Dollar’s Global Status: Not Dead, Not Immortal

The assault on the US dollar’s near-monopoly role in international trade, finance and foreign-exchange reserves is intensifying. Oil is a vital front in that assault. Exaggeration is rampant from dollar attackers and defenders alike. The dollar will not cease to be the most widely used trading currency soon, and it certainly won’t disappear as long as the US holds together. But neither does overwhelming dollar dominance today ensure overwhelming dominance tomorrow or forever. Washington’s ability to enforce sanctions, smooth and transparent functioning of global commodity markets, and perhaps the US’ ability to live on relatively cheap credit are all at risk. The intensity and timing of those risks is unclear. But much of the world wants alternatives for the dollar’s international functions — not to replace the currency, but to create scalable means of bypassing US controls. Diminishing Washington’s power and prestige, whether as a goal or a side-effect, is part of the package.

The ground is shifting under the petrodollar, just as it is under many things in the Middle East since December, when Chinese President Xi Jinping, while in Riyadh, offered the Mideast Gulf countries oil and natural gas purchase guarantees and access to clean-energy and digital technologies, with payment in yuan. No fewer than 34 memorandums of understanding were signed with Saudi Arabia, and large Chinese investment will probably follow.

Barely three months later, longtime adversaries Saudi Arabia and Iran traveled to Beijing to sign an accord to re-establish diplomatic relations — with Saudi investment in Iran also mooted. While that may be premature, Riyadh quickly followed Iran into preliminary membership in the Chinese-Russian-Central Asian Shanghai Cooperative Organization, another sign of how fast alignments are shifting.

Just as the offers Xi made to the Saudis and other Gulf states in December mirror and expand on the aging US Petrodollar Accords, the Iran-Saudi agreement serves to a degree as a China-mediated substitute for US security guarantees for the Saudis and their Gulf neighbors.

These offers and accords may well also mark an end to the dollar’s monopoly in Mideast oil trading. Again, this doesn’t mean that the dollar won’t be used in any Mideast oil purchases, or that dollar benchmarks and spot assessments will no longer be the base off which most oil is priced. It means other currencies and perhaps non-dollar benchmarks will start to be used too, probably slowly at first but perhaps gaining momentum and making markets less transparent — as is already the case with Russian oil.

In February, Iraq’s central bank announced it would allow trade with China to be settled directly in yuan. Whether this will extend to oil is still unclear. India is widely reported to be paying for Russian crude in rubles and United Arab Emirates (UAE) dirham. Both the UAE and Qatar have had renminbi/yuan clearing banks around for a decade. TotalEnergies sold an LNG cargo to China National Offshore Oil Corp. in late March with settlement in yuan through the Shanghai Petroleum & Gas Exchange.

Why Now?

Why is this happening now? In a word, sanctions. Countries want to reduce vulnerability to what many see as Washington’s heavy-handed and impulsive use of unilateral and third-party sanctions and its use of international financial infrastructure for enforcement. This resentment was brought to a head by US blocking of access by most Russian banks to the supposedly internationally controlled Society for Worldwide Interbank Financial Telecommunications (Swift), and its freezing of some $300 billion in Russian foreign exchange reserves.

China sees US sanctions as a powerful weapon it wants to remove from the US arsenal. Besides pressing its commodity suppliers to short-circuit the dollar, Beijing is creating a new financial infrastructure to get those relationships outside Washington’s control, including equivalents to the International Monetary Fund (IMF), World Bank and, of course, Swift.

The tremors rippling through the financial system after the rapid run-up in dollar interest rates by the US Federal Reserve Board over the last year to cool domestic inflation are adding to dollar disaffection. The Fed’s rapid reversal of more than a decade of negligible interest rates led to capital flight from many developing economies into dollars. Central banks across the globe felt compelled to undermine domestic economic growth by raising their own interest rates. It appeared to the world that the Fed was ignoring the negative impact of its actions outside the US.

What Next?

To underscore the obvious: Nobody knows where all this is heading. What we do know is that the renminbi and other currencies are gaining on the dollar in both trade finance and foreign-exchange reserves — albeit off a very low base. The Financial Times reported recently that the renminbi had doubled its share of the value of trade finance over the last year to 4.5%, an amount still dwarfed by the dollar’s 86.8% share. Foreign exchange reserves are more diversified. China’s share is at just 2.45%, but the US share has gradually slid this century to 59.54%.

It’s likely the future will see more and faster shifts away from such heavy reliance on dollars in international trade, with oil out front. Dollars are more convenient to use and offer much more effective hedging of price and other risks. But inconvenience and weak hedging are a price several countries seem willing to pay to diminish exposure to US sanctions.

To make such shifts practicable, digital communications systems established to bypass Swift must be hardened and enlarged. Russia has already done this to a considerable extent — spawning the “de-dollarization” phrase — and China and others are working on it. China’s instrument for this, its Cross-Border Interbank Payment System reportedly has more than 1,300 participants in over 100 countries and regions.

Many expect central bank digital currencies (CBDC) to be the best bypass of Swift in the longer term. The central banks of China, Hong Kong, the UAE and Thailand completed a multi-CBDC pilot last year, involving 20 banks and 164 real payments over six weeks. That’s tiny, of course, as pilots are. The question is whether and when scaleup comes. The UAE looks to be angling for a major intermediary role in digital monetary transactions.

With settlements for its oil sales now mainly non-dollar, Russia is aiming to also get "national price indicators" for crude and products. Many have tried to get away from Western benchmarks and assessments to little avail, but with a narrow field of sympathetic buyers, it’s conceivable Russia could make progress. Who knows?

Does It Matter?

Other commodities are in line for a non-dollar pricing component, too. Both the Brics organization and Brics member Brazil could be big in this. Brics members Brazil, Russia, India, China and South Africa have all expressed interest in alternatives to the US currency in various functions, and a Brics summit this August in South Africa bears watching. Argentina and Iran have applied to join, and Saudi Arabia is among others indicating interest.

Brazilian President Luiz Inacio Lula da Silva on a state visit to Beijing in early April signed an agreement with Xi to settle trade between the two countries in their own currencies. Lula also called on Brics to create a new trading currency to replace the dollar. Talk of a Brics currency is very preliminary, and a currency basket akin to the IMF’s Special Drawing Rights could be tried out on a small-scale basis first. This is not a clear and present danger to the dollar. It is an expression of the breadth of dissatisfaction with the global financial system as it currently operates.

China isn’t aiming to substitute the renminbi for the dollar. Beijing doesn’t want to accumulate huge piles of debt in the form of government bonds to facilitate reserve holdings, as the US has done, or accept an inflated exchange rate that kills manufacturing for export and encourages consumption of imports. What Beijing and others want is a multilateral approach that buffers them from US sanctions and monetary policy.

What that will mean for the US remains to be seen. The likely negative impact on sanctions enforcement is clear. How potentially higher borrowing costs would balance against exchange rate benefits to domestic manufacturing is less clear. Whether a diminished dollar role will be taken as a national humiliation and how that would play out politically are other unknowns. In any case, barring war, it probably won’t play out quickly. But it is playing out and shouldn’t be ignored.

Sarah Miller is a former editor of Petroleum Intelligence Weekly, World Gas Intelligence and Energy Compass.