De-Dollarization

The dollar's dominance of international finance -- as the primary reserve currency, the currency in which most commodity trade is invoiced, and the medium through which most international financial transactions are settled -- is a structural feature of the postwar global order that has provided the United States with significant economic and geopolitical advantages. The ability to run persistent trade deficits without facing balance-of-payments crises, to impose economic sanctions through control of the dollar payment system, and to finance government deficits at lower interest rates than would otherwise prevail -- these are the "exorbitant privilege" that dollar hegemony confers.

Russia's 2022 invasion of Ukraine accelerated discussions of de-dollarization by demonstrating the coercive potential of dollar hegemony more vividly than any previous episode. The freezing of approximately $300 billion in Russian central bank reserves held in Western jurisdictions -- a sanction unprecedented in its scale and its targeting of a nuclear power -- sent a clear message to every government that holds reserves in dollar-denominated assets: those reserves could be frozen if the United States decided to impose that sanction. China, which holds approximately $1 trillion in US Treasuries and has its own reasons to reduce dependence on the dollar system, responded by accelerating the internationalization of the renminbi and by expanding bilateral trade settlements in national currencies.

The de-dollarization trend is real but slow. The dollar's share of global foreign exchange reserves has declined from roughly 71% in 2001 to approximately 59% in 2022 -- a significant shift, though most of the reduction has gone to other currencies (primarily the euro and currencies of smaller economies) rather than to the renminbi, whose share remains below 3%. The network effects that sustain dollar dominance -- the depth and liquidity of US financial markets, the credibility of US legal institutions, the global reach of dollar payment infrastructure -- are difficult to replicate.

The weaponization of the dollar through sanctions has forced countries to ask whether relying on a system controlled by a single power -- one that can freeze your reserves on political grounds -- is a vulnerability they can afford. The answer, for an increasing number, is no.Adapted from Zongyuan Zoe Liu, Sovereign Funds (2023)

The more consequential threat to dollar hegemony is not Chinese currency competition but the long-term sustainability of the US fiscal position. Dollar dominance depends, ultimately, on confidence that the United States will honor its obligations -- that US Treasuries will retain their value and remain liquid in all market conditions. This confidence has been tested by episodes of political dysfunction (the 2011 debt ceiling crisis, which produced the first downgrade of US government debt), fiscal expansion without obvious constraint (deficits that have remained large throughout the post-2001 period), and the politicization of sanctions that raises questions about the reliability of the US financial system as a neutral platform.

A sudden collapse of dollar hegemony is unlikely -- the alternatives are not ready, the transition costs are enormous, and the United States retains sufficient economic and military power to sustain the arrangement. A gradual erosion is more plausible: a slow decline in the dollar's reserve share, a gradual development of alternative payment systems, and a modest reduction in the United States' ability to exercise financial coercion. The long-term consequences depend on whether the United States uses the remaining period of dominance to address the fiscal and institutional vulnerabilities that threaten it.