Think.Nxt: Do China's Economy, Russia-Ukraine War Pose a Threat to US Dollar?
What if the US dollar is no longer the world’s reserve currency, what does it mean for the global economy and India?
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In this episode of Think.Nxt, The Quint’s Editor-in-Chief Raghav Bahl delves into an emerging trend in the global economy called de-dollarisation – or moving away from the dollar as a reserve currency. He dissects the issue by talking about:
How the dollar started dominating global trade
Russia and China’s slo-mo economic divorce from the US dollar
The impact of the said phenomenon on India’s economy
He is joined in this discussion by Sachchidanand Shukla, Chief Economist at the Mahindra Group and former NITI Aayog member, and David Dollar, a Senior Fellow at the John L Thornton China Center of the Brookings Institution and former country director for China and Mongolia in the East Asia and Pacific Region for World Bank.
According to Dollar, the dollar had become the dominant currency of the world essentially during World War II when most countries chose to hold reserves in the dollar, because at that time, the US was 50 percent of the world economy and one of the few places with functioning capital markets.
While he suggests that the development of the offshore markets in the 1970s solidified the role of the dollar, Shukla is of the view that the importance of the dollar isn't only because it comprises a significant part of any forex transaction.
"There is another way to look at the dollar's prominence, and that is the private side of how international trade takes place. I mean private players, corporations, banks, etc. And this is where I think the dollar reigns supreme,” Shukla remarks.
He explains that although the dollar as reserve currency is slipping by 1-1.5 percent every year – the share of the dollar as global currency reserves has fallen from 66 percent in 2014 to 60 percent in 2022 – yet it is “irreplaceable” as far as acceptance from private players is concerned.
Did China’s Emergence as a Powerful Economy Pose a Threat to the Dollar?
Dollar argues that although China is an important factor, its currency – the yuan – has a share of less than 3 percent in global reserves at the moment. He adds that the role of the dollar is not just linked to the size of the US economy, but also some institutional characteristics of the US – such as good property rights, open capital market, and flexible exchange rates – which give it an edge over China.
“There's about $12 trillion of foreign currency reserves globally. So, ask yourself, where do you put $12 trillion? Well, the world puts most of it in US capital markets because they are deep, reliable, and transparent. You can move money in and out. The problem with China is it's very hard to move money in and out of China,” Dollar says.
He further explains that even though countries like Saudi Arabia can make deals with China, it is very hard for corporations and private players to move money in and out of China, and that it even stands that risk of being expropriated because absence of rule of law.
“China needs a lot of institutional reform to complement the fact that it's the big trader. And later in this century, it may very well emerge as an important reserve currency, but not yet,” Dollar asserts.
Shukla adds that in the 1990s and early 2000s, the “dramatic underperformance” of the euro as a replacement to the dollar and the sheer dominance of China in terms of trade – it became the biggest trading partner after the US for almost every important economy in the world – started the move away from the US dollar.
Could Russia’s Invasion of Ukraine Expedite De-dollarisation?
Describing Russia as “a significant player outside the dollar,” Bahl says that the country has faced economic sanctions from the West on many occasions – first in 2014-15, when it invaded Crimea, and now after the Ukraine war. To evade these sanctions, Russia has piggybacked on its vast oil reserves – and the fact that it has friends across a very surprising spectrum.
“I mean, Russia’s got friends in the anti-American camp – China, Syria, Iran, Venezuela, Cuba. But then it also has trading friends, at least, in the pro-American camp and India and Japan, I would wager, belong to that category. So, we are now seeing a very unusual coalition which has come into play because of the Ukraine war and Russia's vast oil reserves, and Russia's insistence on trading outside the dollar, which may be the second serious challenge to the dollar,” Bahl affirms.
Disagreeing with Bahl on this, Dollar says that even though Russia is an important geo-strategic player, it is not as important an economic player globally. He adds that the world is now moving away from oil and gas to bring climate change under control – and Russia could not bank on its reserves for too long.
