Suddenly everyone is looking for alternatives to the US dollar

(Bloomberg) — King Dollar is facing a riot.

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Fed up with a too-strong and recently weaponized greenback, some of the world’s largest economies are exploring ways to get around the US currency.

Smaller nations, including at least a dozen in Asia, are also experimenting with dedollarization. And companies around the world are selling an unprecedented chunk of their debt in local currencies, wary of further dollar strength.

No one is saying that the greenback will soon be dethroned from its reign as the primary medium of exchange. The “peak dollar” calls have repeatedly proved premature. But not so long ago it was almost unthinkable for countries to explore payment mechanisms that bypass US currency or the SWIFT network that underpins the global financial system.

Now, the sheer strength of the dollar, its use under President Joe Biden to impose sanctions on Russia this year, and new technological innovations are together encouraging nations to begin chipping away at its hegemony. Treasury officials declined to comment on these developments.

“The Biden administration made a mistake in weaponizing the US dollar and the global payment system,” John Mauldin, an investment strategist and chairman of Millennium Wave Advisors with more than three decades of experience in securities, wrote in a newsletter last week. markets. “This will force investors and non-US nations to diversify their holdings outside the traditional safe haven of the United States.”

Bilateral payments

Plans already underway in Russia and China to promote their currencies for international payments, including through the use of blockchain technologies, have accelerated since the invasion of Ukraine. Russia, for example, has begun to demand remuneration for energy supplies in rubles.

Bangladesh, Kazakhstan and Laos soon also intensified negotiations with China to increase their use of the yuan. India has started talking louder about the internationalization of the rupee and just this month started securing a bilateral payment mechanism with the UAE.

However, progress appears to be slow. Yuan accounts have not gained traction in Bangladesh, for example due to the nation’s large trade deficit with China. “Bangladesh has been trying to pursue de-dollarisation in trade with China, but the flow is almost one-sided,” said Salim Afzal Shawon, head of research at Dhaka-based BRAC EPL Stock Brokerage Ltd. in Dhaka.

A major driver of these plans has been the move by the United States and Europe to exclude Russia from the global financial messaging system known as SWIFT. The move, described by the French as a “financial nuclear weapon,” has pulled most major Russian banks away from a network that facilitates tens of millions of transactions every day, forcing them instead to lean towards their own much smaller version.

This had two implications. First, US sanctions on Russia have fueled concerns that the dollar could become more permanently an overt political tool, a concern shared primarily by China, but also beyond Beijing and Moscow. India, for example, has developed its own domestic payments system which would partially mimic SWIFT.

Second, the US decision to use the currency as part of a more aggressive form of economic governance puts additional pressure on Asian economies to choose sides. Without any alternative payment system, they would run the risk of being forced to comply or enforce sanctions they might disagree with and lose trade with key partners.

“The complicating factor in this cycle is the wave of sanctions and seizures on USD holdings,” said Taimur Baig, managing director and chief economist at DBS Group Research in Singapore. “Given this backdrop, regional measures to reduce USD dependency come as no surprise.”

Just as officials across Asia are loathe to pick a winner in the US-China fights and would prefer to maintain ties with both, US sanctions on Russia are pushing governments to go their own way. Sometimes the action takes on a political or nationalist tone, including outrage at Western pressure to adopt sanctions against Russia.

Moscow has been trying to get India to use an alternative system to keep the transactions moving. The spokesman for Burma’s junta said the dollar was being used to “bully smaller nations”. And Southeast Asian countries cited the episode as a reason to trade more in local currencies.

“Sanctions make it more difficult – by default – for countries and companies to stay neutral in geopolitical confrontations,” said Jonathan Wood, head of global risk analytics at Control Risks. “Countries will continue to weigh economic and strategic relationships. Businesses are caught in the crossfire more than ever as they face increasingly complex compliance obligations and other conflicting pressures.”

It’s not just sanctions that are helping to accelerate the de-dollarization trend. Rampant gains in the US currency have also made Asian officials more aggressive in their attempts to diversify.

The dollar has strengthened about 7% this year, on track for its biggest annual gain since 2015, according to a Bloomberg index of the dollar. The gauge hit a record high in September, when dollar appreciation drove everything from the British pound to the Indian rupee to record lows.

