The current buzzword in the market is de-dollarisation, the notion that countries will stop using the US dollar as the world’s reserve currency and conduct trade without the US dollar as an intermediary. While the notion is not new, new light has been shone on it lately, partly in the wake of the Russia-Ukraine War, China and Russia doing deals in Yuan, and the Brazilian prime minister statement that his country should stop using the US dollar to trade. While the premise makes sense, the execution thereof is a lot more difficult. Talk of changing US Dollar dominance has been around for ages. The good reasons why this has not happened we explore below.

First, there has been a drop in the reliance of the US dollar in the last 20-odd years. If we look at the data, we see that the reserve amount to be held in US reserves was 71.9% in 1999, and that has dipped to 59.15% in 2022. It is a sizeable dip, but a closer examination reveals that the developed economies have gained in reserves, and not emerging market currencies. Responsible for the decline is not emerging market currencies such as Russia or China but developed economies, commodities, and, nowadays, probably crypto. In the same period, the share of the Euro rose from 18.12% to 20.48%, the share of the Sterling rose significantly from 2.79% to 4.78%, while the share of the Yen is basically unchanged from 6.03% down to 5.83%.

The dip in the dollar leads one to the question: Why is the US dollar important?

A simple answer is that the US dollar facilitates quick and effective trade between various trading partners.

Take South Africa as an example: if South Africa were to export goods, the transaction would be conducted in US dollars. These dollars could be used to conduct business with countries from which South Africa imports. As shown in the graph below, the US dollar is still involved in 80% of FX transactions, and more than 50% of payments are made in US dollars.

With most of the trading in the global market happening in the US dollar, this leaves us in a situation where countries might have excess US Dollars. Through local banking channels, US Dollars ultimately arrive at the Central Bank, which is responsible for managing these reserves.

Capital preservation and Liquidity are two of the primary objectives of the SARB. This essentially means that the SARB must avoid credit risk and obtain returns from deep and liquid markets, where there is minimal risk if the asset must be liquidated.

Where is the safest place to place the excess US dollars? The most obvious answer is the US Treasury market, as it meets the requirements of the SARB and other central banks by being large, liquid, and easy to liquify the asset. Additionally, there is minimal red tape, and it is well-regulated.

While we had a look at the excess FX funds, what about debt? US-denominated debt should play an important part as to why the US dollar will not lose its status as a reserve currency.

The world, excluding the United States, currently sits on $12 trillion of dollar-denominated debt, because in a world where US dollars drive international trade, you need US dollars to finance global businesses. In order to de-dollarise, an unwound of this would be needed. A task far greater than can be achieved without a change in the world order or protracted wars of biblical proportions.

Should a country try and walk away from its US dollar trades, it will shoot itself in the foot with the US dollars needed to repay the US dollar debt. One might argue is there an orderly way to unwind the debt into a different instrument or country, and looking at the alternatives, this is not feasible, as we explain below.

Using our first graph as a guide, let’s look at the countries listed there:

  • Euro: The monetary system is fragile at best, with a lot of moving parts between the member nations. The only country that offers the assurances that Central Bank needs for FX Reserves, Germany, has been stuck in austere governance for the past decade.
  • Japan: The market for Government bonds is very illiquid, as the Central Bank of Japan owns 60% of the bonds in the market. This will not satisfy the demands of other Central Banks.
  • EM’s: In its very essence, the EM’s space is very volatile. We have capital controls in China, wars and sanctions in Russia, and corruption and high inflation in South Africa and Brazil. Would any Central Banks of the world feel “safe” in this market?

While the calls for the US dollar to cease have grown ever louder over the last couple of years, the reality is that while it might happen in the distant future, the swift change that some in the markets have been touting is very unlikely to happen.