The concept of “dedollarization” has gained significant traction in recent years, particularly as China seeks to reduce its reliance on the US dollar and promote the use of the yuan in global trade. Dedollarization refers to the process of reducing the dominance of the US dollar in international trade and finance. With the West’s imposition of sanctions on Russia during the Ukraine conflict, China has capitalized on an opportunity to push its agenda of an alternative, multipolar financial system.
The Rise of Dedollarization: The Russian Case
Sanctions imposed by the West on Russia over its invasion of Ukraine have significantly impacted Moscow’s ability to trade in major Western currencies like the US dollar and the euro. In response, Russia shifted towards other currencies, most notably the Chinese yuan. Russia’s energy trade with China, conducted increasingly in yuan, has become a critical element in the global dedollarization movement. According to data from China’s State Administration of Foreign Exchange (SAFE), yuan-denominated transactions between China and Russia have surged since the sanctions took effect.
This bilateral shift represents a larger pattern in which countries seek alternatives to the dollar, particularly in light of the West’s use of sanctions to freeze Russian foreign currency reserves. The West’s concern is that other countries, especially those in the BRICS bloc (Brazil, Russia, India, China, and South Africa), are observing this shift and may follow suit, potentially undermining the dominance of the dollar.
Key Reasons for Western Concerns
Erosion of Dollar Dominance
The US dollar has long been the world’s reserve currency, used in approximately 88% of global foreign-exchange transactions. This dominance grants the United States considerable geopolitical leverage and economic influence. As countries begin trading in yuan, the dollar’s share of global trade may decrease. Although the yuan still accounts for less than 7% of global foreign-exchange transactions, its growing role in trade deals, particularly between China and key energy suppliers like Saudi Arabia and Russia, signals a shift in global financial power.
The Western concern here lies in the strategic importance of the “petrodollar” system, where oil has been traded primarily in US dollars. As nations like Saudi Arabia consider using the yuan for oil sales to China, this raises alarms for the West, as it could destabilize the dollar’s position in global energy markets.
Geopolitical Implications
The dedollarization movement is not purely an economic trend—it is also deeply political. The US dollar’s dominance gives Washington leverage in international diplomacy. The ability to impose economic sanctions and freeze dollar-denominated assets is a powerful tool in maintaining global order from the West’s perspective. However, as countries diversify their reserves into currencies like the yuan, they reduce their vulnerability to US sanctions.
Many countries in the Global South, wary of Western financial hegemony and the risk of their assets being frozen, are increasingly considering alternatives. If dedollarization accelerates, the United States could face greater challenges in using economic tools as instruments of foreign policy. This loss of financial leverage is a major concern for Western policymakers, especially as China, a geopolitical rival, expands its influence through its currency.
Economic Risk
A rapid move away from the dollar could have significant economic consequences for the United States and its Western allies. The US benefits from the dollar’s status as the reserve currency, allowing it to borrow cheaply and run large deficits. Should global demand for the dollar diminish, it could lead to higher borrowing costs for the US government, increased inflationary pressures, and instability in global financial markets.
While the dollar remains dominant, a gradual erosion of its status could make it more difficult for the United States to finance its debt and maintain its current level of economic influence. This has particularly worried Western financial institutions, as a shift in reserve currency dynamics could lead to volatility in global financial markets, including fluctuations in exchange rates, interest rates, and investment flows.
China’s Strategy for Dedollarization
China’s strategy for dedollarization is multifaceted and gradual, aiming to internationalize the yuan while avoiding the risks of currency speculation and financial instability. The yuan is still not fully convertible, and China maintains strict capital controls, which limits its utility as a global reserve currency. Nevertheless, Beijing is pushing for more yuan-denominated trade deals, particularly with countries in Asia, Africa, and Latin America.
One of the most significant developments in China’s dedollarization strategy has been its bilateral trade agreements with countries like Saudi Arabia, Iran, Brazil, and Argentina. These countries have started conducting more trade in yuan, reducing their dependence on the dollar. In the case of Saudi Arabia, China has signed a currency swap agreement, allowing for greater flexibility in settling oil transactions in yuan. While a full shift away from the petrodollar system is unlikely in the short term, these moves indicate China’s long-term ambition to challenge the dollar’s dominance.
Why the Yuan is Not Yet a Threat to the Dollar
Despite these concerns, there are several reasons why the yuan is not yet a serious threat to the dollar’s global dominance:
- Limited Global Acceptance of Yuan Although yuan-denominated trade has increased, the currency is still not widely used outside of China’s bilateral agreements. Its share of global foreign-exchange transactions remains small compared to the dollar. Moreover, international confidence in the yuan is hindered by China’s opaque financial system, capital controls, and the government’s heavy influence over its currency.
- China’s Economic Challenges China’s economy, while the second-largest in the world, faces significant internal challenges, including high levels of debt, a property crisis, and trade tensions with the West. These issues could slow the yuan’s rise as a global reserve currency, as they raise questions about the stability of China’s financial system. Additionally, China’s reluctance to fully open its capital markets to global investors reduces the yuan’s attractiveness as a reliable store of value.
- US Dollar’s Resilience The US dollar continues to benefit from its deep and liquid financial markets, robust institutions, and relatively stable economy. Moreover, many global investors view the US dollar as a safe haven during times of economic and geopolitical uncertainty. These factors make the dollar resilient, even as countries explore alternatives like the yuan.
Conclusion
While China’s dedollarization movement is gaining traction, particularly through its trade with Russia and other BRICS nations, the yuan is far from displacing the US dollar as the world’s reserve currency. The West is rightly concerned about the geopolitical and economic implications of dedollarization, particularly the potential erosion of the dollar’s dominance and the accompanying loss of leverage in international affairs. However, systemic challenges within China’s financial system and the enduring appeal of the US dollar mean that dedollarization is likely to be a gradual, long-term process rather than an imminent disruption.
References
- Atlantic Council’s Dollar Dominance Monitor
- Financial Times report on yuan internationalization
- Hanns Günther Hilpert’s analysis from the German Institute for International and Security Affairs
- Interviews with Maia Nikoladze from the Atlantic Council GeoEconomics Center
