De-Dollarization Will Change the World, But It’s Still a Long Way Off

Recently, many countries have been nervous about the continuing interest rate hikes by the Federal Reserve, the outflow of U.S. dollar assets and reduced foreign exchange reserves. Furthermore, earlier this year, the U.S. hit the debt ceiling, creating a crisis that made many countries concerned about America’s hegemony in the international financial system. Many of these countries are eagerly trying to find a replacement for the U.S. dollar. Increasingly more countries, ranging from Brazil to those in Southeast Asia, are calling for the use of a currency other than the dollar in trade.

Last year, the U.S. and other Western countries imposed economic sanctions on Russia because of its war with Ukraine. China and Russia were greatly displeased by this, and the central banks of both countries led the central banks of many other countries in accelerating the purchase of gold in an attempt to diversify their reserve currencies to something other than the U.S. dollar.

The long-term effects of de-dollarization can be summed up in a few points. First, de-dollarization can lead to more currency diversification. As each country reduces its dependence on the dollar, regional currency alternatives such as the euro, yen and renminbi might become more important. This may increase the use and demand of these currencies in international trade, investment portfolios and reserve holdings.

Second, de-dollarization will continually drive the development of financial products and services. Financial institutions might promote a broader range of currency hedging and investment tools and derivatives to satisfy the ever-changing demands of those in a market with diverse currencies. This could promote innovation in, and the financial deepening of, markets.

Third, de-dollarization can help strengthen global financial resilience. Diversification of currency holdings and a reduced reliance on one single dominant currency can help lower currency risk and vulnerability to global economic fluctuations, as well as increase the stability of financial systems.

Fourth, de-dollarization will prompt the financial industry to undergo regulatory adjustment. Regulatory bodies will need to revise frameworks relevant to currency exchange, capital control, risk management and cross-border transactions. This might include establishing new regulatory standards to ensure the stability, transparency and efficiency of a financial system with multiple currencies.

Fifth, de-dollarization can boost regional integration and cooperation between countries. It might reshape ally and trade relationships and economic influence, reducing reliance on the U.S. dollar. Geopolitical factors will affect the flow of capital, investments and market dynamics, and financial institutions will have to regulate and respond to a continuously changing geopolitical landscape. This could lead to establishing regional financial frameworks and currency exchange agreements and cooperative initiatives to strengthen the financial stability of the regional blocs and promote trade and investment.

Sixth, de-dollarization could produce a shift in global financial power. As the U.S. dollar’s leadership status declines, alternative economic powers or regional blocs may arise, changing the current global financial situation. Financial institutions will have to pass new, adjusted policies, expand their geographic areas and build cooperative relationships to respond to these changes and remain competitive in the changing environment.

In the past, globalization and dollarization were two factors helping maintain the dollar’s status. As these two factors undergo changes, de-globalization and de-dollarization will challenge America’s economic status. The long-term effects of de-dollarization, however, are complex, and it may take a few years or even decades for them to be fully realized. The specific outcome will depend on the speed and scale of de-dollarization efforts, the global economic situation and the reaction of stakeholders in the financial industry.

According to data from the International Monetary Fund, the U.S. dollar remains dominant in global foreign exchange reserves, accounting for 58.36% at the end of the fourth quarter of 2022. The euro outpaced other currencies, with approximately 20.5%. During the same period, the renminbi accounted for 2.7%. Regarding international settlements, according to payment data released by SWIFT, the U.S. dollar accounted for the highest proportion of payments — 41.74% — among the global payment currencies in March 2023. The second to fifth currencies, respectively, were the euro, with 32.64%; the pound, with 6.19%; the yen, with 4.78%; and the renminbi, with 2.25%. These figures were actually less than those of the previous two years.

A summary of the above data shows that even though there is a current mood and effort for de-dollarization, the hegemonic status of the U.S. dollar has yet to be shaken. For those hoping to see the dollar dethroned, it won’t happen any time soon.

The author is the chief economist of CTBC Financial Holding and chair professor in the CTBC School of Financial Management.