Countries outside the US/UK/Europe bloc are leaving the dollar-based trade community at a rate which has begun to alarm US geopolitical strategists, and neocons in particular. Announcements of large trade deals moving away from the dollar arrive more or less daily, and are typically measured in multi-billions of dollar value. De-dollarisation is in progress, but how much of a threat is it to US geopolitical hegemony?
The trend, which was quietly in train before the Ukraine War but picked up speed when the US froze Russia’s non-resident currency reserves, is now being openly acknowledged as a strategic threat by senior people in the US Administration.
Last week US Treasury Secretary Janet Yellen, interviewed on CNN, conceded that using dollar-connected sanctions could undermine “the hegemony of the dollar”. But she was not worried, going on to say that the depth and liquidity of the US Treasuries market serves to defend its status, because the world has no practical alternative to dollar reserves and dollar trade settlements. Is her confidence justified?
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Global trade grows more or less in line with GDP, and runs at approximately 22% of GDP. Therefore when global GDP grows 2% (adding $1,800bn), world trade may be expected to expand by $390bn. With a money velocity of 3x that would create the need for an additional $130bn of circulating cash.
If the dollar kept its 84% share of trade values that would in turn create a demand for 84% of $130bn in new foreign dollar holdings – or $109bn. So if the dollar keeps it share of global trade, and if global GDP grows, the US can hope to pay for just one tenth of its trade deficit by exporting dollars to global traders.
Those “ifs” are looking a bit soft. Even before the Ukraine war the dollar’s share of global trade was slipping, and it now looks like it might slip some more. The balance is sensitive. If the dollar share of global trade slipped to 80% that would reduce dollar use by $240bn (4% of $6,000bn of circulating capital), wiping out demand up-steps from trade growth.
A similar problem lurks in reserve flows. At present global foreign currency reserves excluding the US sit at around $10,000bn, with the dollar providing about half. Those reserves amount to 15% of non-US global GDP ($70,000bn in 2021). Non-US global GDP growth of 2% per year should add GDP of $1,400bn and, ceteris paribus, generate new global reserves of 15% of that, or $210bn. In the days when the dollar accounted for 60% of reserves the US could rely on a demand for 60% of that $210bn, covering another tenth of its deficit. But the dollar’s share of reserves is falling, and its share of new reserves is probably falling even faster.
So where does that leave Ms Yellen, trying to finance a $1,000bn trade deficit using that exorbitant privilege? Somewhat uncomfortable, it seems to me.
While the dollar appears to have shrugged off threats to its hegemony this year, future demand for reserve and trade dollars looks worryingly weak from Washington’s perspective. With the risk landscape enhanced by sanctions, demand weakening and US trade deficits likely to grow, is this the moment at which net flows into the dollar fade to a critical level?
That is certainly what China, Russia, Saudi, Iran and now Brazil appear to want. 2023 has seen a spate of announcements of bilateral trade deals to be priced and settled in yuan, Saudi riyals and rupees. Ms Yellen can take comfort that the sums involved are so far small by comparison with total world trade. Even the largest component, the China/Russia energy trade based on the ruble/yuan pair, is only $1.5bn per day, with a net working capital requirement of just $180bn. Other non-dollar currency pairs are harder to track but might take another $50bn away from the requirement for dollar-based working capital. Together those remove just 4% of demand for trade dollars – unwelcome but not intrinsically critical when seen from Washington’s perspective.
Ms Yellen’s argument is that for the rest of the world the original reasons for using the dollar, both for trade capital and for reserves, are as compelling as they have been for two generations – where else can an economy find the liquidity and scale of the dollar market? Some look to the euro, and more will do so in future, but the euro comes with the same “weaponisation” risk as the dollar, to which must be added higher regulation, a shallower market pool and weak foundations in a federation of states who are far from the best of friends. At least the dollar has one mind and one purpose.
Beyond the euro the pool of candidates thins dramatically. In theory the yuan could step up as a liquid source of reserves and working capital, but probably not any time soon with existing capital controls and Beijing’s unpleasant experience of capital flight the last time it eased those controls.
If we look at world currencies outside the Western/Nato/Japan bloc, and exclude China (for capital controls), and Russia (for high political risk) we find only around $20,000bn of GDP and $5,000bn of world trade, in economies which frequently have some form of capital controls, not inconsiderable political risks attached, and which collectively run a net trade surplus and have no need to export their currencies anyway. That landscape may explain why the core BRICS states have included discussion of a new currency – some sort of Shanghai Cooperation Currency Unit – at their forthcoming meeting in South Africa. We have been here before, when the European Commission invented the European Currency Unit (the ecu) as a precursor to the euro.
Sadly for the gold bugs, gold is not the answer, at least at any gold price this side of the stratosphere. ...
