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The US dollar has been the king of international trade for decades. However, the situation has recently started to change rapidly. China, Russia, India, Brazil, Saudi Arabia and several other countries are taking steps to reduce their dependence on the dollar. Why is this trend intensifying and where will it ultimately take us?
It is much more difficult for countries without access to US dollars to participate in international trade. After abandoning the gold standard in 1971, the new monetary system can be called a system based on the dollar reserve currency.
This is bad news for Americans, who have long enjoyed the privileges that the dollar’s reserve currency status has afforded them. Most central banks’ foreign currency reserves are in dollars – a total of 59 percent as of 2022. However, this share has steadily decreased, in 1999 this figure reached 70 percent. Raw materials, including oil, are predominantly traded in dollars on the world market.
While in 1980 the USA accounted for 32 percent of the total global economic product, by 2020 this figure had dropped to 24 percent, according to data from the Federal Reserve. The share of the country in international trade fell from 14 percent to 11 percent in the same time period.
About 100 years ago, the British pound was the most demanded currency in the world. However, after the First World War, the dollar’s influence grew. Americans were largely unaffected by the war, and much gold flowed into the country. The Bretton Woods Agreement concluded in 1944 strongly favored the dollar, and the majority of international trade began to take place in the American currency. At the Bretton Woods conference, the dollar was backed by gold, and the money of other countries were in turn backed by the dollar. This system gave the Americans enormous advantages on the international stage.
Recently, there has been an accelerated trend where more and more countries make bilateral agreements to settle in each other’s currencies. The main parties to the agreements are the countries of BRICS (Brazil, Russia, India, China and South Africa), South America and the Middle East.
On the one hand, this is because the US has recently used the dollar as an economic weapon (for example, against Iran and Russia). On the other hand, in connection with the share of the BRICS countries in the world economy, they want to reduce their dependence on the USA.
The BRICS countries alone account for more than 40 percent of the world’s population and nearly a quarter of the global gross domestic product. The rise of China has been particularly significant. According to the IMF, the Lowy Institute has put together an infographic that shows in a timeline whether the US or China has been the biggest trading partner for different countries. The 2018 standings are shown below.
For example, in 2001, 80 percent of the world’s countries traded more with the United States than with China. By 2018, this figure had dropped to around 30 percent. As many as two-thirds of countries trade more with China than the US. For almost half of the countries, trade volumes with China are twice as large as with the USA.
Countries where China is a larger trading partner than the US are marked in red. For countries in blue, the US is a larger trading partner than China. The timeline below shows the change over 38 years (the bluer, the more countries that trade more with the US, and vice versa for the red).
In addition, there are also ongoing discussions in the East to create a politically neutral reserve currency. It is true that these discussions have been going on for years, but it seems that concrete steps have been taken to move towards it this time.
At the end of March, China and Brazil agreed to start using their own currencies – the real and the yuan – in their trade. This means avoiding the use of dollars in transactions. China is Brazil’s largest trading partner, with volumes reaching $150.5 billion last year.
Recently, there was a meeting between Chinese President Xi Jinping and the Gulf Cooperation Council. According to Jinping, we are entering a new paradigm in energy cooperation. The GCC countries include Saudi Arabia, Kuwait, Qatar, Bahrain, Oman and the United Arab Emirates. These countries account for more than 25 percent of the world’s oil exports.
“We will use the Shanghai Petroleum and Natural Gas Exchange as a platform to pay for oil and gas in yuan,” Xi said at the meeting. In 2018, the Shanghai International Energy Exchange (INE) launched oil futures contracts denominated in yuan. From then on, producers will be able to sell oil in yuan as well.
Some time ago, the Chinese also made the first LNG purchase transaction, which was settled in yuan instead of US dollars for the first time. The deal included 65,000 tons of liquefied natural gas purchased from the United Arab Emirates.
It is true that so far countries have not wanted to accumulate very large yuan reserves. Because of this, China has made it possible to exchange yuan for physical gold through the Shanghai and Hong Kong stock exchanges. Now more agreements are being made with other countries, undermining the so-called petrodollar system, where the dollar and thus the global power of the United States has been guaranteed by the international oil business taking place in dollars.
Saudi Arabia’s Finance Minister Mohammed Al-Jadaan said earlier this year that he was open to using currencies other than the US dollar in trade. In the past, the Saudis have wanted payments for oil in dollars. China is already the world’s largest oil importer.