Huge headache

The strength of the dollar is a huge headache for Asian nations that have seen food prices rise, debt repayment burdens worsen and poverty worsened.

Sri Lanka is a case in point, defaulting on its dollar debt for the first time ever as a skyrocketing greenback crippled the nation’s ability to pay. Vietnamese officials at one point blamed the dollar’s appreciation on fuel supply struggles.

Hence moves such as India’s deal with the UAE, which accelerates a long-standing campaign to transact more in the rupee and set up trade settlement agreements that bypass the US currency.

Meanwhile, sales of dollar-denominated bonds by nonfinancial corporations fell to a record low of 37% of the global total in 2022. They accounted for more than 50% of debt sold in a year on several occasions over the past decade.

While all of these measures may have limited short-term market impact, the end result could be an eventual weakening of demand for the dollar. The shares of the Canadian dollar and the Chinese yuan in all currency exchanges, for example, are already slowly climbing.

Technological advancement is another factor facilitating efforts to move away from the greenback.

Several economies are chipping away at using the dollar as a byproduct of efforts to build new payment networks, a campaign that precedes the greenback’s rise. Malaysia, Indonesia, Singapore and Thailand have set up systems for transacting with each other in their local currencies instead of dollars. Taiwanese can pay with a QR code system linked to Japan.

All in all, the efforts are further drawing momentum away from a Western-led system that has been the bedrock of global finance for more than half a century. What is emerging is a three-tier structure with the dollar still very much in the spotlight, but increasing bilateral payment avenues and alternative spheres such as the yuan looking to capture any potential US overshoot.

And despite all the turmoil and action going on, the dollar’s dominance is unlikely to be called into question anytime soon. The strength and size of the US economy remains unchallenged, Treasuries are still one of the safest ways to store capital, and the dollar takes the lion’s share of foreign exchange reserves.

The renminbi’s share of all foreign currency transactions, for example, may have risen to 7%, but the dollar still makes up an 88% share of those transactions.

“It’s very difficult to compete on the fiat front – we have the Russians doing it by forcing the use of rubles, and there’s also caution with the yuan,” said George Boubouras, a three-decade markets veteran and head of research at the hedge fund K2 Asset Management in Melbourne. “At the end of the day, investors still prefer liquid assets and in this sense nothing can replace the dollar.”

However, the combination of moves away from the dollar pose a challenge to what then-French Finance Minister Valéry Giscard d’Estaing famously described as the “exorbitant privilege” enjoyed by the United States. The term, which he coined in the 1960s, describes how greenback hegemony protects the United States from currency risk and projects the nation’s economic power.

And eventually they could test the whole Bretton Woods model, a system that established the dollar as the leader in the monetary order, that was traded in a hotel in a sleepy New Hampshire town at the end of World War II.

The latest efforts “indicate that the global trading and settlement platform we’ve used for decades may be starting to break down,” said Homin Lee, an Asian macrostrategist at Lombard Odier in Hong Kong, whose firm oversees the equivalent of $66 billion .

“The whole web that grew out of the Bretton Woods system – the Eurodollar market in the 1970s and then financial deregulation and the floating rate regime in the 1980s – this platform that we have developed so far may start to change into way more fundamental sense,” Lee said.

Valuable lesson

The net result: The King Dollar may still reign supreme for decades to come, but the growing momentum for alt-currency transactions shows no signs of slowing down, particularly if geopolitical wild cards continue to persuade officials to go their own way.

And the US government’s willingness to use its currency in geopolitical struggles could ironically weaken its ability to pursue such methods as effectively in the future.

“The war in Ukraine and the sanctions on Russia will provide a very valuable lesson,” Indonesian Finance Minister Sri Mulyani Indrawati said at the Bloomberg CEO forum on the sidelines of the G-20 meetings in Bali last month.

“Many countries feel they can transact directly – bilaterally – using their local currencies, which I think is good for the world to have a much more balanced use of currencies and payment systems.”

–With assistance from Finbarr Flynn, Shruti Srivastava, Sudhi Ranjan Sen, Adrija Chatterjee, Daniel Flatley, Nguyen Dieu Tu Uyen, Yujing Liu, Anirban Nag, Claire Jiao, Grace Sihombing, Philip J. Heijmans, Jeanette Rodrigues, and Arun Devnath .

(Adds broker comment in 9th paragraph)

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