The dollar is losing its status as a world currency: some countries are looking for an alternative to store their reserves

The dollar has been the world's reserve currency since World War II, but a combination of political and economic reasons is slowly weakening its dominance, reports Insider.

Photo: IStock

According to the International Monetary Fund, almost 60% of international reserves are held in dollar-denominated assets. The dollar is also the most widely used currency for trading. Now, Western sanctions against Russia linked to its invasion of Ukraine are making other countries wary of possible repercussions from Washington.

Brazil, Argentina, Bangladesh and India are lining up reserve currencies and assets such as the Chinese yuan and bitcoin for trade and payments.

While the macro geopolitical environment encourages countries to look for alternative currencies, there has long been concern about the dollar's excessive dominance in global trade and finance.

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This talk of de-dollarization has been recurring in waves every few years since at least the 1970s.

Three reasons

Countries are trying to develop plans for a possible exit from a dollar-dominated world. There are three reasons for this.

1. US monetary policy has too much influence on the rest of the world

The US is the issuer of the world's reserve currency, which is also the dominant currency in international trade and payment systems. Consequently, the dollar has a huge impact on the global economy and is often overvalued, the Wilson Center think tank reported in May.

This provision gave the US what Valéry Giscard d'Estaing, President of France from 1974 to 1981, called "an exorbitant privilege". One aspect of this perk is that the US may not face a crisis if it fails to pay its debt when the value of the dollar plummets, because Washington can simply issue more money.

It also means that countries around the world must keep a close eye on US economic and monetary policy to avoid spillovers on their economies.

Some countries, including India, have said they are tired of US monetary policy holding them hostage, and even claim that the US has been an irresponsible issuer of the world's reserve currencies.

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A working group at the Reserve Bank of India is currently pushing for the use of the Indian rupee in trade, a stance that is in line with Indian Prime Minister Narendra Modi's vision of the currency.

2. Strong dollar becomes too expensive for developing countries

The US dollar is gaining strength against most of the world's currencies, making imports much more expensive for developing countries.

In Argentina, political pressure and reduced exports have pushed down US dollar reserves and put pressure on the Argentine peso, which in turn fueled inflation. This prompted Argentina to start paying for Chinese imports in yuan instead of US dollars, the country's economy minister said on July 19.

“If access to U.S. dollars becomes more expensive, borrowers will seek alternatives,” economists at global financial services firm Allianz wrote in a June 29 report.

Brazilian President Luiz Inácio Lula da Silva has been one of the most vocal advocates for the creation of alternative currencies for trade settlements, going as far as instigating Brazil, Russia, India, China and South Africa to abandon the US dollar.

3. Global trade and demand for oil are diversifying, putting the petrodollar at risk

The key reason why the US dollar became the world's reserve currency is because the Gulf countries in the Middle East used the US dollar to trade oil. By the time they were trading in oil, the dollar was already a widely used trading currency.

The agreement was formalized in 1945 when oil giant Saudi Arabia and the US reached a historic deal. According to the agreements, Saudi Arabia will sell its oil to America only for dollars. In return, Saudi Arabia will reinvest excess dollar reserves in US Treasuries and companies. This arrangement guaranteed US security for Saudi Arabia.

But then the US became energy independent and a net oil exporter with the rise of shale oil production.

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“The structural changes in the oil market caused by the shale revolution could paradoxically damage the role of the US dollar as the world's reserve currency. Oil exporters, who play a decisive role in the status of the US dollar, will have to refocus on other countries and their currencies,” Allianz economists say.

Not only oil

The rocky relationship between the US and Saudi Arabia has also been tense in recent years due to several issues. For example, when President Donald Trump complained that Saudi Arabia was not paying the United States a fair price for its protection, and when President Joe Biden disparaged Crown Prince Mohammed bin Salman over the killing of Washington Post journalist Jamal Khashoggi.

Such tensions amid the shale energy revolution raise the possibility that Saudi Arabia may one day ditch its dollar-denominated oil prices, Sarah Miller, editor of energy news company Energy Intelligence, wrote last November.

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