Newspapers reported that Chinese President Xi Jinping and Russian President Vladimir Putin pledged on Tuesday to “significantly increase” trade between their countries by 2030. In addition, President Putin threw his weight behind the broader globalisation of the Yuan, a move aimed at weakening the power of the US dollar. “We are for the use of the Chinese yuan in settlements between Russia and Asian countries, Africa, and Latin America,” Putin said, according to the RIA Novosti news service. “This practice should be further encouraged.”
The recent meetings between President Putin and President Xi regarding using the Yuan as a currency for trade in Asia, Africa and South America have raised concerns about the future of the US dollar. It’s an interesting move seen to reduce the hegemony of the US dollar and an attempt to de-weaponize it. However, I see the move in the short term as a need of the Russian Federation struggling from the sanctions to find an alternate currency and mechanism to trade.
So many articles and VLOGs exist on social media about the end of the US dollar. So, I thought about doing my assessment. Here are some points that make me believe that the decline of the US dollar will be gradual and may take decades before it loses its status as the leading global currency, if at all.
BACKGROUND
The US dollar has been the dominant reserve currency for decades, with many countries holding US dollars as a store of value and using it for international trade and finance. There are several reasons for the strength of the US dollar (USD) as a reserve currency, including:
Economic Size and Stability: The United States has the largest economy in the world (25% of the total $94 trillion global economy), and it is considered a stable and reliable economic power. It's economic size and stability have made the US dollar popular for foreign governments and central banks to hold as a reserve currency.
Political Stability: The United States has a stable political system and a long history of democratic institutions, which has helped to instil confidence in the US economy and the US dollar.
Depth and Liquidity of Financial Markets: The US financial markets, including the stock and bond markets, are among the deepest and most liquid in the world. This depth and liquidity have made it easy for foreign investors to buy and sell US dollar-denominated assets.
Global Trade Dominance: The US dollar is widely used in international trade, with many commodities priced and traded in US dollars. This has made the US dollar a convenient currency for foreign governments and central banks to hold as a reserve currency.
Reserve Currency Status: The US dollar has been the dominant reserve currency since the end of World War II, and many countries have held US dollars as a reserve currency for decades. This entrenched status has helped to reinforce the strength of the US dollar as a reserve currency.
WHY USD DECLINE WILL BE GRADUAL?
Replacing the US dollar as a reserve currency would likely be gradual and take decades to unfold. This is because the global economy and financial markets are complex systems. Any significant shifts in the use of reserve currencies would likely have far-reaching impacts that are difficult to predict.
The US dollar (USD) is currently the dominant reserve currency, accounting for about 60% of global foreign exchange reserves and approximately 40% of international trade. The euro is the second most widely held reserve currency, accounting for about 20% of global foreign exchange reserves, followed by the Japanese yen and the British pound. The share of the yuan is about 2-4%. If countries were to move to use the Chinese yuan (also known as the renminbi) as a reserve currency, the share of US dollars in global trade and foreign exchange reserves could decline. However, it's important to note that the yuan currently only accounts for a small share of international trade and foreign exchange reserves, with estimates ranging from 2-4% of global trade and around 2% of global foreign exchange reserves.
Large US companies operating around the globe contribute to the strength of the US dollar (USD) in several ways. Here are some examples:
Demand for US Dollars: Large US companies that operate internationally often need to pay for goods and services in the local currency of their country. As a result, it can create demand for US dollars as companies may need to convert their home currency into US dollars to pay these expenses.
Repatriation of Profits: Large US companies that operate internationally may also repatriate profits back to the United States, which can also create demand for US dollars. Companies may need to convert foreign currency into US dollars to bring profits back to the United States.
Confidence in the US Economy: Large US companies that operate internationally can also contribute to confidence in the US economy and the strength of the US dollar. These companies are leaders in their industries, and their success is a sign of the strength of the US economy and the US dollar.
