[US]The Way Out of the "Dollar Hegemony Trap

Author: Zhang Monan; Researcher, Deputy Director, US-European Research Department, China Center for International Economic Exchanges

Unofficially translated from https://mp.weixin.qq.com/s/2nEA23rf4uVNKEeXU_cYPQ

At present, the international monetary system is characterized by the coexistence of a strong dollar cycle and a wave of "de-dollarization". In recent years, the US has abused the "excessive privileges" of the US dollar to harvest the world's wealth cyclically, and has frequently raised the stick of financial sanctions, which has not only exacerbated the risks of the world economy, but also seriously eroded its own international credibility. Although the dollar hegemony is still strong, its foundations are being shaken.

The first manifestation of dollar hegemony: the dollar's cyclical harvesting of the world

As a global currency, the US dollar occupies an absolutely dominant position in global payment settlements, foreign exchange transactions and reserve assets, and the Federal Reserve has become the world's central bank. The Fed's monetary policy not only dominates the global monetary policy cycle, but the rise and fall of its interest rates has also had a huge "tidal effect" and "siphon effect" on global dollar liquidity.

This year, the US dollar is extremely strong, with the US dollar index breaking the 110 mark and hitting a new 20-year high. And including the euro, the yen, the Korean won and other major non-US currencies are "a plunge". According to the Bank for International Settlements (BIS), the nominal effective exchange rate of the US dollar against a wide range of currencies, including developed and emerging countries, is at its highest level since the data was released in 1994. The cyclical fluctuations of the US dollar have led to sharp fluctuations in global exchange rate markets, which in turn have caused instability in the macroeconomic and financial systems of countries and even led to frequent international financial crises, with the US using this to harvest the wealth of other countries. The dominance of the US dollar and its "excessive privileges" have become the greatest systemic risk of the current international monetary system.

The second manifestation of US dollar hegemony: the abuse of the financial sanctions stick

Historically, strong dollar cycles have often coincided with dollarisation. However, unlike in the past, the current strong dollar cycle has not seen a "dollarisation" but a "de-dollarisation". The abuse of financial sanctions and the extreme pressure exerted by the US have seriously damaged the international credibility of the US dollar and are the initiators of the "de-dollarisation". According to BIS data, the US dollar currently accounts for 40.4% of international payments, 88.3% of foreign exchange transactions, 45.1% of international bond notes, 41.73% of the SDR basket and 59.23% of global foreign exchange reserves. With global dollar reserves exceeding US$7 trillion, the dollar's hegemony will remain unshakable in the short term. However, the "cracks" in the existing international monetary system have long been visible, with an escalating wave of "de-dollarisation" characterised by an accelerated decoupling from the US dollar clearing system, a sell-off of US treasury bonds, an increase in gold reserves and a reduction in US dollar settlements.

The Russia-Ukraine conflict and the unprecedented financial sanctions it has led to are the accelerators of this wave of "de-dollarisation". The weaponisation of finance by the United States has not only cast a shadow over the stability and reliability of the international monetary and financial system and order, but has also completely changed the logic of the functioning of the international financial markets. The international financial markets are no longer governed by the principle of neutrality and the property owned by sovereign states is no longer inviolable. The financial system long controlled by the United States, such as the SWIFT clearing system, has become a tool for unilateralism, and the US dollar is no longer a "risk-free asset" but is becoming a "high-risk" international settlement instrument. In the long run, this is causing serious damage to the international credibility of the US dollar.

The global trend of "de-dollarisation" is accelerating

The monetisation of the dollar's debt and the reduction of financial sanctions to a gaming tool have led to the destabilisation of the dollar's hegemony. From a global perspective, more and more overseas creditors, in addition to Japan, China and Russia, are accelerating their sales of US debt. In October, Japan's holdings of US debt fell to around US$1.12 trillion, a three-year low. China's US debt position stood at US$933.6 billion, compared to US$1.32 trillion in November 2013, representing a cumulative net sell-off of 30%. It is noteworthy that Saudi Arabia has sold a cumulative US$62 billion of US debt since 2020, representing a cumulative sell-off of 35% of US debt. In particular, Saudi Arabia has increased its sales of U.S. debt in recent times, mainly in response to the U.S. "Organization to Combat Crude Oil Production and Export Monopolies Act (NOPEC Act)" imposed on Saudi Arabia earlier. Saudi Arabia has also claimed that its oil transactions will abandon the US dollar to stop the NOPEC Act, and the rift in the petrodollar system is deepening.

At the same time, the international alternative trade settlement system has moved from conception to reality. In recent years, a growing number of economies are developing or have developed independent payment systems to bypass the global financial payment and settlement system dominated by the U.S. In 2019, Germany, France and the UK announced the creation of an EU trade settlement support mechanism for Iran, designed to facilitate non-dollar and non-SWIFT transactions and bypass U.S. sanctions, and the INSTEX (Instrument to Support Trade Transactions) mechanism was created. India has also established an Indian rupee settlement mechanism for international trade to reduce its reliance on the US dollar.

The process of 'de-dollarisation' of the international reserve currency landscape is set to accelerate further. Since this year, the Bank of Israel has started to promote the diversification of its foreign exchange reserves and plans to reduce the proportion of the US dollar in its foreign exchange reserves from 66.5% to 61%. Brazil's central bank released a report on international reserve management, showing that in 2021, the dollar's share of Brazil's foreign exchange reserves will fall by 5.69 percentage points to 80.34% in 2020, the lowest level since 2014. The share of the RMB in Brazil's foreign exchange reserves, on the other hand, rises from 1.21% in the last 2020 to 4.99% in 2021, the highest level since the RMB entered its currency basket in 2019, making it its third largest foreign exchange asset. And the first China-Gulf Arab States Cooperation Council summit also saw a strategic consensus to develop RMB settlement for oil and gas trade. All of these show that the process of "de-dollarisation" is accelerating in both depth and breadth.

The direction of reforming the international monetary system is "one super, many strong” rather than "only super". As the internationalisation of sovereign currencies in emerging economies advances, a multi-polar international monetary system can, to a certain extent, limit the "excessive privileges" of the US dollar. At the same time, the establishment of an international alternative trade settlement system has also strengthened the power to counteract the hegemony of the US dollar in the world's polarised power pattern, paving the way for a balanced development of the international monetary system in the direction of multi-polarity.