The de-dollarization trend is gaining momentum, and the Federal Reserve’s recent actions are contributing to this shift, according to insights from the Atlantic Council. While geopolitical motivations, such as responses to sanctions, play a role, economic fundamentals driven by the Federal Reserve’s policies are also significant factors in the move away from the greenback.
The Impact of Fed Rate Hikes:
The Federal Reserve’s rate hikes, coinciding with Russia’s invasion of Ukraine, have made dollar borrowing more expensive and scarcer. Authors Niels Graham and Hung Tran highlight how these rate hikes, taking effect in the aftermath of geopolitical events, have led emerging market firms to explore alternatives to the dollar, with a notable focus on the Chinese yuan (RMB).
Economic Fundamentals in De-Dollarization:
Beyond geopolitical motives, the Atlantic Council emphasizes economic fundamentals. The Fed’s aggressive hiking cycle has increased the cost of short-term borrowing in dollars. For the first time in two decades, pursuing short-term borrowing in yuan has become considerably cheaper than in the greenback. The widening interest rate differential and the dollar’s appreciation have prompted emerging markets to seek alternatives.
Cheaper Yuan-Denominated Debt:
China’s ability to maintain stable interest rates due to muted inflation has allowed international firms to take advantage of cheaper, yuan-denominated debt. The Atlantic Council underscores that even without geopolitical pressures, the shift away from the dollar would still be driven by the cost advantages associated with borrowing in yuan.
Fed-Induced Dollar Appreciation:
The Fed’s rate hikes have led to dollar appreciation, with the greenback remaining approximately 10% above its pre-2022 average. The uncertainty caused by Russia’s invasion of Ukraine has further strengthened the dollar’s position as a safe-haven asset. However, this surge in demand has limited dollar availability, leading to a decline in credit for borrowers relying on short-term greenback funding.
Adoption of Yuan and China’s Global Finance Infrastructure:
To overcome the challenges posed by restricted dollar availability, global firms are increasingly turning to yuan-denominated debt. Beijing’s promotion of RMB-denominated lending has facilitated this shift. The use of Beijing’s Cross-Border Interbank Payment System, an alternative to the SWIFT system, has seen rapid growth, especially during periods of constrained dollar availability.
Looking Ahead:
While the Fed may start a rate-cutting cycle, the era of ultra-low interest rates that provided a dollar cost advantage is unlikely to return. Despite the yuan’s limitations as a free-floating currency, macroeconomic trends suggest that emerging market firms will continue to embrace RMB-denominated debt for trade financing, further amplifying the use of the RMB in international trade.
Conclusion:
The evolving landscape of de-dollarization involves both geopolitical considerations and economic factors influenced by the Federal Reserve’s policies. As emerging markets seek alternatives to the dollar, the yuan emerges as a cost-effective option, with China’s global finance infrastructure gaining traction. The Federal Reserve’s role in shaping these dynamics underscores the complex interplay between economic fundamentals and geopolitical shifts in the international financial landscape.
