The share of U.S. dollar reserves held in central banks fell to 59 percent –its lowest level in 25 years – during the fourth quarter of 2020, according to the IMF’s Currency Composition of Official Foreign Exchange Reserves (COFER) survey. Some analysts say this partly reflects the declining role of the U.S. dollar in the global economy.

Economic analysts expect that the U.S. dollar’s share of global reserves will continue to fall as emerging market and developing economy central banks seek further diversification of the currency composition of their reserves. A few countries, such as Russia, have already announced their intention to do so.

Greenback’s rise

On July 1, 1944, as the battles of the Second World War raged in Europe and the Pacific, delegates from 44 countries met at the secluded Mount Washington Hotel in Bretton Woods, New Hampshire. Thus, the name Bretton Woods Agreement to create a new world order in the post-World War II era. The agreement instilled the dollar as the de facto global currency.

Under the agreement gold was the basis for the U.S. dollar and other currencies were pegged to the U.S. dollar value. By 1971, former U.S. President Richard Nixon ended the dollar’s convertibility to gold as U.S. balance of payments deficits led to foreign-held dollars exceeding the U.S. gold stock, implying that the U.S. could not fulfill its obligation to redeem dollars for gold any longer.

Although the Bretton Woods was short-lived, the dollar standard remained as the currency for international trade and the price of the commodity that made the global wheels run, i.e. price crude oil was fixed in dollars.

Today the dollar reigns supreme. The world’s biggest economy can print greenbacks at will to save itself from budget deficits, can lower or hike federal reserve interest rates to control the price of global crude and other commodities, can manipulate interest rates to pressure emerging and poor economies that hold their foreign reserves in the Greenback.

Recent U.S. Federal Reserve’s historic interest rate rises raised indebtedness of emerging economies. The Association of Southeast Asian Nations (ASEAN) members are exploring how to promote the use of local currencies in their bilateral trade.

Downward trend

According to the IMF the greenback’s share of global foreign-exchange reserves has extended a two-decade decline, but it’s still used more than all other currencies combined.

The dollar continues to play the role of number one global currency as the American economy has been producing a shrinking share of global output over the last two decades.

RMB bloc

Chinese trade and lending have been expanding in recent years as the renminbi (also known as yuan) use has risen.

With China’s share of global goods trade now around 15 percent, the renminbi’s reach will expand. The world’s second largest economy and the largest consumer of crude is bound to challenge the dollar’s hegemony with renminbi.

Kicking off his first visit since taking office in January to China, Brazilian President Luiz Inacio Lula de Silva attacked the U.S. dollar hegemony in international trade, asking “why can’t we do trade based on our own currencies?”

Lula called on developing nations to work towards replacing U.S. dollar with their own currencies in international trade. He called on BRICS (acronym for five regional economies: Brazil, Russia, India, China and South Africa) to come up with their own alternative currency for use of trade.

Prior to Lula’s visit, China and Brazil agreed to settle trades in each other’s currencies. France also recently conducted its first liquefied natural gas sale in renminbi.

The rise of the Chinese currency will take some time as only three percent of central bank reserves are in renminbi. The Society for Worldwide Interbank Financial Telecommunication (SWIFT) puts global transactions in renminbi at 2.5 percent, compared to 39.4 percent for the dollar and 35.89 percent for the euro.

Sanctions regime

The U.S. economic sanctions on many nations have prompted them to use alternative currencies and even barter trade for exchange of goods.

After sanctions were applied to Russia following the Ukrainian conflict and simultaneously many Chinese companies were sanctioned by U.S. and EU, transactions between the two neighbors shifted to renminbi.

Official data shows yuan became the most widely used currency for cross-border transactions in China overtaking the dollar for the first time.

Imports of Russian oil, piped-gas, coal and some metals from its neighbor were settled in renminbi. According to Reuters, the bilateral trade stands roughly at 88 billion dollars. This accelerates China’s efforts to internationalize its currency.

Iran and India established a rupee payment mechanism to eliminate dollar transactions. The state-owned United Commercial Bank (UCO) has been the primary payment settlement bank for India-Iran trade ties due to U.S. sanctions on Iran.

The payment mechanism to import crude from Iran had provided the state-owned lender good chunk of interest-free floating fund, which helped it reduce its cost of funds.

Last year in a meeting between Iranian Foreign Minister Hossein Amir Abdollahian and his Indian counterpart Dr. Subrahmanyam Jaishankar, Abdollahian pointed out that there are existing mechanisms within the framework of international law which can help in reviving the “banking and financial interaction”, pointing out that Tehran has implemented such a mechanism with a dozen countries already.

A landmark agreement was signed by Jaishankar and visiting Russian deputy prime minister Denis Manturov on April 18 in New Delhi, where India agreed to adopt the Russian SPFS financial messaging system for making banking payments to Russia.

The deal also allows acceptance of Indian Ru-Pay cards and India’s Unified Payment Interface (UPI) in Russia, and the Russian MIR cards and its Fast Payments Systems (FPS) in India.

Meanwhile, last year UCO Bank received the necessary approval from the regulator – the Reserve Bank of India – to open a special rupee account with Russia’s Gazprombank to facilitate trade between the two countries.

Conclusion

History has proven the emergence and decline of different currencies.

The ancient Mayans are believed to have used chocolate as money.

The British pound sterling, the oldest global currency still used today, anchored the global economy, until its fall in the early, mid and late 20th century.

The imminent sudden decline of the Greeenback is one of those things that can take every analyst by surprise.

The dollar’s share of global foreign exchange reserves fell from 70 percent in 1999 to below 59 percent in the last quarter of 2021, extending a two-decade decline according to IMF’s Currency Composition of Official Foreign Exchange Reserves data. However, it still remains the currency of choice for international trade, dominates exchange and debt markets

However, the greatest threat to dollar comes from central bank digital currencies, which can provide more efficient ways to settle transactions. The U.S. is waking up to this danger, but should accelerate efforts on digitizing the dollar.