The de-dollarization of the global financial system will continue. This will be facilitated primarily by the development of technology in the financial sector. In the future, the digital currencies of central banks can also be used for international transactions, reducing costs for economic agents. However, this is a rather slow process; one should not expect a decisive change in the global financial system in the foreseeable future, writes Marcel Salikhov.
The US dollar has long been the dominant world currency. Its use in international transactions has for many decades significantly exceeded the share of the United States in the world economy, which now stands at about 24%. For example, according to the IMF, the share of the dollar in the international reserves of central banks, distributed by currency, was 58.4% at the end 2022. According to SWIFT, the share of the dollar in interbank transfers in April 2023 was 59.7%, having increased significantly compared to last year.
The active use of the US dollar even in transactions between third countries is facilitated by several factors: the size of the American economy, the largest and most liquid market for financial instruments, including reliable ones, political influence, and the role of American multinational companies in global markets. All these factors work together and have supported each other for a long time. In particular, the global financial crisis of 2008/2009, the primary source of which was the US economy itself, did not affect the position of the US dollar in the global economy.
However, the blocking of the reserves of the Bank of Russia by Western countries, coupled with large-scale financial sanctions against Russian banks and companies, have raised the question of whether the advantages of dollarization can be offset. The non-economic risks of US dollar transactions and dollar-denominated assets have become apparent to everyone, especially to central banks. In particular, Article 21 of the 2004 UN Convention on Jurisdictional Immunities of States and Their Property guarantees the immunity of central bank assets. However, this did not protect the assets of the Bank of Russia from being frozen, which became a precedent for all countries.
Russia’s actions under these conditions were expected and understandable. Starting in early 2023, the Central Bank began to conduct operations, within the framework of fiscal rules, in Chinese yuan. Russian companies are restructuring foreign trade operations and the accumulation of foreign assets in favour of the predominant use of the currencies of friendly countries.
At the same time, the current data does not show a massive abandonment of the use of the US dollar by the central banks of other countries. The share of the American currency in international reserves has been steadily declining over the past decades, but this has been happening quite slowly. If in the early 2000s about 70% of the reserves of the world’s central banks were in US dollars, since 2020 it has been below 60%. There was no drastic reduction in US dollar reserves in 2022. Its share in reserves fell by 0.44 percentage points, while its share in interbank transfers even increased.
Are there alternatives to the dollar?
The main reason for such rigidity in the seemingly understandable increased political risks is the lack of serious alternatives that can absorb significant amounts of savings from central banks.
The traditional role of foreign exchange reserves, both for private agents and for the state, is to ensure financial stability and diversify risks. Central bank reserves, which are comprised of low-risk bonds and gold, are one possible tool that fulfils such goals. They have high liquidity and can be used quickly for foreign exchange interventions if necessary. The downside is the high transparency of such assets in terms of the imposition of sanctions and low profitability.
The eurozone government securities market is fragmented due to the number of individual countries, many of which have low credit ratings. The Chinese yuan is not a freely convertible currency and is divided into internal (onshore) and external (offshore) parts, which are tightly controlled by the National Bank of China. Gold as an asset can be a good hedge in times of crisis, but it does not bring any interest income and has low liquidity. Therefore, for the central banks of developing countries, it is far from obvious what assets and what currency can serve as an alternative to those assets that are stored in US dollars.
Looking beyond gold and foreign exchange reserves to store value
A more important factor than the nominal share of the US dollar in international reserves is the change in approaches to the management and formation of external assets. The same IMF data show that over the past 10 years, the total value of central bank reserves has remained virtually unchanged and remains at the level of $11.5-12.0 trillion, even given the growth of the global economy. China’s foreign exchange reserves peaked at $4 trillion in 2014 and have been declining ever since. The current value is $3.2 trillion, which is 20% less than in 2014. Many other developing countries are, if not reducing, at least not building up their international reserves.
However, this does not mean that external assets are not being formed. They can also take other “non-standard” forms – the assets of wealth funds, state banks and development institutions, as well as other structures that are not directly related to central banks. The direct foreign investments of state structures can also be seen as a form of reserve assets. Such a strategy does not aim to ensure the maximum availability and liquidity of such assets, but makes it possible to ensure their own economic interests in foreign markets. To some extent, it provides more protection against the political risks of blocking assets, since their legal status is less transparent.
A similar strategy is followed by China, which seeks the gradual “internationalisation” of the yuan. Formally, the share of the yuan in the international reserves of central banks is small and amounts to no more than 3%. Moreover, between a third and half of this demand is provided by the Bank of Russia.
China’s strategy is to secure the international status of the yuan through foreign trade rather than investment. In recent years, China has been actively trying to motivate and encourage its partners to trade in yuan rather than other currencies. This is done through various channels, including through the development of infrastructure, its own analogue of the SWIFT system, the development of clearing, international lending in yuan, and so on. Many have heard about the “petroyuan” – a kind of analogue of the petrodollar. In fact, we are talking about the conclusion of long-term contracts for the supply of oil in yuan, in exchange for a counter flow of goods and equipment. Thus, trade is already carried out in yuan, and not in US dollars. This creates demand for the yuan outside of China’s economy. At the same time, the Chinese authorities maintain restrictions on capital transactions.
The de-dollarization of the global financial system will continue. This will be facilitated primarily by the development of technology in the financial sector. The development of automated trading platforms helps to reduce the cost of exchanging one currency for another. Central banks will seek to conduct direct clearing with each other, not directly using the currencies of developed countries. In the future, the digital currencies of central banks can also be used for international transactions, reducing costs for economic agents. However, this is a rather slow process; one should not expect a decisive change in the global financial system in the foreseeable future.