The international monetary system is going through a strong U.S. dollar cycle, and a pivot away from the currency — or de-dollarization. In recent years, the U.S. administration has abused the currency’s excessive privileges, reaped massive benefits from dollar supremacy and frequently resorted to financial sanctions, which not only exacerbated global economic risks but also seriously eroded its international credibility. Although the dollar maintains a strong grip on its hegemony, its foundations have been shaken.
• The first manifestation of dollar hegemony is siphoning off global liquidity in every dollar cycle.
The dollar reigned supreme as the global currency used in most payment settlements, foreign exchange transactions and reserve assets, and the U.S. Federal Reserve has literally become the world’s central bank. The Fed’s monetary policy steers the global monetary policy cycle, and the fluctuation of interest rates generates tidal effect and siphon effects on global dollar liquidity. This year, the dollar has been on a rising trajectory, with the dollar index breaking the 110 mark, a new 20-year high. Meanwhile, currencies such as the euro, the yen, the Korean won and other major non-U.S. currencies are thrown off a cliff.
The Bank for International Settlements calculated that the nominal effective exchange rate of the U.S. dollar against a wide range of currencies, including developed and emerging countries, was at its highest level since 1994, when the data were first released. The cyclical fluctuations of the dollar have led to drastic swings in global exchange rate markets. That, in turn, has unsettled the macroeconomic and financial systems of countries and even led to frequent financial crises. The U.S. stands to benefit massively as capital flows to the U.S. market, with the dollar being used to harvest the wealth of other countries. The dominance of the U.S. dollar and its excessive privileges have become the greatest systemic risk of the current international monetary system.
• The second manifestation of dollar hegemony is the abuse of financial sanctions.
The history of the dollar cycle suggests that strong cycles often coincided with dollarization. However, in a departure from the past, the current strong dollar cycle doesn’t come in tandem with dollarization but rather de-dollarization. The excessive use of financial sanctions and extreme pressure employed by the United States has severely undermined the credibility of the dollar, and is the root cause of de-dollarization. According to BIS data, the dollar currently accounts for 40.4 percent of international payments, 88.3 percent of foreign exchange transactions, 45.1 percent of international bond notes, 41.73 percent of the SDR basket and 59.23 percent of global foreign exchange reserves, topping $7 trillion.
However, the fault lines in the existing international monetary system have long been visible, and the trend of de-dollarization has accelerated, characterized by more decoupling from the U.S. dollar clearing system, U.S. treasury bond sell-offs, overweight gold reserves and shrinking settlements in dollars.
The Russia-Ukraine conflict and the unprecedented financial sanctions in its wake are becoming an accelerator of de-dollarization. The weaponization of finance has not only cast a shadow over the stability and reliability of the international monetary and financial system and order but has also upended the logic of the functioning of international financial markets, which no longer observe the principle of neutrality. The property owned by sovereign states is no longer inviolable. The financial system long controlled by the United States, such as SWIFT, has become a tool for unilateralism, rendering the U.S. dollar no longer a risk-free asset. It is becoming a high-risk settlement instrument. In the long run, this portends serious damage to the credibility of the U.S. dollar.
• The global trend of de-dollarization is accelerating.
With the monetization of dollar-denominated debt and the use of financial sanctions as an instrument, the foundation of dollar hegemony has been destabilized. From a global perspective, more overseas creditors — in addition to Japan, China and Russia — are increasingly divesting their U.S. debts. In October, Japan’s holdings of U.S. debt fell to around $1.12 trillion, a three-year low. China’s U.S. debt holdings totaled $933.6 billion, compared with $1.32 trillion in November 2013, representing a cumulative net sell-off of 30 percent.
It is noteworthy that Saudi Arabia has sold a cumulative $62 billion of U.S. debt since 2020, a cumulative sell-off of 35 percent. Saudi has increased its sales of U.S. debt recently, mainly as a response to the implementation of the NOPEC Act by the U.S. against Saudi Arabia. Saudi has also claimed it has abandoned the use of the U.S. dollar in oil transactions to stop the NOPEC Act. The rifts in the system are deepening.
At the same time, an alternative global trade settlement system has moved from concept to reality. In recent years, a growing number of economies have been 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. It was 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 U.S. dollar.
The process of de-dollarization in the international reserve currency system will further pick up speed. This year, the Bank of Israel began diversifying foreign exchange reserves and is set to reduce the proportion of the U.S. dollar from 66.5 percent to 61 percent.
According to Brazil's central bank report on international reserve management, in 2021 the U.S. dollar fell in proportion in Brazil’s foreign exchange reserves by 5.69 percentage points from the 2020 level to 80.34 percent, the lowest level since 2014. The share of Chinese yuan in Brazil's foreign exchange reserves, on the other hand, rose from 1.21 percent in 2020 to 4.99 percent in 2021, the highest level since the yuan was incorporated into its currency basket in 2019 and becoming its third-largest foreign exchange asset.
The first China-Gulf Arab States Cooperation Council summit also reached a strategic consensus to develop settlement in yuan for oil and gas trade. All of these show that the process of de-dollarization is accelerating in both depth and breadth.
The international monetary system will evolve into a system characterized by one superpower and multiple major players, as opposed to a single hegemony. As the internationalization of sovereign currencies in emerging economies advances, a multipolar international monetary system can to some extent limit the excessive privileges of the U.S. dollar. At the same time, the establishment of an alternative trade settlement system responds to the need to strengthen the counterweight to the hegemony of the dollar in a polarized world, paving the way for the balanced development of multi-polarization in the international monetary system.