On being probed by Bahl over the coalition of significant economies – all allies of Russia – moving away from the dollar, Dollar explains, “I just think China is the leader of that faction, frankly. Russia is the junior partner in the friendship with China, which is a serious, complete economy, but with a lot of institutional weaknesses that I mentioned. Now, India is going to be an important part of the world economy.”
Shukla, too, says that Russia has triggered the move away from dollar, especially among its allies which are symptomatic of a display of diplomatic and economic autonomy. But, he points out, Russians do not have the economic or political heft going forward to expedite de-dollarisation.
It’s a Complicated World
Even as China seems to lead a coalition of nations to trade outside the US dollar, it has over $2 trillion in US dollar reserves, its currency is spent to the dollar and its markets – largely linked via Hong Kong – are also suggestive of dollar flows.
“Basically, China is very tightly integrated with the US economy and the global economy. So, it's a complicated world. I don't see Russia is that integrated into the global economy other than being a supplier of oil and gas,” Dollar remarks.
Shukla agrees that while China and Russia have triggered a move away from the dollar, it has its limitations.
“The dollar cemented its position via the petrodollar arrangement in the 1970s. What the US has been able to do is that it has built up a large net liability to the rest of the world, which is $13-14 odd trillion. And foreigners now own about $40-43 trillion of US assets. So, if the dollar loses, it is the holders of the dollar who are losing out,” Shukla elucidates.
Pointing out that there is a decline in the share of the US dollar as global reserve currency, Bahl states that China is picking up almost a quarter of the dollar’s loss, but the remaining 75 percent of that loss is going to many smaller currencies. Shukla agrees and says this could lead to internationalisation of smaller currencies such as the INR (Indian rupee), giving way to a multipolar world.
China’s Friendship With Saudi Arabia a Cause of Concern?
Drawing attention to the emerging equation between China and Saudi Arabia, Bahl claims, “China is trying to woo the Saudis. China is the biggest importer of oil from the Saudis today. Now, China is trying to get the Saudis to agree to invoicing their imports of Saudi oil in the yuan instead of the dollar. Will that be a really big impact?”
Given that the US dollar cemented its position via the petrodollar arrangement in the 1970s, Shukla says this arrangement between China and Saudi could trigger a big move. However, with the world moving away from fossil fuels, the sustainability of the China-Saudi equation to trade oil in yuan instead of dollars could be questionable.
To add to this, Dollar says that even if the Saudis agree to trade oil in the Chinese yuan, private firms in global markets would not agree to trade outside the dollar.
"Your typical private firm is not going to want to be paid in the yuan, because what do you do with it? Maybe you're going to need it in 90 days. So, where do you put it? Well, you can't put it into a 90-day market in China. You can't move it in and out easily,” Dollar remarks.
He affirms that the holding of the Chinese yuan as global reserves remains miniscule but smaller currencies such as the Swiss franc or the Australian dollar are witnessing a rise in their share.
Stable Diversification of Smaller Currencies
Dollar and Shukla both agree that the US is undermining the advantages of the dollar – by overdoing economic sanctions and by becoming the “single-largest source of policy accidents” – and by doing so, accelerate the process of de-dollarisation.
Shukla also points out a stable diversification of global reserves with the Indian rupee, Swiss franc, Aussie dollar or the Canadian dollar gaining significance, albeit very slowly.
“It's no more a single-trick pony. It's not about the dollar, the euro or even the yuan. What we are seeing is there is a stabilising diversification towards a mix of currencies,” Shukla remarks.
Bahl concludes by saying that de-dollarisation is inevitable but there is a threshold beyond which the dollar will continue to be supreme.
“This is because of the inherent advantages of seamless convertibility, rule of law, governance, and also the fact that exchange mechanisms among a basket of currencies do need the dollar to give it a scientific conversion,” he says.
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