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Excerpts from:
De-dollarisation: The eroding dominance of the US Dollar
5 min read 15 Jul 2023, 12:33 PM IST Sugandha Sachdeva
De-dollarisation is driven by concerns about US monetary policy, geopolitical tensions, and the rising use of alternative currencies
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Challenges of De-dollarisation
The transition away from the US dollar as the world’s reserve currency, known as de-dollarisation, can be a complex and challenging process. There are a number of potential risks and disruptions that need to be carefully considered before embarking on a de-dollarisation strategy.
One of the biggest challenges is the potential for devaluation or loss of trust in the new currency. If the new currency is not seen as being as stable or as liquid as the dollar, it could lead to economic instability and hinder financial transactions. It is therefore important to build confidence and trust in the new currency before making the switch. Another challenge is that many commodities, such as gold and oil, are priced and traded in dollars. This means that shifting away from the dollar could complicate international transactions and make it more difficult to trade these commodities. This could also hamper foreign direct investment and capital flows. Countries with significant debt in USD will also face special challenges when trying to reduce their reliance on the dollar. If they suddenly move away from the dollar, their debt could become more expensive because their currency may lose value or exchange rates may fluctuate. This could lead to financial instability and make it more difficult to repay the debt.
Finally, de-dollarisation could lead to increased volatility in currency exchange rates during the transition period. Countries with less developed financial markets or limited policy tools may face greater challenges in managing exchange rate volatility. The successful management of these challenges is crucial for preserving global financial stability and sustaining economic growth. It is therefore important to carefully consider all of the potential risks and disruptions before embarking on a de-dollarisation strategy.
Is De-dollarization a far-fetched Idea?
The United States has the world’s best financial markets, attracting participants from around the globe. The liquidity and stability of these markets create a strong network effect, making the US dollar indispensable for global financial transactions. The US dollar has long served as the dominant global reserve currency, with central banks holding significant amounts of US dollars to facilitate international trade. Shifting away from the dollar would require diversifying reserve holdings into other currencies, which carries risks and uncertainties related to the stability and liquidity of alternative currencies. Moreover, international financial institutions, such as the International Monetary Fund (IMF) and the World Bank, conduct operations and provide financial assistance in US dollars, reflecting the dollar’s global role and the established infrastructure built around its use. Any shift away from the dollar would necessitate significant structural changes and consensus among member countries.
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Conclusion
The current global financial system heavily relies on the US dollar, and despite its vulnerabilities, there is currently no clear and attractive alternative to replace it. While the US economy may be facing challenges and its supremacy may be weakening, it still maintains a strong position with credibility in the financial markets. The key factor is the availability of better alternatives. As long as the US continues to provide stability, credibility, and attractive opportunities compared to other options, the world will likely continue to rely on the US dollar. However, if a viable alternative currency emerges that offers similar advantages, the breaking point for the US dollar and its dominance could occur.
(Author is Executive Director & Chief Strategist at Acme Investment Advisors. Views expressed are completely personal. These do not represent the views of Mint.)
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