Here’s the hard-hitting fact, investors are beginning to lose confidence in the US dollar, and this could be a source of global instability.
According to the International Monetary Fund (IMF), the share of countries’ foreign exchange reserves held in US dollars is in structural decline. The dollar’s dominance in global forex reserves has slipped from 72% in 2010 to around 58% in 2023. Meanwhile, the Chinese renminbi, which had a 0% share in global payments in 2010, now holds 4.3% of the market as of 2023, even overtaking the Japanese yen, per the US Federal Reserve. Developments like India importing oil from Russia in local currency and China expanding trade payments in renminbi further indicate a shift.
So, what’s the cause of this trend?
Nassim Nicholas Taleb, a statistician and former options trader, claims the biggest mistake of the 21st century was the US confiscating Russia’s dollar assets. This event accelerated the de-dollarisation process, a global movement to reduce the use of the US dollar in world trade, financial transactions, and as a storage of reserves through US debt.
The Impact on Global Trade
China, like many other nations, has been reducing its holdings of US Treasury securities. Back in 2013, China held USD 1.3 trillion worth of US securities, but by mid-2024, this had dropped to USD 780.2 billion. Since April 2022, China has held less than USD 1 trillion in US Treasury bonds, despite being the second-largest holder of US debt. This declining international demand for US debt presents a significant challenge for the US, as it needs foreign buyers to support its ballooning borrowings.
As foreign demand wanes, the yields on US debt could rise once the Federal Reserve finishes cutting rates. Adding to this complexity, US Presidential candidate Donald Trump has indicated that the dollar is too strong, and a new administration could push for a devaluation to boost local manufacturing.
What’s Really Happening?
Globally, countries are using the dollar for transactions but are less keen on storing it. While the dollar remains the leader in global trade, its status as the world’s reserve currency is facing slow, steady erosion. This brings into question whether the dollar’s long-standing position as the backbone of the global financial system will endure.
Emerging market central banks, including India’s Reserve Bank (RBI), are increasingly turning to gold as a way to diversify their reserves and move away from a USD-led system. Central banks’ gold holdings, which had been declining until 2009, reversed course and have risen steadily since then. Global central banks now collectively hold more than 35,000 tonnes of gold, up from under 30,000 tonnes in 2009. Central banks collectively purchased 1,136 tonnes of gold in 2022, the highest ever, followed by another 1,037 tonnes in 2023.
Why Does This Matter?
The diversification away from the dollar by central banks has meant a reduction in US Treasury holdings and a steady increase in gold reserves. For instance, the RBI’s physical gold holdings rose from 618.16 tonnes in 2020 to 822.10 tonnes in March 2024.
Joyce Chang, chair of global research at JP Morgan, acknowledged this shift in an October 8 report titled, De-dollarization: Is the US dollar losing its dominance? Chang observed that while the trend of diversification away from the dollar is growing, the structural factors that support the dollar’s dominance are still firmly in place. However, as global powers form new trading blocs, particularly in the aftermath of Russia’s invasion of Ukraine and the intensifying US-China competition, the narrative of a declining dollar has gained momentum.
Countries Moving Away from the Dollar
Alongside Russia, China, the world’s largest trading economy, is leading the charge in seeking alternatives to the dollar. China has been steadily cutting its holdings of US debt securities, increasing its gold reserves, and taking significant steps to internationalize the renminbi (RMB). These efforts aim to reduce the dollar’s dominance in the global financial system, moving toward a more multipolar currency environment. Notably, in 2023, the renminbi overtook the dollar as China’s most used cross-border currency, with a large part of the boost coming from trading with Russia in local currencies.
China’s Cross-Border Interbank Payment System (CIPS) has grown rapidly, now including 142 direct and 1,394 indirect participants. Designed partly as a rival to SWIFT’s messaging system and dollar-based settlement mechanisms, CIPS is seen as a strategic tool in China’s efforts to reduce reliance on the dollar.
Global Views
According to The Atlantic Council’s Dollar Dominance Monitor, “The renminbi displaced the dollar as Russia’s most traded currency in 2023, while renminbi and gold have become Russia’s primary reserve assets. Russia and China have established a currency-swap instrument with a daily cap of 10 billion renminbi, rising to 20 billion renminbi on the first and last two trading days of each month.”
However, the Chinese renminbi’s rise to global prominence is still far from guaranteed. Bastian von Beschwitz, chief of the global financial markets section at the US Federal Reserve, wrote in an August 2024 paper titled Internationalization of the Chinese Renminbi: Progress and Outlook: “At a daily usage of about USD 60 billion, the volume of payments processed by CIPS is dwarfed by the USD 1,800 billion payments processed each day by the Clearing House Interbank Payments System (CHIPS), which is the main method of settling large US dollar transactions.”
Bastian concluded that, absent large-scale political or economic changes that damage trust in the US dollar, the renminbi is unlikely to rival the dollar as the dominant global currency in the foreseeable future.
At the recent BRICS summit in Kazan, Russia—where Prime Minister Narendra Modi was in attendance—there were discussions about developing a new global payment system to serve as an alternative to dollar-dominated systems. China is also involved in the Bank for International Settlements (BIS)-backed Project mBridge, a multi-central bank digital currency platform. This platform connects central and commercial banks across China, Hong Kong, Thailand, the United Arab Emirates, and Saudi Arabia, without depending on the dollar. As of June 2024, the project has reached the minimum viable product stage, according to a BIS update.
Is the Dollar Losing Its Sheen?
With these developments, one can argue that the dollar is slowly losing its grip on global financial dominance. The increasing use of the renminbi, the diversification into gold by countries like Russia and China, and initiatives like Project mBridge suggest that alternatives to the US dollar are steadily emerging. While the dollar remains the dominant global currency for now, the push towards a more diversified and multipolar currency system is gaining momentum.
Hence, while the dollar may still reign supreme in global trade for now, there’s no denying the slow and steady decline in its status as a global reserve currency. With central banks diversifying their reserves, particularly through increased gold holdings, and major nations like China reducing their reliance on US debt, the global financial system could be in for a significant shake-up.
Whether the dollar’s dominance is truly fading or just evolving, one thing is clear, there could be a new challenger on the scene very soon.
