De-dollarisation: the race to attain the status of global reserve currency

Context

Countries have tried to dethrone the dollar as the global reserve currency for many decades now for various reasons. But of late, attempts to de-dollarise have picked up pace in the aftermath of Russia’s invasion of Ukraine last year.

What is ‘reserve currency’?

A reserve currency refers to any currency that is widely used in cross-border transactions and is commonly held as reserves by central banks.
- It is the currencies of economic superpowers that have usually ended up being used as the global reserve currency.

De-dollarisation refers to the replacement of the U.S. dollar with other currencies as the global reserve currency.

What are the advantages of reserve currency?

Power over transactions: Since international transactions carried out in the U.S. dollar are cleared by American banks, this gives the U.S. government significant power to oversee and control these transactions.
Privileges over others: The global reserve currency status gives it unfair privileges over other countries.
Irresponsible expansion of money: When a country’s fiat currency enjoys reserve currency status, it gives the country the power to purchase goods and other assets from the rest of the world by simply creating fresh currency out of thin air.

What gives the US dollar the power in international trade?

The U.S. dollar is not forced on anyone to be accepted as a medium of exchange for cross-border transactions.
It is widely used in international transactions because people actually prefer to use American currency over others for various economic reasons.
Other currencies that have tried to compete against the U.S. dollar are not as popular as the greenback for carrying out international transactions.
The global acceptability of the U.S. dollar has primarily been attributed to the
- the popularity of U.S. assets among investors
- high level of trust of global investors in the US

Example

India and Russia recently attempted to carry out trade between the two countries in Indian rupees rather than in U.S. dollars.
However, it hit a roadblock because the value of India’s imports from Russia far outweighs its exports to the country.
This left Russia with excess rupees in hand which it was unwilling to spend on Indian goods or assets, and led to Russian demands for the settlement of bilateral trade in U.S. dollars.
So, even Russia, a long-time friend of India and a long-time foe of the United States, preferred to carry out its trade with India using U.S. dollars since the dollar is far more widely accepted than the Indian rupee.

Why was the call for de-dollarisation renewed?

The profound economic disruption experienced by Iran, and more recently Russia(for invading Ukraine), after being disconnected from international dollar-trading systems like SWIFT, prompted smaller countries to look for alternatives.

Who can be the next?

Currently, the Chinese Yuan is seen as the primary alternative to the U.S. dollar owing to China’s rising economic power.
Many countries like Russia, Brazil, and Argentina are increasingly exploring the use of the CNY.
Beijing is now settling most of its international trade operations using the Chinese yuan.

How would it impact (if becomes reality)?

The positive side
De-dollarization can benefit local economies in a number of ways.
Trading in local currencies allows exporters and importers to balance risks, have more options to invest, to have more certainty about the revenues and sales.
The negative side
De-Dollarisation could potentially undermine the economic power of the US, but it also presents challenges and potential costs for developing countries.
Moving away from an established currency like the dollar will impact a country's networking effect and create substantial barriers.
- The US dollar is the cheapest means of access to acquire nominally risk-free US Treasury instruments.