The Dollar's Demise: Is The World's Reserve Currency On The Way Out?

The dollar has been the world's reserve currency since World War II, but a combination of political and economic reasons is slowly chipping away at its supremacy.

Nearly 60% of international reserves are held in dollar-denominated assets, according to the International Monetary Fund. The dollar is also the most widely used currency for trade.

Now, Western-led sanctions against Russia related to its invasion of Ukraine are making other countries wary of potential consequences of crossing Washington.

Some, such as Brazil, Argentina, Bangladesh, and India, are lining up backup currencies and assets — such as the Chinese yuan and bitcoin — payments. 

While the macro-geopolitical environment is spurring countries to seek alternative currencies, there's long been uneasiness over the dollar's outsized dominance in global trade and finance.

This de-dollarization talk has come back in waves every few years since at least the 1970s.

Here are three other reasons countries around the world are attempting to line up plans to possibly move away from a dollar-dominated world. 

1. US monetary policy holds too much sway over the rest of the world

The US is the issuer of the world's reserve currency, which is also the dominant currency in international trade and payments systems.

Consequently, it has an outsized hold on the world economy and is often overvalued, the Wilson Center think tank reported in May. 

This position has afforded the US what Valéry Giscard d'Estaing, the president of France from 1974 to 1981, called an "exorbitant privilege." One facet of this privilege is that the US might not run into a crisis if it is unable to pay its debt when the value of the dollar falls sharply because Washington could simply issue more money.

It also means that countries around the world have to tail US economic and monetary policies closely to avoid a spillover impact on their economies.

Some countries, including India, have said that they are sick and tired of US monetary policies holding them hostage — going as far as to say that the US has been an irresponsible issuer of the world's reserve currencies.

A working group at the Reserve Bank of India is now pushing to use the Indian rupee for trade — a stance that is in with Indian Prime Minister Narendra Modi's vision for the currency.

2. The strong USD is getting too expensive for emerging nations

The greenback gaining strength against most currencies around the world is making imports far more expensive for emerging nations.

In Argentina, political pressure and a decline in exports contributed to a fall in US-dollar reserves and pressured the Argentinian peso which, in turn, fueled inflation. 

This has spurred Argentina to start paying for Chinese imports using yuan instead of US dollars, the nation's economy minister said on Wednesday, Reuters reported. 

"A stronger USD would weaken its role as reserve currency," economists at Allianz, an international financial-services firm, wrote in a June 29 report. "If access to USD becomes more expensive, borrowers will search for alternatives."

Brazilian President Luiz Inácio Lula da Silva has been one of the most vocal proponents of setting up alternative trade-settlement currencies, going as far as to egg on Brazil, Russia, India, China, and South Africa to move away from the US dollar.

3. Global trade and oil demand is diversifying — putting the petrodollar at risk

A key reason the US dollar became the world's reserve currency is that the Gulf countries in the Middle East used the greenback to trade oil — because it was already a widely used trade currency by the time they were trading oil.

The arrangement was formalized in 1945 when the oil-giant country Saudi Arabia and the US reached a historic deal wherein Saudi Arabia would sell its oil to America only using the greenback. In return, Saudi Arabia would reinvest excess dollar reserves into US treasuries and companies. The arrangement guaranteed US security for Saudi Arabia.

But then the US became energy independent and a net oil exporter with the rise of the shale-oil industry.

"The structural change in the oil market brought about by the shale-oil revolution can paradoxically hurt the role of the USD as the global reserve currency since oil exporters, which play a crucial role in the USD status, would need to re-orient themselves to other countries and their currencies," Allianz economists reported.

It's not just oil, either.

The relationship between the US and Saudi Arabia — which has been described as similar to "frenemies" — has also been testy over several issues in recent years, such as when then-President Donald Trump complained that Saudi Arabia wasn't paying the US a fair price for its defense, and when President Joe Biden snubbed Crown Prince Mohammed bin Salman over the murder of the Washington Post journalist Jamal Khashoggi.

Such tensions, against the backdrop of the shale-energy revolution, raise the possibility that Saudi Arabia could abandon its US-denominated oil pricing one day, Sarah Miller, an editor at Energy Intelligence, an energy-information firm, wrote in November last year.