De-dollarisation of the global financial system

China’s ascendancy on the world stage as a major power is facilitated by the fast-transforming global economic order. China’s strategy includes targeting “de-dollarisation” in the international financial system as a key enabler of its preeminence. The dollar’s rule dates back to the 1944 Bretton Woods Agreement when it replaced the pound sterling for international trade and central currency reserves, and also led to the establishment of the IMF and the World Bank. Since then, the dollar has been widely used for international trade and as the primary global reserve currency.

Currently, 84% of cross-border transactions are conducted in dollars, and 58% of global currency reserves are held in the same currency. The use of the dollar in international transactions has given the US considerable oversight through the SWIFT financial transfers network, granting it significant influence over global financial systems and the ability to impose sanctions on foreign entities and individuals.

This dollar dominance led to its weaponisation in global dynamics until 1999, when the introduction of the Euro questioned its position. The Euro quickly became the sole medium of Europe’s financial system and gained outreach in the international financial system. As a result, the percentage of dollar-based currency reserves declined from 71% in 2001 to 58% in 2022, with Euros accounting for 20%, followed by the Japanese Yen at 5.5%, Pound Sterling at 4.6%, and Chinese Yuan at 2.7%.

During the early 21st century, China’s economic strength continued to surge, challenging the US’s position in the world economic sphere. China’s increasing economic influence in Africa, Asia, and Europe, coupled with the US’s coercive economic policies through the IMF and the World Bank, raised concerns for nations dependent on these institutions. Countries under dollar debt faced hardships due to higher interest rates and appreciation in the dollar’s value, leading them to seek alternatives.

After the Ukrainian incursion, US and European sanctions on Russia accelerated the global urge for de-dollarisation. Russia, facing economic punishment, turned to China and boosted yuan-based energy trade instead of using dollars. Other countries, such as India, Argentina, Brazil, and Venezuela, followed suit and made agreements with China for mutual trade in yuan.

The BRICS platform – consisting of Brazil, Russia, India, China, and South Africa — is actively pursuing de-dollarisation by introducing its own currency. With a collective GDP of $28 trillion, BRICS already outweighs not only the US but the entire G-7 combined. The group plans to expand further with the possible inclusion of 20 additional countries, which would enhance the de-dollarisation process even further.

The “Belt and Road Initiative” involves 151 countries, covering almost 75% of the world’s population and more than half of the world’s GDP. China’s investments in the BRI region exceed $1.0 trillion. China also has significant engagement with ASEAN in terms of trade, which amounted to $970 billion in 2022. As trade in the BRI and ASEAN regions expand, the financial system is expected to increasingly use the yuan, further squeezing the dollar’s space.

In 2016, China established the Asia Infrastructure Investment Bank (AIIB), representing a seismic shift in economic power from the US to China. The AIIB, with 92 member states, including US and European allies, Middle Eastern states, and India, poses a challenge to the World Bank and IMF.

Despite the prevalent decline of the dollar and the rise of the yuan in the global currency matrix, certain factors limit the complete replacement of dollar-based reserves with other currencies in the near future. The shift could affect exchange rates and cause instability in domestic economic hubs and international trade. Major economies like Japan, China, and the UK continue to hold significant amounts of US treasury securities, ensuring the dollar’s continued dominance in the international financial system.

The BRICS, despite its potential, only delivers 23% of total global output and 18% of trade. Member states have fundamental mutual differences, and even if they introduce a common currency, their inclusive trade cannot be limited to block members, implicitly relying on the dollar.

While the dollar-based financial system has been exploitative in nature and has failed to address poverty in weaker economies through the IMF and World Bank programs, it has ensured financial stability in international markets in the past decades. It will take time for the yuan and other currencies to qualify as reserve currencies, and the global financial system will closely scrutinise the functioning of Chinese financial alternatives, including interest rates, collateral conditions, and the credibility of emerging financial arrangements.

Countries like Pakistan, which have economic vulnerabilities and rely on the Western financial system, must make conscious decisions as they become willing participants in the de-dollarisation process, particularly in trade transactions and foreign investments related to the emerging Chinese global financial system.

Published in The Express Tribune, July 3^rd, 2023.

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