The multipolarization of the global reserve currency system is accelerating. Ironically, Western sanctions against Russia have intensified the move away from the US dollar.
In late March, a team of CITI economists raised eyebrows in financial markets as they proposed that this year that “China could at least be a relative ‘safe haven’ given its growth premium, financial soundness, policy discipline and the new political economy cycle.”
Among its global peers, China is an outlier this year with its accelerated expansion, giving the country a hedge for growth while economies in the U.S. and Europe face heightened risk of financial disruptions.
At the end of April, Uday Kotak, the billionaire investor and CEO of Kotak Mahindra Bank, denounced the U.S. dollar as “the biggest financial terrorist in the world.”
Despite the expected dollar controversy, Kotak didn’t mince his words. As a billionaire investor, he sees the dollar hegemony as untenable and as lethal to America and global economic prospects overall.
In early April, the International Monetary Fund (IMF) reported that more than half of all central bank currency reserves remain held in U.S. dollars, based on data by COFER (Currency Composition of Official Foreign Exchange Reserves).
How can the world’s biggest financial terrorist continue to dominate global transactions, based on data by COFER (Currency Composition of Official Foreign Exchange Reserves)? And how can the Chinese yuan’s share in global transactions matter if more than half of all central bank currency reserves remain held in U.S. dollars, while the Chinese currency represents less than three percent of the COFER total?
U.S. banking crisis, debt-default risk
In early May, as the Federal Reserve pushed ahead with the 10th rate hike since last March, its chairman Jerome Powell declared the failures of Silicon Valley Bank, Signature Bank and First Republic Bank marked the end of the banking crisis.
In the U.S. and European banking sector, the rollercoaster ride began in early March, with three weeks of substantial volatility. Following the failures of major U.S. regional banks, one of the 30 global systemically important banks, the Switzerland-based Credit Suisse, lost its autonomy after a government-facilitated takeover by UBS. To prevent contagion, G7 and Swiss global regulators were compelled to intervene and provide liquidity.
However, structural vulnerabilities remain huge. As Mohamed El-Erian, chief economic advisor at Allianz, put it, “the cancer within [these banks] is starting to spread.” Almost 200 more banks may be vulnerable to the type of risk that caused the collapse of SVB. Presumably, 2,315 banks – almost half of the total – across the U.S. are sitting on assets worth less than their liabilities.
If the Fed’s monetary pain wasn’t enough, the Biden administration’s foreign policy has contributed to runaway inflation and elevated uncertainty. After years of trade protectionism, the global pandemic and depression, the U.S./NATO-led proxy war against Russia in Ukraine has resulted in a lethal mix of a global energy crisis and the meltdown of the global food system.
In the U.S., the banking crisis occurs at a time when the Congress has wasted half a year failing to agree on a debt limit. The U.S. hit the statutory limit already in December. Since then, Yellen has repeatedly warned that failure to address the $31.4 trillion debt limit would lead to “economic and financial catastrophe.”
Whatever the short-term stance by the Biden administration in the debt-ceiling debacle, the long-term challenges have barely begun. US government debt to GDP will soar to 133 percent by the year-end, which exceeds that of Italy amid its debt crisis in the early 2010s.
Erosion of the global dollar hegemony
In the past year, the greatest single risk to the erosion of the U.S. dollar has been the Biden administration as it has effectively weaponized the global dollar hegemony. None of these dependencies are new; but the administration’s full-scale quest to weaponize them is both new and self-destructive.
Some asset managers estimate that U.S. currency’s share of global reserves fell 10 times faster in the last year than in the previous twenty. According to Morgan Stanley’s Stephen Jen, the U.S. dollar has “suffered a stunning collapse” as a reserve currency, which accelerated after the Biden administration’s decision to exploit its dominance over the dollar-based international financial system against Russia.
Today, the U.S. dollar still represents some 55 percent of total global reserves, but that’s down from 73 percent since 2001. In Jens’s view, it fell to 47 percent of the total last year.
The process accelerated when Russia’s assets were frozen abroad and Moscow was cut off from the SWIFT, the worldwide transactions and payments system. In the West, it was seen as a concerted triumph; in the Global South, it represented the weaponization of the dollar, which intensified a search for alternative systems.
Multipolarization of the global currency system
Most economies that seek to reduce their reliance on the dollar are striving to establish an alternative economic, monetary, and global reserve currency system. This system is not necessarily a substitute to the existing regime. Rather, it is complementary to it. In the long-run, it’s not a threat to the U.S. dollar either, but a stabilizing opportunity.
Dollar hegemony remains central in the major advanced economies because most of these countries have not officially been targeted by U.S. trade wars, sanctions or more coercive forms of pressure, such as destabilization and regime change.
By contrast, at one point or another, many if not most large emerging and developing economies have been targeted, sanctioned and destabilized. That’s why they resist unwarranted pressure points, hoping to focus on economic development. The U.S. dollar will remain important to them, but alternative instruments are as vital to ensure stability, growth and rising living standards.
Since last year, Russia has been fostering its use of alternative currencies in transactions. In March, President Putin met with President Xi and called for wider use of the renminbi for trade settlement between Russia and Asian, African, and Latin American countries. Meanwhile, the yuan surpassed the U.S. dollar to become the most-used currency in China’s cross-border transactions. Indian policymakers have also taken steps towards shifting away from the dollar to rubles and rupees in mutual trade with Moscow.
US dollar as a costly, redundant intermediary
In April, Brazil’s President Lula da Silva proposed in Shanghai that the BRICS countries – Brazil, Russia, India, China, and South Africa – should look for an alternative currency to the dollar for trade.
”Every night I ask myself why all countries have to base their trade on the dollar. Why can’t we do trade based on our own currencies?” Lula said. “Who was it that decided that the dollar was the currency after the disappearance of the gold standard?”
Several other countries have expressed their interest in joining the bloc, including Argentina, Iran, Indonesia, Turkey, Saudi Arabia, and Egypt.
As Brazil and China agreed to carry out bilateral trade and financial transactions using their local currencies, the 10 member countries of the Association of Southeast Asian Nations (ASEAN) are planning to use local currencies to support cross-border trade and investment, seeking to reduce dependency on the dollar.
Progressive erosion, unless…
What we are witnessing is not an overnight effort to replace the U.S. dollar with the Chinese yuan in international transactions, but a progressive move to deploy the yuan in those transactions in which the Chinese economy plays a central role. This shift is gradual, linear and accumulative.
Thanks to sticky network effects, global currency reserves remain dominated by the U.S. dollar, which constrains the renminbi internationalization – at the moment.
However, make no mistake: The U.S. dollar is under progressive erosion that’s accelerating. And if investors lose faith in the U.S. dollar – say, due to renewed inflation risks, another unwarranted proxy war, a debt-limit debacle, or debt default – the shift away from the U.S. dollar could turn disruptive, accelerative, and exponential.
This is an update of the original commentary published by China-US Focus on May 19, 2023.
About the Author
Dr. Dan Steinbock is an internationally recognized strategist of the multipolar world and the founder of Difference Group. He has served at India, China and America Institute (US), Shanghai Institutes for International Studies (China) and the EU Center (Singapore). For more, see https://www.differencegroup.net/