Politics

Dedollarization, i.e. the U.S. dollar’s fall from the reserve currency around the globe, is a phenomena often discussed by economists but is not well understood.

Background

The U.S. dollar has been the dominant global reserve currency for decades, enabling the United States to enjoy many economic benefits and privileges, such as lower borrowing costs, easier access to foreign goods and services, and greater influence over international trade and finance. However, in recent years, the trend of dedollarization has been gaining momentum, as more countries and entities seek to diversify their currency holdings, reduce their exposure to U.S. sanctions and political risks, and assert their own financial sovereignty. This blog post aims to explore what dedollarization means, why it matters, and how it could affect the U.S. economy.

What is Dedollarization?

Dedollarization refers to the process of reducing or eliminating the use of the U.S. dollar as a means of payment, store of value, or unit of account in international transactions. This can take various forms, such as switching to other currencies, such as the euro, yen, yuan, or digital assets; creating new regional or global currencies, such as the euro or the SDR (Special Drawing Rights) of the IMF; bartering goods or services directly without using any currency; or adopting alternative payment systems, such as blockchain-based platforms or SWIFT alternatives.

Why Does Dedollarization Matter?

Dedollarization matters for several reasons, both for the countries that initiate it and for the global economy as a whole. For the countries that seek to dedollarize, the benefits can include reduced dependence on the U.S. financial system, enhanced economic autonomy and resilience, improved access to non-U.S. markets and investments, and reduced exposure to U.S. sanctions or other forms of financial pressure. For example, Russia has been actively dedollarizing its economy since 2014, following the imposition of Western sanctions over the annexation of Crimea, by increasing its use of domestic currency, barter deals, and non-dollar trade with China and other partners.

For the global economy, dedollarization can pose some challenges and opportunities, depending on the pace, scope, and coordination of the shift. On the one hand, dedollarization can increase the volatility, uncertainty, and fragmentation of the international financial system, as different currencies and payment systems may not be fully interchangeable, may not have the same liquidity and stability as the dollar, and may face geopolitical or regulatory obstacles. On the other hand, dedollarization can also promote more diversified, inclusive, and multipolar monetary and financial arrangements, which may reduce the systemic risks and imbalances that arise from the dominance of a single currency.

How Could Dedollarization Affect the U.S. Economy?

Dedollarization could affect the U.S. economy in various ways, depending on the extent and speed of the trend, and the responses of U.S. policymakers and markets. Here are some possible scenarios and impacts:

• Reduced demand for U.S. dollar assets: If more countries and investors shift away from holding U.S. dollars, U.S. Treasury bonds, and other U.S. assets, the demand for those assets could decline, leading to higher borrowing costs, lower asset prices, and weaker fiscal and monetary positions for the U.S. government and the private sector. This could also erode the status of the U.S. dollar as the world’s reserve currency, which could make it more expensive and harder for the U.S. to finance its deficits and maintain its global influence.
• Increased inflationary pressures: If the U.S. dollar depreciates relative to other currencies or assets, the imports of goods and services could become more expensive, leading to higher inflation and reduced purchasing power for U.S. consumers and businesses. This could also put upward pressure on U.S. interest rates and reduce the attractiveness

Few are talking about it, but it is happening much quicker than people thought. Is dedollarization the next Black Swan that impacts the U.S. economy?