De-Dollarization: When, Why and How it Will Happen

The Dollar dichotomy 

For the proverbially almighty US Dollar, it is the best of times and it is the worst of times. Under the current leadership of the US Federal Reserve the value of the Dollar has shot up due to a tightened money supply which itself has been the result of the end of the Obama era quantitative easing/stimulus schemes along with hiked interest rates. This along with rising oil prices has put pressure on currencies in so-called emerging markets (aka developing economies), thus making debt repayments in Dollars all the more burdensome for multiple nations. For US consumers, the strong Dollar has been a blessing, especially at a time when certain foreign goods are becoming more expensive due to tariffs. For US producers, a high Dollar theoretically takes its toll on exports although the overall health of the US stock market has tended to minimise such complaints for the time being.

In a normal period in international relations, a strong Dollar would necessarily be attractive to all foreign sovereign and private funds who are able to get their hands on as many greenbacks as possible while those with large Dollar reserves would theoretically be happy. This however is no ordinary time for several reasons. The decreased Dollar supply as a result of Federal Reserve tactics and the Dollar’s value becoming increasingly out of reach due to the Trump led trade war and parallel sanctions barrage has meant that for many nations, the Dollar while valuable is being viewed as unreliable. As sanctions are now an American weapon of every day use in terms of exerting pressure on foreign economies, many nations are coming to the conclusion that just because one has open access to the Dollar based banking system one day, this does not guarantee such ease of access the next day.

Furthermore, the combination of a rising Dollar and the declining value of currencies throughout the world (including the Chinese Renminbi, Indian Rupee, Turkish Lira, Iranian Rial, Philippine Peso, Argentinian Peso and many others) has made the idea of Asian and Latin American nations trading among each other in a combination of local currencies all the more attractive.

While Russia’s economy is experiencing a surge due to the increase in global oil prices, Russia remains detached from much of the Dollar based financial system due to a plethora of sanctions that have continued to pile on since 2014. It is for this reason that Russia has been a vocal champion of de-Dollarization in bilateral trade with its Asian partners including China, Iran and Turkey.

China’s strategy 

While Russia has little to lose by championing a pan-Eurasian ditching of the Dollar, for China the matter is far more nuanced. China is well aware that by the time its overall GDP eclipses that of the US (the IMF currently estimates that this will happen around the year 2040), the Renminbi will likely pivot its status to that of a primary global reserve currency. As the world’s most economically powerful nations have throughout history tended to automatically dictate that which is the global reserve currency, the perpetually strong Chinese economy will not be an exception.

However, until then, China seeks to avoid artificially pushing up the exchange rate (value) of Renminbi, not only because this would be bad for its export business but also because China is well aware of the troubles Japan got itself into by voluntarily allowing the Yen to over-appreciate after the 1985 Plaza accords. While the US today uses much the same rhetoric regarding an allegedly “undervalued” Renminbi as that which was used against Japan in the early 1980s, China does not plan to capitulate on any front, let alone in terms of caving to US pressure over the Renminbi. China has no plans to overvalue the Renminbi by allowing a free float which would likely lead to a higher value in the national currency. Likewise, China has no plans to artificially de-value the Renminbi either.

Instead, China aims for a stable national currency in order to avoid boom and bust cycles at home while also doing with the Renminbi what Japan could have never realistically done with the Yen – position itself to become the world’s future reserve currency. Furthermore, China’s managed float (which could easily be called a managed peg) of the Renminbi to other major currencies including the US Dollar, Korean Won, Japanese Yen, Euro and other less globally traded currencies will help the Renminbi to ease itself into its inevitable future position as the world’s major reserve currency.

At the same time, while not taking drastic moves to alter the value of its currency one way or another, China is working to gradually transform the Renminbi into the world’s de-facto reserve currency. As China’s overall GDP is set to overtake that of the US by 2040, as history indicates, the nation with the world’s largest economy will necessarily provide the world with it’s reserve currency. But far from siting and waiting for another forty years, China is already taking steps to entice other countries towards using its the Renminbi as a currency of bilateral international trade while the addition of Renminbi to the SDR currency basket in late 2015 has further underscored the role of China’s currency as a major player in international markets. This year’s launch of the so-called Petroyuan has further demonstrated that China is very serious about promoting its currency as an alternative to a US Dollar that while strong is increasingly volatile in terms of its reliability in international exchanges among nations targeted by sanctions and other economic pressures from Washington.

China’s oil issues 

While the increase in the price of Bent crude has benefited China’s neighbour and close partner Russia, for energy hungry China, the rise in oil prices is not a positive development, although there are some subtle silver linings. As such, there exists a clear impetus for China to more actively promote the Petroyuan denominated oil futures contracts in order to take more control over how it buys its oil from various partners including Russia, Saudi Arabia and close ally Venezuela. In particular, because Venezuela has been effectively sanctioned out of the Dollar market, the combination of rising oil prices and the Petroyuan could lead to some interesting win-win arrangements between China and its Venezuelan partner for whom rising oil prices are something of a Godsend.

In this sense, rising oil prices could help to accelerate China’s willingness and even eagerness to purchase oil in currencies other than the Dollar and as such, these agreements could easily dovetail into other de-Dollarized transactions with its primarily petro-partners. Furthermore, as Pakistan looks to take advantage of its own latent oil reserves, as an all-weather friend of Islamabad, China could become all the more vital in respect of helping to kick-start Pakistan’s petro-economy.

Furthermore, as China looks to gradually push for more global economic connectivity along its Belt and Road network in the long term, the Chinese currency will likely become the de-facto means of exchange along Belt and Road. This however remains a long term rather than immediate goal. The experience of the Eurozone in the Mediterranean has demonstrated that dangerous of rushing into any harmonisation of monetary schemes before the right pre-conditions are in place.

Slow and steady wins the race 

China is aware that because of the inflationary spirals hitting many of the currencies of its Asian partners, ditching the Dollar is by no means a panacea as China like any other country is not interested in receiving effectively worthless currencies as payment for its goods. At the same time, in terms of China’s long term geopolitical calculations, it is in Beijing’s medium and long term advantage to ween its Asian partners off the Dollar and gradually towards currency baskets in which the Renminbi has a central role.

Conclusion 

Taken in totality, while many emerging markets feel the need to rush towards de-Dollarisation, the overall pace of such a phenomenon will likely be guided by China because it is the Chinese economy which now underpins and guides the aspirations of the pro-free trade developing world. China’s currency is increasingly seen as more reliable than the Dollar for the wider world and China is well placed to take advantage of this new reality. However, because China itself is in no rush to stop receiving valuable Dollars for its goods, the pace at which this transition will take place is necessarily going to be gradual rather than rapid.

Russian President Vladimir Putin recently stated,

“It seems to me that our American partners are making a colossal strategic mistake (as they) undermine the credibility of the dollar as a universal and the only reserve currency today. They are undermining faith in it… They really are taking a saw to the branch they are sitting on”.

While the Russian President is accurately pointing out a historical truth, the branch upon which the US is sitting will not break as rapidly as some might expect – namely because the saw is made in (and hence controlled by) China.

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