Fevered speculation of the dollar’s demise has gained intense currency throughout 2023. Yet the world’s reserve currency and the market bulls driving it ever higher haven’t gotten the memo.
This disconnect is sure to dominate discussions at this weekend’s Group of 20 summit in New Delhi, Indian.
Officially, the host, Indian Prime Minister Narendra Modi, wants the September 9-10 confab to focus on cooperation and showcasing India’s rising clout in global trade and finance.
Yet the sideline of these events is where the real action happens. And a major source of discord is why the dollar is climbing for an eighth straight week, the longest such streak since 2005.
The plot thickens when you consider that the US Federal Reserve is wrapping up its tightening cycle, Washington’s dangerous fiscal trajectory continues apace and many G20 members are determined to sideline the dollar in global market circles.
“Many of the dollar-supportive factors of 2022 have abated,” says strategist Dwyfor Evans at State Street Global Markets.
He notes that other top central banks “are playing catch-up on rates.” And if China’s Covid re-opening trade reasserts itself, giving global demand a lift, “then cautious safe haven buying is on the back foot.”
Others argue that the surprising stability of the US service sector, despite still-high inflation and global headwinds, continues to offset trade weakness and support dollar buying.
“This resilience, whether looking at jobs growth, sticky inflation or consumer spending, is predominantly driven by services,” says strategist Adarsh Sinha at Bank of America. While the bank remains bullish, Sinha says, “In our view, a meaningful slowdown in the service sector is necessary if not sufficient for sustained US dollar depreciation.”
The more capital the dollar lures out of the developing world, the less there is to finance growth, keep bond yields stable and help private sector companies innovate, disrupt and create new wealth.
Past periods of extreme dollar strength – including the 1997-98 Asian financial crisis – posed existential financial risks to emerging markets. Yet the writing is seemingly on the proverbial wall, notes Natasha Kaneva, head of global commodities strategy at JPMorgan.
“The US dollar, one of the key drivers of global oil prices, appears to be losing its once powerful influence,” Kaneva says.
The bank’s research corroborates views that dollar strength and oil prices are steadily weakening. This, of course, is partly by design, with oil increasingly being transacted in non-dollar currencies.
Case in point: G20 member Saudi Arabia, which along with China has ambitious designs for a post-dollar financial system.
Between 2005 and 2013, JPMorgan says, a 1% increase in the trade-weighted dollar would lower the price of international benchmark Brent crude oil by roughly 3%.
Between 2014 and 2022, an equivalent dollar gain only resulted in a 0.2% change in Brent crude prices.
Kaneva’s JPMorgan colleague, Jahangir Aziz, head of emerging market research, notes that “overall, we find that the importance of the dollar has declined significantly from 2014 to 2022.” It’s “hard to ignore” this downshift, Aziz says.
China’s pivot to using the yuan in almost all of its Russian oil purchases is a major factor. Asia’s biggest economy is a huge energy buyer with great sway over smaller nations keen to tap its markets.
Despite international trade sanctions, Russian oil is finding ready demand from Asian trading partners using local currencies rather than the dollar.
It’s complicated, certainly. Both China and the US are keeping score of countries ignoring Washington’s sanctions and curbs imposed in punitive response to Russia’s invasion of Ukraine.
The trajectory is toward less dollar use. For now, the dollar is still at the center of the global financial system and US Treasury securities remain a safe haven of choice.
Within the SWIFT payments system, the dollar share of transactions is north of 40%, affording it the dominant position. The euro’s share is about 25%, while the yuan’s is roughly 3%.
But the dollar’s share in foreign reserves volume was a record low 58% at the start of 2023, down from 73% in 2001.
Old habits die hard, though. In a recent report, economists at JPMorgan conclude that while “marginal de-dollarization” is afoot, it won’t unfold rapidly. The dollar, for all its flaws, is simply too ingrained in global transactions to shift to another monetary unit in short order.
“Instead,” JPMorgan economists write, “partial de-dollarization – in which the renminbi assumes some of the current functions of the dollar among non-aligned countries and China’s trading partners – is more plausible, especially against a backdrop of strategic competition.”
Some are far less convinced that the dollar’s days are numbered. As economist Steve Hanke at Johns Hopkins University notes, “only 14 dominant international currencies have existed since the 7th century BC. This suggests that dethroning King Dollar will be easier said than done.”
Barry Eichengreen at the University of California, Berkeley, notes that the reasons why most economies favor the dollar “all reinforce each other.” He adds “there just isn’t a mechanism for getting banks and firms and governments all to change their behaviors at the same time.”
