De-dollarization: myth or reality?

Last August, at the 15th BRICS (Brazil, Russia, India, China and South Africa) summit in Johannesburg, Brazil's president called for the creation of a common currency for trade between their countries as an alternative to the dollar.

In recent years, a large share of growth in world trade has been attributable to emerging countries. This raises the question of whether the change in the structure of international trade, coupled with a political will to disconnect from the US currency, is likely to tip the international monetary system into a new era? Just as the "king dollar" dethroned the British pound sterling in the last century, could another currency, such as the Chinese renminbi (yuan), supplant it as the benchmark currency for international trade, central bank reserves and investments?

Three experts from Natixis Corporate & Investment Banking, Jean-François Robin, Global Head of CIB Research, Michela Cicenia, Global Head of Corporate Trade, and Valéry Gombert, Co-Head Rates & Currencies Markets, observe the signs of a decline in the dollar's influence in the international monetary system that is set to intensify. De-dollarization is thus no myth.

However, the dollar remains difficult to replace, especially in trade, as it reduces currency risk and offers investment capabilities in vast capital markets. De-dollarization, signaling the end of the dollar's reign, is therefore a long way off, even if it is likely to become more pronounced under the impetus of the energy transition.

The de-dollarization trend emerged a few years ago, as a result of a change in the structure of international trade, explains Michela Cicenia. "In the early 2000s, international trade basically boiled down to trade between Chinese manufacturers and consumers in Western countries. The entire supply chain - purchasing machinery and raw materials, on the one hand, and export contracts, on the other - was denominated in dollars, and the proceeds, in dollars, were invested in US assets such as US bonds and US treasuries".

Today, a large share of growth in world trade is beginning to be driven by bilateral trade between emerging countries. "To talk about de-dollarization, we need to look at whether this trade is denominated in dollars or whether it is increasingly carried out in local currencies," continues Michela Cicenia, who despite noting some initiatives supporting this, observes that, in practice, commercial contracts remain almost exclusively denominated in hard currency.

The trend is also driven by a political desire to break away from the US currency, accentuated by the conflict in Ukraine. This is due to the geopolitical vulnerability caused by dollar-dependency and in particular, the power it gives the United States to impose sanctions.

Leading the way is China, which also aims to circumvent trade rivalry, and is presenting its currency as an alternative to the dollar, particularly for oil and gas imports. At the end of 2022, China's President Xi Jinping announced a 35-year plan to implement a new paradigm, marking a stated aim to develop a trade zone between China and the major raw materials producers outside the sphere of influence of the United States.

This desire to bypass the American currency, in particular by using the yuan, affects the entire emerging world - the Global South, as Jean-François Robin calls it: "China, India, Russia, Brazil, Turkey, Saudi Arabia and, in part, Latin America, all aim to denominate a growing proportion of their trade in yuan. The weight of the dollar in Chinese trade has thus fallen from 84% at its peak to 44% today".

"Similarly, to avoid weaponization of the dollar, Russia now systematically uses the yuan in its export contracts," notes the economist. "Before the war, the share of Russian exports denominated in yuan was 1%, today it is 15%", he adds, citing other signals: Argentina has announced that it will repay part of its debt in the Chinese currency, Pakistan recently denominated oil import contracts in yuan, China and Saudi Arabia have reduced their holdings of US treasuries by almost 40%....

So, can we say that the US currency is in decline? "Today, 58% of foreign exchange reserves, 80% of the volume traded daily on the foreign exchange market, and 65% of international debt is denominated in dollars..." sums up Jean-François Robin. "The state of the world today is still characterized by the arch-dominance of the dollar. International demand for dollars and dollar-denominated financial assets remains strong, and the weight of the dollar in financial markets continues to rise. The inertia of the dollar's role is probably underestimated," says Jean-François Robin.

Michela Cicenia confirms. "Using a currency other than the dollar or the euro in international contracts means adding currency, sanction and political risks to execution, country, counterparty and other risks inherent in international trade. Emerging countries do not have the negotiating clout to impose contracts in local currency. This is happening very slowly in the flows between Asia, Africa and Latin America. Asia, for example, has every interest in positioning itself in commodities in these regions, and contracts could gradually become denominated in yuan. For the time being, this is still very marginal."