As of 2021, 41 countries had currencies tied directly or indirectly to the US dollar. These countries either use the US dollar as their official currency, peg their currency to the US dollar, or use a currency basket that includes the US dollar as a significant component. Some examples of countries with currencies directly pegged to the US dollar include the Bahamas, Bahrain, and Hong Kong. Other countries, such as Saudi Arabia and the United Arab Emirates, use a managed currency peg against a basket of currencies, with the US dollar being a major component. If other countries were to move away from using the USD for their trade and the US continued to use the USD, it's possible that the percentage of global business denominated in USD could decline. How much and how fast is the question? However, it cannot go below 22 trillion as it is the US share (~25%) of the global GDP. Further, countries that have their currencies tied to USD or hold the USD dollar as a store of value and use it for international trade will likely continue with USD. Finally, the impact of large multinational US companies will keep the USD's strong presence aloft. How much will it go down from the current 60%, and how fast is it to be seen?
In some cases, using the US dollar as the currency for trade transactions can be more cost-effective, primarily if both parties are located in countries with less stable currencies or if there is much international trade between countries. This is because the US dollar is one of the world's most widely accepted and traded currencies, and many banks and financial institutions have extensive networks for processing transactions in USD. On the other hand, there may be situations where there are more cost-effective options than using the US dollar for trade transactions. For example, if the exchange rate between the USD and the currency of one of the parties is unfavourable or if the bank fees for processing USD transactions are high, it may be more cost-effective to use a different currency or payment method.
IMPACT OF A DECLINE OF USD
Currency Exchange Rates: If the demand for US dollars declines as a reserve currency, it could lead to a decline in the value of the US dollar relative to other currencies. This could impact international trade, as goods priced in US dollars would become more expensive for countries that hold other currencies as reserves.
Interest Rates: The US Federal Reserve sets interest rates for the US economy, and these rates can impact the value of the US dollar. If the demand for US dollars declines, there will be inflation and Federal Reserve may need to adjust interest rates to maintain the value of the currency. This could impact borrowing costs and access to credit for businesses and individuals.
Bond Markets: US Treasury bonds are considered a safe-haven asset, and many countries hold US Treasury bonds as a reserve asset. If the demand for US dollars declines, the demand for US Treasury bonds may also decline, which could impact global bond markets.
International Trade: If the US dollar is no longer the dominant reserve currency, it could impact international trade and finance. Countries may need to hold other currencies as reserves or use other currencies for international transactions, which could increase currency exchange costs and potentially impact trade flows.
Geopolitical Shifts: A decline in the use of the US dollar as a reserve currency could have geopolitical implications, as it could impact the global influence of the United States.
POSITIVES OF YUAN
The Chinese gold yuan issue is fully provisioned, its composition must be composed of assets of which 40% must be gold, silver, and foreign exchange currency, with the remainder being filled with marketable securities and government-designated state-owned business assets.
On the other hand, the US dollar is not backed by government IOUs or any other physical asset, such as gold or silver. Since 1971, the US dollar has been a fiat currency, meaning that its value is not tied to any underlying commodity or asset. Instead, the value of the US dollar is determined by supply and demand in the foreign exchange market, as well as the policies of the US government and the Federal Reserve.
The US government does, however, issue Treasury bonds and other securities that are purchased by investors both within and outside the US. These securities represent a promise by the US government to repay the principal plus interest at a future date. However, these securities are not directly tied to the value of the US dollar, and their issuance does not provide any direct backing for the currency.
CONCLUSION
In conclusion, while the recent move by China and Russia to increase trade using the Chinese Yuan has raised concerns about the future of the US dollar, it is unlikely that the decline of the US dollar as the dominant global reserve currency will be sudden or immediate. The US dollar's strength as a reserve currency is due to a complex mix of economic, political, and financial factors, and any significant shift in the use of reserve currencies would likely take decades to unfold.
Moreover, the role of large US multinational corporations, the continued use of the US dollar for international trade, and the fact that many countries continue to hold US dollars as a reserve currency suggest that the US dollar will remain a prominent global currency for the foreseeable future.
However, the risks to the US dollar as a fiat currency are worth noting. The continuous printing of US dollars to fund government debt could put the currency's value at risk if demand for it falls significantly. It is essential to consider the potential consequences of a decline in the value of the US dollar, such as currency exchange rates, interest rates, bond markets, and international trade, as well as its geopolitical implications.
Ultimately, while the decline of the US dollar as the dominant global reserve currency is not imminent, it is vital for policymakers to be aware of the challenges and risks to the US dollar's continued prominence and take steps to mitigate them in the long term.
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