Why are countries doing away with the Dollar?

WHAT IS DE DOLLARISATION?

For the last 8 decades, US Dollar has enjoyed an imperial status and has played a crucial role in the global economy. Most countries use US Dollar for all cross-border transactions and their central banks park forex reserves in US Dollar. This put the United States in a very strong position in geopolitics also. It empowers the US to influence and shape decisions taken by governments, businesses, and institutions. But in recent years, the USD is steadily losing its grip. Many countries including India, China, Russia, and European Union are now pushing for a new phenomenon called ‘de-dollarization. It can be a major setback for the US. So what is de-dollarization? Why are the countries taking this path? Let's analyze this in detail. 

De-dollarization is the process of reducing the dollar's dominance in global markets. It means countries replacing the US dollar as a reserve currency, medium of exchange, and unit of account. Instead, they use their own currency or alternate resources. It involves the following ways.  One is accumulating forex reserves in other currencies like the euro, Japanese yen, British pound, etc. The other is exploring alternative means of international payment, such as digital currencies or regional settlement systems. It is a gradual and complex process that can vary in scale and speed across different countries. 

WHY COUNTRIES ARE DOING AWAY WITH THE DOLLAR?

For nearly 80 years, the US dollar has dominated international reserves. It served as the main currency used in global trade. The Bretton Woods Agreement at the end of World War II established USD as the primary currency of international trade. That's a massive source of economic power for the US. So many countries seek to reduce dependence on the US dollar by diversifying their currency reserves and conducting transactions in alternative currencies. Let's check the reasons behind it. 

Geopolitical Concerns

- The geopolitical challenges faced by many countries under US sanctions or influence is a major reason. The dollar's dominant role in the global economy gives the United States enormous influence over other economies. Sanctions have been utilized by the United States to achieve foreign policy interests. So, countries seek to reduce their dependence on the U.S. dollar to mitigate exposure to U.S. sanctions or political pressures. The economic disruption faced by Iran, and more recently Russia after being disconnected from international dollar-trading systems like SWIFT, prompted many countries to look for alternatives. Apart from the fear of sanctions, countries have manifold interests to proceed with de-dollarisation. 

- As a growing economic power, India wants to internationalize Rupee not only to reduce transaction costs and stabilize the exchange rate but also to enhance geopolitical influence and strengthen economic and diplomatic ties with other countries. 

- China and Russia want to diminish the influence of the US dollar in global trade to counter American hegemony and mitigate the impact of sanctions. Being the second largest economy, Beijing wants to increase the use of the yuan in cross-border trade settlements and investment. So it has been promoting the use of its currency as an alternative to the dollar. 

- Other countries, particularly those in the Eurozone, have pursued de-dollarisation to promote the international use of their currency, the euro, in a bid to enhance their global economic standing and secure greater financial autonomy.

- The US involvement in several geopolitical conflicts has led to tensions between the US and other countries, which has made some countries reluctant to use the dollar.

Economic Reasons

Let's look into the economic reasons. 

- As the rates of the US dollar continue to rise with every passing year, the inflation rates across various countries have skyrocketed. The over-dependence on a single currency exposes the nation to risks associated with fluctuations in the value of the dollar. Diversifying into other currencies may provide a hedge against currency risk. So De-dollarization may be pursued as part of broader economic policies to achieve financial stability and reduce vulnerabilities to global economic fluctuations. 

- Reducing reliance on the US dollar enables countries to develop their financial systems, pursue economic policies aligned with their national interests, and strengthen their financial objectives while having greater economic sovereignty.

- As the world becomes more interconnected, many countries prefer to use their national currencies for bilateral trade or investment with key trading partners to reduce currency conversion costs and enhance economic ties.

- Cryptocurrencies, such as Bitcoin, are a new form of digital currency that is not subject to government control. This has made them attractive to people who are looking for an alternative to the dollar.

The global financial system heavily relies on the US dollar. Despite its vulnerabilities, as of now, there is no clear and attractive alternative to replace it. Hence de dollarisation will be a slow and gradual process. However, the shift towards a multipolar global financial system, where no single currency dominates, can lead to increased financial inclusivity and reduced vulnerabilities associated with currency fluctuations.