De-Dollarisation of the World Economy: An Inevitable Outcome?
The rise of CBDCs has raised serious questions about the US Dollar (Dollar) status in the international financial and trade system. Over the past 70 years, the Dollar has taken an interesting trajectory to become the world’s hegemon currency.
Let’s skip the era of the Cold War and look at the Dollar post the fall of the USSR. This was when the United States emerged as the only hegemon globally, and experts called it the ‘End of History’; an era where no ideology could challenge the idea of market economy and liberal democracy.
Edward Luttwak, in his famous article in 1990, “From Geopolitics to Geo-Economics: Logic of Conflict, Grammar of Commerce”, said that:
The methods of commerce are now replacing the traditional military methods of exerting influence. The world is in a phase wherein disposable capital is used instead of firepower and civilian innovation in place of military-technical advancements.
The idea of Weaponised Interdependence gave Luttwak’s idea of Grammar of Commerce a push. Farell and Newman argue that the rise of Globalisation led to the formation of dense networks and interdependence between nations. And these networks are not symmetric. Certain countries have an advantage that can be used to coerce other nations into acting in specific ways.
The focal point of the world post the ’90s has been the United States. And with the US, there have two Bretton Woods institutions which have advanced their powers over the past 3 decades: The IMF and the World Bank. It would be no surprise when we realise that these two institutions lend in the Dollar. What else? When Central Banks report their foreign exchange reserves, they do so in Dollars. The USD is also the reserve currency for over 90% of the reserves of the world. In contrast, the Chinese Renminbi accounts only for about 2% of the reserves.
Most of the MNCs also use Dollar as their unit of account and reporting. Think of Apple, Alphabet Inc and all other companies from Europe; most of them use Dollars.
Let’s think of international trade systems now. What currency do importers and exporters use around the world? The Dollar and all these transactions are directed through the SWIFT or the CHIPS system. If the US government wants to choke payments to some nation or a company, they can do so at once. A case in point is the Iran sanctions of 2012, wherein the oil exports went down by more than fifty per cent because the US won’t allow nations to buy oil in Dollars from Iran. When Iran couldn’t get the USD, they couldn’t export essential goods from the world, thus crippling the economy.
It is not very difficult to observe that its Dollar has primarily supported US dominance in the world economy and liberal world order. Now, as China races to become the largest economy in the world, it wants its currency to unseat the Dollar as the hegemon.
The current Dollar centric system does not work for China and its desire to dominate the world. The escalation of the US-China trade war in recent years and the Trump administration’s threats to delist Chinese companies from US Stock exchanges has revealed the pain points for the Chinese. As early as 2014, the People’s Bank of China had made plans to launch its own digital Yuan. This early mover advantage has now landed China in the pole position of the CBDC race. These steps hold great geo-political and geo-economic significance.
The PRC is not the only nation in this race. More than 86% of Central banks are now exploring this option. This further threatens the status of the USD as the reserve currency and the currency for international settlements. Nations are looking at multiple advantages with introducing their own CBDCs.
First, it lowers transaction costs. The current system has multiple intermediaries who have a cascading effect on the transaction costs for both companies and countries. According to the World Bank, the global average cost of retail remittances is 6.51 per cent of the total amount sent. It also reduces the cost of liquidity management, thus contributing to lower transaction costs. (Bansal & Singh, 2021)
Second, it enables real-time cross border transactions. Currently, the system has many intermediaries, complicating the whole transaction process, thus hindering the occurrence of real-time settlements. The only way to achieve real-time transactions in cross-border transfers is by eliminating intermediaries, thereby reducing the excessive communication hops. This can be done through digital currencies that enable the settlement of transactions through a p2p network between the payer and the payee. (Bansal & Singh, 2021)
Third, the digital infrastructure around a CBDC is easier to scale and does not need special-purpose settlement systems. It can be easily done through the existing infrastructure. In the case of China, it could be Alipay and Wechat based payment systems and Paytm, Phonepe and other intermediaries in the case of India. (Bansal & Singh, 2021)
However, another advantage, the most obvious one of incorporating the Decentralised Finances in an economy, is the ability to keep data secure. This enables the financial inclusion of individuals and companies. Since blockchain technology creates a tamper-proof digital ledger of transactions, transparency is almost impossible to change or remove data once recorded.
Another important implication in this unfolding scenario is the disruption that SWIFT and CHIPS will face. They can be circumvented very easily in the future, thus dismantling a fundamental pillar of the dollar hegemony.
The De-Dollarisation of the World Economy will accelerate in the near future, and it will be interesting to see whether the Chinese Yuan will be able to displace the USD or nations will resort to keeping reserves in multiple currencies.