The US dollar has dominated global finance for decades, but cracks may be emerging in its supremacy.
Several factors could indicate its waning dominance. This includes sustained selling of US Treasuries by foreign central banks, a shift in global currency reserves away from dollars, more oil exports being invoiced in non-dollar currencies undermining the petrodollar, declining international dollarisation, a dollar bear market, higher dollar debt credit spreads, and warnings to diversify large dollar holdings from bodies like the IMF.
Mounting geopolitical tensions that threaten to disrupt global trade and financial relations could likewise accelerate the weakening signals already apparent in the dollar’s international dominance, experts told Arabian Business.
Rising challenges from shifting economic and political power dynamics are prompting questions over whether changes to the prevailing financial order will further rebalance away from dollar hegemony – or if deliberate policy actions might help bolster ongoing confidence in the greenback.
Rising threats from China and other rivals
One of the greatest threats to the dollar comes from the rising economic power of China, according to an Economics Professor at Middlesex University Dubai, Ajit Karnik.
“The main threats are growth of China as the second-largest economy as well as its expanding sphere of influence,” said Karnik.
China’s rapid economic ascendancy over the past few decades has seen it emerge as a serious rival to US global influence.
While the renminbi (China’s official currency of which the yuan is a unit) still only accounts for a small fraction of global transactions compared to the dominant dollar, its usage has grown significantly in recent years.
Associate Vice President of the Continental Group, Abhishek Datta, highlighted that despite the immense potential of the euro and yuan, they are not without fundamental challenges.
“They will continue to draw skepticism from all quarters for the foreseeable future,” he told Arabian Business.
The euro, on the other hand, will not emerge as a rival to the dollar since the EU economy is “not growing fast enough,” said Omar Al Ubaydli, Economist and Director of Research at Bahrain’s Centre for Strategic, International and Energy Studies (DERASAT).
“What we will see is a system where the dollar remains #1 by some distance, but where there is a much bigger pack chasing it, and the pack is much closer.”
However, as Valerijs Rezvijs, Economist at S&P Global Ratings, pointed out, “the role of the Chinese yuan in cross-border settlements has increased amid China’s rising economic influence…around 3 percent of global trade have been settled in yuan, up from less than 1 percent ten years ago.” If China continues growing its economic clout, the renminbi poses a credible long-term threat to the greenback’s supremacy.
The current BRICS member states – which represent over a quarter of global GDP – are Brazil, China, India, Russia, and South Africa. However, earlier this year, the bloc announced that the UAE, Saudi Arabia, Iran, Ethiopia, Argentina, and Egypt will join the group in 2024.
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The expansion of groups like the BRICS alliance, comprising major emerging economies, also pose a challenge, according to the experts.
Karnik noted that the BRICS expansion to include additional countries, the establishment of BRICS Development Bank (now called New Development Bank), and talk of a BRICS currency all signal efforts to circumvent absolute dollar dominance. However, for now the internal divisions within BRICS and lack of a true alternative limit this threat.
Risks from sanctions and dollar militarism
The Russia-Ukraine conflict has demonstrated the potent weaponisation of dollar sanctions by Washington, with Moscow effectively cut off from much of the global financial system.
The aggressive use of economic sanctions by the US, at times seen as exceeding international law, is another key risk factor, according to Al Ubaydli. He believes that this has “created a growing incentive to create an alternative that is not beholden to the, at times, capricious whims of [Washington] DC policymakers.”
Sanctions on major economies like Russia and Iran have prompted efforts to insulate from such dollar-based coercion.
The Russia-Ukraine conflict, which began last year, led to heavy sanctions and major changes in trade which affected the global economy. These sanctions only accelerated the use of China’s renminbi.
“At the start of the war in February 2022, the renminbi accounted for less than 2 percent of trade finance which has accelerated to about 4.5 percent by 2023. While this is a substantial increase, it pales into insignificance in front of the US dollar which accounts for 85 percent of international transactions,” said Professor Karnik.
