USA DOLLAR'S GOVERNANCE IS OVER?

BY CA A. K. JAIN

Two events in the past few weeks point to a change in the global balance of power. The first was the peace deal in Beijing between once sworn enemies Iran and Saudi Arabia, where China played peacemaker. Considering that Iran and Saudi Arabia have been at each other's throats for decades, this was quite a diplomatic achievement for Xi Jinping.

The second event was the recent meeting between Xi and Putin in Moscow. These two leaders have met one-on-one 40 times in the last ten years, which is a record for both. Putin says that Xi is the only world leader he has celebrated his birthday with, and calls him “his best and bosom friend”.

This has left the US feeling insecure, and trying hard to reassert its dominance.China is increasingly a challenge for the US. China’s rising economic power speaks for itself – the country’s GDP in PPP (purchasing power parity) terms is already 25% larger than the US, according to the IMF.

Geopolitics, inflation, China’s global ambitions and rising interest rates in the US are now threatening the dominance of the US dollar.

In 1944, the US dollar became the world's official reserve currency, after 44 allied countries signed the Bretton Woods agreement. However, major economies are increasingly concerned about American dominance over the global financial system, and its willingness to weaponize it.

As a result, countries are trying to reduce their reliance on the dollar as their reserve currency. 'De-dollarisation' is the talk of the town. US dollar in the line of fire, but far from being dethroned .The United States in the role of the global police is nothing new. Before Russia, Iran was Villain No.1 and the most sanctioned nation by the US, due to its efforts to develop a nuclear weapon. The dollar’s dominance in international trade allows the US to crack the whip on ‘rogue’ nations. American sanctions can cut these countries off from international finance systems, trade and funding. Take the case of Russia. After it invaded Ukraine, the US cut off top Russian banks from the international SWIFT payment system and froze the dollar-denominated reserves of the Russian Central Bank. These two strikes left Russia unable to pay for its energy imports, settle its financial debts and support its currency from depreciating.

The US move to freeze $300 billion of Russia's reserves startled many, and had other countries looking uneasily at their own dollar savings.The dollar is dominant, but losing market share .The market share of the US dollar in the world's forex reserves fell to nearly 58.4% in Q4-2022 from 61.85% in Q1-2020, although it is still the dominant reserve currency. Its market share was around 71% in 2001. In the past 12 quarters, the Chinese renminbi (yuan), Canadian dollar, pound sterling and Australian dollar have gained market share at the expense of the US dollar.

The Chinese yuan has gained the most share from the US dollar, despite being only partially convertible. Reports are abuzz that the BRICS nations (Brazil, Russia, India, China and South Africa) may decide on a common reserve currency in their upcoming summit. But there are practical difficulties here. For one, the yuan is the dominant currency in this group, but it’s subject to heavy-handed capital controls by the Chinese government, and the People’s Bank of China limits yuan outflows. This self-goal hurts the ability of international investors to use the yuan in global trade. Another concern for BRICS is the ongoing Indo-Chinese border tensions.

But, why are countries so focused on dethroning the dollar? Well, there are considerations other than the usual US sanctions.

The US Fed's hawkish stance has had ripple effects across the globe. A rise in US interest rates starting early 2022 made US Treasuries an attractive investment, leading to capital flows into the United States and a stronger dollar.

Emerging market currencies, on the other hand, lost value, sinking to fresh lows. The dollar’s strength impacted nations with high foreign debt, which is dollar-denominated. As the dollar rose, Sri Lanka defaulted, while Pakistan and Egypt knocked on the doors of the IMF for financial assistance.

During this time, the world was already grappling with high inflation due to the Russia-Ukraine war. A stronger dollar made inflation worse, as imports of many commodities, which are paid for in dollars, became even more expensive. This forced EMs like India to sell dollars in the open market to protect the value of the rupee.

Crude oil crossed the $100/bbl mark in Feb-2022. As a result, countries like India and China, among the top importers of crude petroleum, not only paid for expensive oil but also for the appreciation of the dollar, a double whammy.

But then the tide turned with India and China increasing their Russian oil imports. India settled this oil trade in UAE dirhams and roubles, while China settled it in yuan.

Fear of losing out to Russia has caused Middle Eastern oil exporters to start thinking of alternatives to the dollar. “There are no issues with how we settle our trade, whether it is in US dollar, euro, or Saudi riyal,” Mohammed Al-Jadaan, Finance Minister of Saudi Arabia, said in January 2023. Essentially, Russia’s emergence as a dollar pariah sped up the shift to other currencies for international trade and transactions.

Central Banks like the RBI are buying gold as a hedge against the dollar. Countries like India are trying to trade in their own currencies, and buying gold as a hedge against the dollar.

However, this attempt to trade in its own currency is futile, as countries like Russia are net exporters to India and the Russian central bank can’t just pile up INR with nowhere to spend it.

RBI has bought 43.6 tonnes of gold since the start of CY22, an increase of 5.86%. Gold as a percentage of total reserves has gone up from 6.5% at the start of CY21 to 8.1% at CY22-end.

Other central banks have done the same. In CY22, central banks bought 1,126 tonnes of gold, which accounted for 24% of the global gold demand. It’s the highest since 1950. Chinese yuan is emerging as a dollar contender, but has a long way to go .China and Russia have been at the forefront of the de-dollarisation campaign since 2014. Since the Ukraine invasion, the yuan has replaced the dollar as the most traded currency in Russia.

The recent global uncertainty has given Xi Jinping the chance to push for the internationalization of the yuan. But while the yuan has gained market share in global trade finance since Jan 2021, it still has a long way to catch up.

A key reason for the yuan's slow progress is that it is pegged to the US dollar, which makes it more controlled and less attractive for countries trading with China. Developed economies, on the other hand, have floating exchange rates determined by market forces.

And although the yuan has gained market share, the US dollar and euro are still the dominant currencies in global payments and unlike reserves, have gained market share here post-January 2021. The gains may be on account of a stronger dollar, but still, the Chinese yuan has a lot of ground to cover.

The world has come to terms with the dangers of a single dominant currency. The USD continues to hold on to its numero uno position, but change is in the air: a shake-up in the old order has begun, with the rise of rival powers.
 

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Author : CA A. K. Jain is a practicing Chartered Accountant at New Delhi for
more then 30 years. www.tjaindia.com, e-mail : caindia@hotmail.com