As such, even though the dollar's share of central bank reserves is declining - it stood at 72% 15 years ago - its use worldwide remains dominant, far outstripping the role of other currencies. The euro, the second most important international currency, is stagnating at 20% of central bank reserves. "The yuan, the only real non-Western reserve currency, is growing extremely slowly, at 2.7% compared with 1% eight years ago," points out Valéry Gombert. "Compared with the dollar and its G10 "allies", which account for over 90% of currencies held by central banks, we are still a long way from massive de-dollarization".

Rather than the emergence of a major new currency, we are witnessing more the emergence of a multi-currency world, with a diversification of exchange and reserve currencies. Jean-François Robin predicts that the euro, which currently accounts for 20% of world trade, should benefit slightly from this trend to reach 25% "in line with Europe's share of world trade", he adds. Rising powers such as Australia, India and Indonesia, which are currently virtually non-existent on the foreign exchange market, are also set to be used increasingly in his view. Another example, Valéry Gombert has observed a rise in the dinar of the United Arab Emirates, "a jurisdiction considered to be fairly neutral politically, whose currency is linked to the dollar by a "peg" system, making it a fairly strong and very stable currency".

Valéry Gombert also highlights a fundamental trend: de-dollarization goes hand in hand with greater holdings of gold in central bank reserves. In an unprecedented recent phenomenon, whereas appetite for gold is normally inversely correlated with real interest rates, it has not wavered during the current cycle of rising global interest rates. According to some market observers, we are even potentially heading towards a Bretton Woods 3, in which central banks are significantly increasing the share of gold and other commodities in reserves.

In concrete terms, Natixis CIB is integrating these de-dollarization signals by deploying its Global Markets activities in these new markets. "In recent years, a large part of financial market activity has diversified from the G10 to emerging countries. Cross-currency trading in Chinese renminbi, Saudi Arabian rial, Indian and Indonesian rupees, Korean won, etc. is expanding, thereby reducing the share of the euro-dollar," explains Valéry Gombert. "This is why we are strengthening our product offering and diversifying our franchise in emerging countries, Latin America, the Middle East and Asia, to be able to offer our local customers the instruments to exchange these currencies and hedge their foreign exchange risks."

As far as the yuan is concerned, Jean-François Robin predicts that its share of trading volumes will double, if not triple, to reach 10-15% of the total. This is in line with China's 19% share of global GDP but is capped by exchange and capital controls that make the yuan difficult to access. "For a currency to represent a genuine alternative to the dollar, you need real capital markets, a liberalized economy, a liberalized foreign exchange market, and external debt, which is not the case for China," analyzes Jean-François Robin. "The yuan is a highly controlled currency that remains primarily used by countries close to China," he notes.

Ultimately, no currency has the weight to replace the dollar in the international monetary system. However, Jean-François Robin clearly sees a decline in its influence. Beyond the desire of governments to free themselves from the dollar, de-dollarization should accelerate mechanically under the impetus of the digitalization of currencies, the energy transition and industrial relocation.

Central bank digital currencies, using blockchain technology, could indeed contribute to a transformation of international financial infrastructures at the expense of the dollar. In a few years' time, we can imagine currency transaction hubs organized by central banks that would not use the dollar as an intermediate currency. "Following the example of India, which is already looking to promote a digital payment system where all Indians in the world can make transfers and payments in their local currency, without using the dollar," explains Jean-François Robin, adding, "Similarly, the digital Euro is bound to facilitate the use of the euro throughout the world."

The energy transition will also reduce the dollar's role in international trade. "Renewable energies are produced locally, unlike oil and gas, which have to be purchased via contracts denominated almost exclusively in dollars". The electrification of the economy and the gradual replacement of fossil fuels in the energy mix by solar, wind, hydro and nuclear power will mechanically reduce the use of the dollar as a transfer currency.

Finally, globalization, which is clearly moving towards regionalization, is set to amplify this de-dollarization of the world. "Industrial relocation and the 'local is beautiful' trend run counter to global trade as we've known it for several decades now," asserts Jean-François Robin. "If trade is more regional, it will inevitably be less dollarized than it is today.".