.
Of course, Rome was not built in a day, and de-dollarization cannot be completed in the short term, during which there will be adjustments and iterations due to the policies and market changes of the US government. During the Fed's rate hike cycle, investors' willingness to overweight dollar assets may increase. In order to protect its economic influence and enjoy seigniorage, the US government will not sit idly by while the dollar declines. At the beginning of the formation of the euro in 1999, it was considered to have the potential to challenge the dollar, but under the active intervention of the United States and the impact of the international financial crisis, the vitality and attractiveness of the euro were significantly weakened. The United States will also take action against other economies that challenge the dollar's status. In the long run, the size of the US economy and the size of trade will remain ahead, and the number and types of financial products denominated in dollar terms and service dollars will still have an absolute advantage, thus playing a role in slowing down the decline in the status of the US dollar to a certain extent.
Source: China Economic Network