“The sanctions on Russia – and the desirability of these sanctions is a different debate – has signalled to the world that the US can put the economy of any country on the defensive in the event of a conflict,” added Karnik. This over-dependence on sanctions as a geopolitical tool may backfire by fast-tracking efforts to circumvent dollar reliance.
Also commenting on the US’ aggressive use of its currency as a geopolitical tool through sanctions was Al Ubaydli, who believes that this is a primary cause of the problem which is “too late to reverse course now.”
“The US’ addiction to economic sanctions is exacerbated by its newfound aversion to direct military involvement in foreign affairs. It is going to lean more heavily on sanctions, rather than laying off them as it should be,” he said.
Threats to the petrodollar system
Another front fueling desire for monetary autonomy is attempts to diversify oil trade away from dollar denominated exchanges.
The importance of oil as a key global commodity traded in US currency underpins significant demand for the currency. However, with major oil producers like Saudi Arabia exploring pricing oil in other currencies, this petrodollar system faces risks. As Rezvijs noted, “Despite the increased importance of yuan and other non-USD currencies when trading oil, hurdles remain significant.”
“With regards to yuan, hampering factors include limited use of yuan globally, currency pegs of several major oil-exporting economies – particularly in the GCC – and the continuing US dollar dominance in the global commodity trade. Because of that, trading oil in yuan would incur significant costs and impose funding and exchange risks on both exporters and importers,” said Rezvijs.
Significant moves away from dollar oil invoicing could undermine this prop for the currency.
Al Ubaydli cautioned that trading oil in non-dollar currencies would have ‘“two main disadvantages from the US perspective.”
“The first is undermining the effectiveness of future economic sanctions. The second is decreasing the long-term value of the US dollar, thereby inflating the real value of its debt, and making it harder for the US to pay its huge debts.” Such a scenario poses grave risks.
Emerging challenges from digital currencies
The rise of technologies like cryptocurrencies and central bank digital currencies (CBDC) present another challenge, according to Professor Karnik.
“Digital currencies are the rage and so were cryptocurrencies until they took a beating in the recent past with allegations of fraud. However, CBDCs are different since the central banks of countries are involved,” he said.
Among the 130 countries that are considering CBDCs, only 11 have launched it thus far, none of which are major economies.
While still in their infancy, widespread adoption of CBDCs in the future could pose a challenge to the currency, he believes.
“It is not already a challenge to the USD but, perhaps, a potential challenge,” said Karnik.
“The question is whether the US should ignore the threat or take steps to meet the challenge by creating a CBDC of its own. There is no clear indication of that yet.”
Prospects for dollar decline or resilience
Most experts agree that outright replacement of the dollar as the predominant global currency is unlikely in the short-to-medium term.
“The present conditions in the global financial market aren’t conducive to a single currency surpassing the dollar,” said Datta.
Rezvijs also argues that despite trends, “we do not expect US dollar to lose its status as global reserve currency any time soon.”
However, things may change over the longer term.
“It will take longer than a decade for the euro or yuan to challenge the USD…shifts will take time,” said Karnik. The key signs to watch for include a declining share of the dollar in global trade or finance volumes, according to the experts.
Datta believes the US must prioritise fiscal prudence and technological innovation “to sustain confidence.”
Policymakers must also calibrate sanctions use carefully.
“Increasing partisanship has contributed to a deterioration in the quality and coherence of US foreign policy. The dedollarisation movement is a symptom of this deeper malaise,” noted Al Ubaydli. Addressing such internal weaknesses will determine dollar resilience against external challenges.
While absolute replacement is unlikely soon, the dollar’s hegemony is at risk of erosion from multiple directions. Decisive US action is needed to sustain its preeminent global standing amid these emerging threats to its financial leadership role. A gradual shift to a multi-polar currency system also seems probable over the long run.
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