Since the end of the Second World War, the U.S. dollar has held the coveted role of reserve currency to the world. Backed by the planet’s largest economy and undisputed global power, the greenback became the most important means of exchange and an integral conduit of cross-border commerce. As time went on, dependence on the dollar became self-reinforcing, increasing its value further and supporting its reputation as a stable store of wealth.
But recently there’s been increased talk of challenges to the U.S. dollar’s dominance. China’s growing place in global trade and debt markets has meant an expanded role for the renminbi. In fact, use of the Chinese currency in trade finance has more than doubled in the last year, to 5%. And with China now accounting for 18% of global merchandise exports, this is expected to grow.
Western sanctions in response to Russia’s invasion of Ukraine, which froze official Russian foreign exchange reserves, have only accelerated interest in de-dollarization on the part of countries looking to “sanction-proof” international financial flows. Increased bilateral trade between China and Russia, and the settling of commodity transactions in renminbi are reminders of the evolving nature of our global financial architecture.
Beyond the geopolitical drama, many developing countries—long encumbered by the dollar’s influence on their domestic economies and the Federal Reserve’s outsized role in dictating available policy options—are looking for greater monetary independence. The recent expansion of the so-called BRICS grouping of countries to include oil exporters, like the United Arab Emirates and Saudi Arabia, may increase the use of alternative currencies in settling contracts. Talk of developing a common BRICS currency and the desire of some countries to settle cross-border transactions in local currency have only increased the momentum around such deliberations.
But amidst the noise, the U.S. dollar still dominates foreign exchange trades, accounting for more than half of international payments and almost 85% of all trade finance transactions. As a result, slightly less than 60% of official foreign exchange reserves held in the world’s central banks are denominated in U.S. dollars, with the renminbi still only accounting for about 3%.
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This dominance exists despite the decline in the United States’ contribution to both global gross domestic product (GDP) and global trade. Structural advantages such as access to deep capital markets, openness to trade and investment, and trust in its supporting institutions means that the world doesn’t have a credible substitute to the dollar. The greenback has weathered many challenges over the years, including the collapse of Bretton Woods in 1971, the emergence of the euro in 1999, and the 2008 global financial crisis.
China’s insatiable appetite for commodities, and the impact of emergent geopolitical realignments will inevitably lead to more announcements of trade settled in non-USD currencies. These patterns may also grow due to greater regionalization of trade, in the absence of a credible and inclusive trade governance system. But, for the time being, there isn’t yet a reliable alternative to the U.S. dollar on a truly global scale. Even the newly emboldened BRICS countries have expressed a preference for diversification and stability over outright abandonment of the USD.
The bottom line?
While chances of the U.S. dollar collapsing are incredibly slim, Canadian exporters, particularly commodity exporters, shouldn’t take anything for granted. As others have rightly pointed out, the Spanish real was also once the dominant global currency. However, rather than full-scale abandonment, the current push against the dollar could mean having to focus more on changes in pricing, currency risk management, and overall export competitiveness.
Exporters may have to adapt by offering pricing in local currencies in order to access new markets, hedging against currency fluctuations, and diversifying their trading partners. But for now, reports of the dollar’s demise still appear to be greatly exaggerated.
This week, a very special thanks to Sanjam Suri, country risk analyst in EDC’s Economic & Political Intelligence Centre.
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