Even the Wall Street Journal wrote:
The move by the Saudis could probe the supremacy of the US dollar in the international financial system. Washington has depended on it to issue government bonds and finance the state budget deficit.
In addition to China, other countries are also interested in using other currencies. For example, Kenyan President William Ruto signed an agreement with Saudi Arabia to buy oil in Kenyan shillings instead of US dollars.
In the past, Iran, Iraq and Libya have also tried to avoid the dollar when trading oil. All these countries are united by the fact that the USA has considered them as hostile countries and has also intervened militarily. It is up to the reader to decide whether this is somehow related to the use of the dollar.
Alexander Babakov, deputy head of Russia’s State Duma, said on March 30 that the BRICS countries – Brazil, Russia, India, China and South America – are working on creating a “new currency” that will be presented at the organization’s summit in Durban in August this year.
Settlement in national currencies is the first step. The second step is to introduce a completely new currency into circulation in the near future. I think that readiness to take such a step will be announced at the BRICS meeting, work is underway for this.
In addition, Babakov said that one currency will probably grow out of BRICS, and in addition to gold, it will probably also be backed by rare earth metals and earth.
It is noteworthy that after the start of the war in Ukraine, the use of yuan in trade between China and Russia increased as much as 80 times. The comparison base was shallow before the war, but the growth is still significant.
At the same time, it is worth noting that the Chinese yuan still has a long way to go in the global arena, and there has been talk of a new reserve currency for more than 10 years. However, this has not yet come.
According to IMF data, 2.7 percent of all foreign currency reserves globally were in yuan in the last quarter of last year. Back in 2016, this figure was just over one percent. This puts the Chinese currency in fifth place after the dollar, the euro, the Swiss franc and the British pound. For example, in the case of dollars, the corresponding figure is 58.4 percent, and for the euro, 20.5 percent.
If you look at international trade transactions, the yuan’s share in them reached 1.9 percent as of the beginning of this year, according to SWIFT, the global interbank financial telecommunications association. Dollars are used for more than 40 percent of transfers and euros for more than 30 percent.
The dollar also dominates the international currency market (Forex). In April 2022, the dollar was one of the parties in 88 percent of all foreign exchange market transactions. These numbers show that the yuan and other currencies still have a long way to go against the dollar. However, the decline of the dollar’s hegemony and the rise of the yuan may accelerate.
This is the case, for example, if the reliability of the dollar and US bonds drops sharply. A potential US debt crisis can lead to this, for instance – for example, the annualized interest payments on the US national debt have risen above the country’s defense budget.
In addition, bonds have suffered a rather sharp price drop in recent years. This has been mainly caused by the rise in interest rates and that investors no longer want to lend to countries at low-interest rates in a high-inflation environment. The depreciation of bonds was one of the main reasons for the banking crisis in March. This may continue in the future, undermining the dollar’s credibility.
However, for China, the country’s large gold reserves are key. Although officially, the country’s central bank has a little more than 2,000 tons of gold, according to various estimates, it is believed that this number can be up to ten times higher , i.e. around 10,000-20,000 tons. Publicizing this information and, for example, partially backing the yuan with gold can also speed up the processes.
Last year, the world’s central banks bought the largest amount of gold since 1967. This year was significant in the development of financial history – mainly because of what happened in the London Gold Pool and how it related to the collapse of the Bretton Woods system in 1971. Current gold purchases may indicate something similar is coming.
The London Gold Association was an agreement between central banks to stabilize the price of gold and support the Bretton Woods system. According to it, the dollar was backed by gold, and one ounce cost $35. However, in 1967, the London Gold Association collapsed because there was not enough gold and the demand had increased sharply. The reason was the fact that the central banks of Europe started to buy gold massively because it was not believed that the USA would be able to keep the price of gold at 35 dollars.
In essence, 1967 was the beginning of the end of the Bretton Woods system. The US finally abandoned the gold standard in 1971 because the country’s spending on the Vietnam War and social programs had grown too large. This was followed by the so-called petrodollar system, where no currency was backed by anything. The current gold purchases may also indicate a paradigm shift in the international monetary system.
China and Middle Eastern countries bought the most gold in 2022. Many South American and Eastern countries seem to be preparing for major changes in the world’s financial power lines and monetary system by buying gold. And these changes are probably not far away.
Net gold purchases by central banks by year (purchases minus sales, in tons). Source: World Gold Council.