Since the Bretton Woods Agreement was established in 1944, the US dollar has dominated international trade and financial sectors.
When a nation starts to accept the U.S. dollar as legal money in addition to or instead of its own currency, this is known as “dollarization.”
It typically happens when the local currency loses its usefulness as a medium of exchange for market transactions and becomes unstable. Dollarization can be advantageous and expensive. Although it inevitably leads to a loss of economic autonomy in monetary policy, it usually improves monetary and economic stability.
The dollar has long been the predominant currency in use in international trade; prices for commodities like oil, gold, and most other goods are listed in dollars. The main way that many nations hold their dollar reserves is in the form of US Treasury Securities.
De-dollarization refers to a shift from this system of global governance to one in which countries trade their US Treasury holdings for gold or other reserve assets. They simultaneously aim to conduct business with their most significant trading partners using their own currencies. Although the US dollar will probably continue to be important for some time to come, structural tendencies are beginning to lessen its significance.
Although not a recent occurrence, de-dollarization is a complicated policy. De-dollarization must be implemented successfully with a number of well-crafted economic, legislative, regulatory, budgetary, and political instruments.
Significant Global Events leading to De-Dollarization
Russia-Ukraine War
In addition to producing food and energy shortages, the Russia-Ukraine conflict has also sparked the biggest de-dollarization surge since the 2008 global financial crisis. And while Russia is spearheading the de-dollarization movement to counteract the consequences of the US-led West’s financial sanctions against it, many other nations have also stepped up their de-dollarization initiatives in response to growing worries about the United States turning the dollar into a weapon.
Since the start of the war this year and the ensuing economic sanctions against Russia, Moscow has simply accelerated this de-dollarization process even more. In order to protect the ruble after being banned from the SWIFT (Society for Worldwide Interbank Financial Telecommunication) system, which banks use to transfer money around the world, Russia first increased its benchmark interest rate to 20%, imposed additional capital controls to stop the excessive currency from leaving its borders, and mandated that all “unfriendly” countries pay only in rubles for its massive exports of fossil fuels.
China’s Emergence
The biggest danger to the dollar’s position as the world’s reserve currency may come from China’s fast-expanding global economic power.
With President Xi Jinping and Crown Prince Mohammed bin Salman’s relationship improving and China providing Saudi Arabia with billions of dollars in investment funds this year, events may soon turn in the East’s favor. And while some analysts think a full switch to yuan pricing is improbable, others think a partial switch might allow payments to Chinese contractors now working on large-scale projects inside the kingdom.
Large corporations from all over the world swarm to the US stock market to raise cash because it is a dominant economic and financial force, further extending its financial pie. However, the administration has forced numerous Chinese companies out of the US stock market by using the dollar and the financial system as weapons, which ironically has eroded the US’s position as the world’s preeminent financial power and the currency’s prestige.
The dominance of America in the world was necessary for the hegemony of the U.S. dollar. The influence and position of the dollar may be decreasing as the world shifts toward multipolarity and China overtakes the United States as the largest trading nation. The dollar may be on the decline given the growing importance of China, the European Union, and other developing nations.
Israel and Chile Initiation
Another effective example of de-dollarization is in Israel. Although there hasn’t been a conscious effort to de-dollarize the economy, since the 1990s, a deliberate policy has been conducted in this direction when deciding on the currency composition of public sector issuance in an effort to expand the market for government bonds denominated in local currencies.
The price has been greater in public sector interest payments, particularly during a time of high real interest rates. However, because the disinflation initiative was successful, costs have decreased each year.
Israel ‘nominalized’ the debt at first by indexing consumer prices, and then without any indexing at all. Israel simultaneously extended the maturity of its government debt (although there is not necessarily a trade-off between the currency of composition and the maturity of public debt).
To protect against currency rate risk, the Central Bank has actively promoted the markets for financial derivatives and other securities. Like Chile, the Bank of Israel likely pioneered inflation targeting, which grounds expectations and lessens investors’ uncertainty over assets denominated in local currencies.
The focus of Chile’s experience has been on using indexed instruments to draw investors away from assets denominated in dollars. Through the development of an accounting unit called the “Unidad de Fomento” (or “UFs”), the majority of instruments were indexed to the consumer price index (CPI).
The credibility of the UF can be used to explain the success of these tools. More importantly, Chile recognized that indexation alone is not a complete solution and that it must be accompanied by the growth of secondary financial markets for these instruments, strong legal support for the indexation unit, and uniform indexation measures. Chile was confident that it would not experience a sudden loss of value.
Finally, price stability had to be the main goal of monetary policy through inflation targeting. A definite directive to lower inflation served as evidence of that policy. The set of measures lessened macroeconomic volatility and investor uncertainty.