Yet US fiscal and political strains are colliding with global efforts to knock the dollar down a peg or two or more.
In August, Fitch Ratings yanked away Washington’s AAA credit rating. The rating agency said its downgrade “reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to AA and AAA rated peers over the last two decades that has manifested in repeated debt-limit standoffs and last-minute resolutions.”
Washington’s debt topping US$32 trillion was one problem. “Continued fiscal expansion/deficits could result in additional downgrades from rating agencies,” notes strategist Lawrence Gillum at LPL Financial. “So, until the US government gets its fiscal house in order, we’re likely going to see additional downgrades.”
Another big concern: Republican Party members toying around with the nation’s debt ceiling. “In Fitch’s view, there has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025,” the rating agency said.
A number of G20 members may find this weekend’s summit in New Delhi fertile ground to try and accelerate the dollar’s demise. It presents a timely opportunity for China, Russia, Brazil, Saudi Arabia, Turkey and others to compare notes on devising a new reserve currency.
Earlier this year, Brazil began doing trade in other currencies like the Chinese yuan and Russian ruble. Brazilian President Luiz Inacio Lula da Silva threw his support behind creating a BRICS monetary unit to be used by members Brazil, Russia, India, China and South Africa.
Meanwhile, Malaysian Prime Minister Anwar Ibrahim said China is open to resurrecting the formation of an Asian Monetary Fund, a move that would reduce the International Monetary Fund’s influence and revive a decades-old proposal to marginalize Washington’s power in Asia.
Chinese leader Xi Jinping’s efforts to internationalize the yuan are bearing some fruit. France, for example, is beginning to conduct some transactions in yuan. China and Brazil have agreed to settle their trade in yuan and reals.
Beijing and Moscow are ramping up trading in yuan and rubles. Pakistan is working to pay Russia for oil imports in yuan. Argentina recently doubled its currency swap line with China to $10 billion.
This month, Bank of China, one of China’s big four state-owned commercial institutions, opened its first branch in the Saudi Arabian capital of Riyadh with big plans to expand the use of the yuan in finance and trade there.
At the opening ceremony, BOC president Liu Jin said its new foothold in the Saudi capital will broaden trade and investment exchanges. Those include new “high-quality” construction projects via Beijing’s Belt and Road Initiative.
It’s but one example of efforts amongst BRICS members to rely more on local currency settlements in cross-border trade while reducing dollar-denominated transactions.
At the same time, India and Malaysia are increasing use of the rupee in bilateral trade. The United Arab Emirates is also talking with India about doing more non-oil trade in rupees.
The 10-member Association of Southeast Asian Nations is doing more regional trade and investment in local currencies. Indonesia, ASEAN’s biggest economy, is working with South Korea to ramp up transactions in rupiah and won.
Yet, despite all of these de-dollarization efforts, the greenback continues to defy gravity.
One explanation, says strategist Elsa Lignos at RBC Capital Markets, is that the dollar is currently the highest yielder in the Group of 10, offering even higher returns than many perceived as riskier emerging markets. RBC’s base case, Lignos says, is for the dollar to remain on an upswing until year-end.
The odds of additional Federal Reserve rate hikes are another wildcard.
“The recent upward trajectory in oil prices has laid the groundwork for potentially elevated consumer price index figures for August,” says Stephen Innes, managing partner at SPI Asset Management.
“These impending increases in oil prices present a fresh challenge for central banks as they continue their diligent efforts to bring inflation levels back in line with their desired targets.”
The dollar’s stubborn advance is ringing alarm bells in Asia as currencies hit multi-month lows. The worry is that capital outflows will accelerate, slamming equity markets and increasing risks of importing inflation.
Such concerns have done the near impossible: put China and Japan on the same side of an international debate.
Officials in Tokyo are particularly worried that the yen’s drop to near 30-year lows will accelerate. “If these moves continue, the government will deal with them appropriately without ruling out any options,” says Masato Kanda, vice finance minister for international affairs.
In Beijing, People’s Bank of China officials are using daily yuan reference rates to warn against speculators pushing the exchange rate much lower. China’s waning growth prospects have economists at Morgan Stanley taking a bearish view on emerging market currencies in general.
Still, arguments for why the dollar’s best days are behind it will be the talk of the town in New Delhi, whether that’s actually the case or not.
Follow William Pesek on X, formerly known as Twitter, at @WilliamPesek