Living in the COVID World ... and Beyond #35: Dedollarization of the Global Economy

There are a lot of challenges in the world today – the climate crisis, multiple wars, threats of nuclear war, global inequality.  The list goes on and on.   And all of these challenges are happening within a global economy that directly or indirectly stimulates the challenges and makes finding solutions more difficult.

What is happening in the global economy that we might need to pay attention to?

One significant trend is the dedollarization of the global economy.

Let me start by explaining how there has tended to be a single dominant currency for the exchange of goods and services across country boundaries.   For many years, it was the British pound during the time when the British empire stretched across the world from Australia to Hong Kong to India to Kenya to Canada.   The implication of the British being the dominant currency is that when traders sold goods, they would request payment in British pounds rather than a local currency.   

Since World War II, the U.S. dollar has been the dominant global currency.   Trade for the last 60+ years has most often been facilitated by the use of U.S. dollars.   One glaring example of how dominant the dollar has been, and many of you might remember the introduction of this term in the 1970’s, is that the trading of oil was done in dollars creating the term petrodollars.    Because of the need to use dollars for trade and because of the strength and stability of the United States economy, central banks in countries around the world have held dollars in their reserves.   The US economy directly and indirectly benefitted from the US dollar being the reserve currency of choice and from the US dollar being the primary means of facilitating exchanges of goods and services between countries.   Essentially this activity created a virtuous cycle for the U.S. dollar – the more it was in demand, the more it was used, the stronger the dollar became, and then it was even more in demand. 

So, what does it matter that the dollar is strong?

At an individual or business level, some people notice the strength of the dollar because the US dollar can buy more when you go on a trip outside of the US than a weaker dollar could.  Or that imports into the US are relatively cheaper to buy.  Or that US exports are relatively more expensive for non-US citizens to buy.

At a national level for the United States, a strong dollar means easier access to capital and lower borrowing costs which supports the US government to run a deficit, both in terms of the federal budget and international trade.

However, there is a trend in recent years, and there are more indications all the time, that the global economy is likely going through what is being called a period of dedollarization.   Some countries are beginning to trade cross-boundaries using their own currencies, not US dollars.  Many factors are contributing to this de-dollarization including the extent of the US federal government debt, political polarization in the US, the Russian invasion of Ukraine and the freezing of Russia’s foreign currency assets, many countries’ desires for autonomy and independence from US economic power, and China’s desire to exert an increasing influence on the global economy.

No one expects dedollarization to happen overnight … it will take some years even assuming the current trends continue.  Long-term there would likely be significant implications for the United States.   Those implications could be less access to capital and higher borrowing costs for the US government and businesses and this would cause less growth, less tax dollars, overall belt-tightening or reduced spending by the federal government, and less government services for its citizens.

The US has benefited from global agreements made in 1944 to have the US dollar function as the global currency.   There is no reason to believe that this agreement will continue indefinitely.   And there are many indications that things have already started to change.