The de-dollarization trend is accelerating: How it will impact your investments
Meanwhile, global central banks have been adding gold to their coffers, rather than stocking up on the dollar. In 2022, central banks bought a whopping 1,126 tonnes of gold—the highest since 1950. They have been buying gold at the fastest pace since 1987. Further, multiple countries have started exploring settlement of cross-border trade and investments in their own or alternate third-party currencies, ditching the dollar as the intermediary. This visible shift towards de-dollarisation represents a critical transformation and reshaping of the world order. It has implications for asset prices as well. In this week’s cover story, we discuss why the de-dollarization trend is accelerating and how it will impact your investments
US dollar’s share in forex reserves has declined
The dollar’s prominence among global reserve currencies has fallen.
Why faith in the dollar has been shaken
Why are countries stepping away from the comfort of the dollar? Only two years ago investors were running to the safety of the greenback in the aftermath of the pandemic. Vikas Gupta, CEO and Chief Investment Strategist, OmniScience Capital, remarks, “It represents a paradigm change. It was unthinkable before but today countries that would not even consider it are actively exploring alternatives to the dollar.” The big push is owing to the US government’s reckless monetary policies in recent years. It is perceived that the US takes undue advantage of its position as the owner of the world’s reserve currency. For several years,it resorted to profligate money printing to prop up its economy, disregarding the negative spillovers its actions caused in other economies, particularly emerging countries.
After flooding the globe with excess money, the US then resorted to unprecedented rapid monetary tightening to tame the spiraling inflation. This caused severe disturbances globally. A stronger dollar made inflation worse, as imports of many commodities, which are paid for in dollars, became even more expensive. It singed countries with high foreign debt, which is dollar-denominated. Emerging countries had to fight off capital outflows and currency depreciation.
Further, increasing ‘weaponisation’ of the reserve currency is another reason why countries are shying away from the dollar. The US government’s unrelenting use of monetary sanctions as a strong-arming tactic against hostile nations has made even neutral countries uneasy. The freezing of billions of dollars’ worth of Russia’s assets by the US got many countries to reassess their own dollar-heavy reserves. It has already prompted nations targeted by sanctions to find alternate arrangements to bypass the sanctions. But tellingly, it is also spurring other nations to be less reliant on the dollar. “Even friendly nations are rethinking their dollar dependency,” observes Gupta.
Ultimately, the need for a more diversified and resilient global financial system—one that is less susceptible to the foibles of a single, dominant currency—is slowly pushing the world towards weaning away from the dollar. Chirag Mehta, CIO, Quantum AMC, argues, “The de-dollarisation narrative is for real and has been shaping up for some time.”
“Void left by the dollar will be positive for gold. The share of gold in countries’ forex kitties has been rising and that trend is here to stay.” CHIRAG MEHTA, CIO, QUANTUM AMC
No worthy challengers
Even though it is losing its earlier vicelike grip over global exchange, it would be naïve to suggest that the dollar’s demise is near. It will not be easy or even desirable for the world to completely shed reliance on the dollar. The dollar still offers several benefits that other alternatives cannot, for now. The sheer heft and stability of the US economy coupled with the free convertibility of the dollar are not found anywhere else. The Chinese Yuan has the economic might to back its claim to the throne but tight capital controls derail its global ambitions. The Euro offers the easy convertibility of the dollar but is held back by the shaky economic and political ballast of the European Union. Besides, the US boasts the world’s deepest and most liquid financial market, burnishing its credentials as the owner of the world’s reserve currency.
Joseph Thomas, Head of Research, Emkay Wealth Management, asserts, “The dollar has the backing of the largest open economy with a sound, well-managed financial system.” Additionally, the inconvenience of making the switch to alternative arrangements is itself a big deterrent. Any developing countries transitioning away from the US dollar face prospects of heightened exchange rate volatility, hurting trade, investment and capital flows. “As long as the US is the largest open trading economy, as long as everyone in the world wants access to the US economy, and as long as it is a lot of work and a great inconvenience to switch, the position of the dollar as the global reserve currency is secure,” remarks Brad MacMillan, CIO, Commonwealth Financial, in a blog. This reality is underscored by how the dollar has largely held strong amid all the chatter around its fading power.
Russia and China want to diversify away from the US dollar
Several other nations are also trying to reduce their reliance on the greenback.
“Whenever the world goes through turmoil, gold always performs. In recent weeks, everyone has fled towards gold with banks failing.” KALPESH ASHAR, FOUNDER, FULL CIRCLE FINANCIAL PLANNERS AND ADVISORS
Kalpesh Ashar, Founder, Full Circle Financial Planners and Advisors, observes, “It is a strange paradox that despite all perceived problems plaguing the US economy, the dollar has not materially weakened by any yardstick. Even digital currencies have spectacularly failed to offer a viable alternative.” This is not to suggest that the dollar is infallible. Powerful currencies can and do collapse, but it needs a big enough trigger— a significant political or economic event that destabilises the domestic economy. The British pound was the go-to currency for the world before World War I ravaged the local economy and its currency. This pushed the world into the arms of the US dollar, a position it solidified in the post World War II environment. It will take a similar catastrophic event or severe domestic instability to sink the dollar.
India is also shoring up gold reserves
Gold as a percentage of total reserves has gone up from 6.5% at the start of 2021 to 8.7% in 2023.?
“The dollar can only lose its status naturally; it cannot be forced,” insists Thomas. Experts maintain the dollar is not likely to be dethroned anytime soon, and certainly not by any one currency. There is no strong contender for an alternative global reserve currency. Mehta argues, “The dollar will still remain the reserve currency of choice given lack of a credible alternative.” Instead, what is more likely to emerge is a multi-polar system, with the world getting broken into groups of nations with common currencies, akin to the European Union. India could be part of one such grouping. Brazil, Russia, India, China, and South Africa, collectively known as the BRICS, are reportedly trying to develop their own common currency. But there are various challenges to running such currency blocs and may not even see the light of day.
How should one counter a waning dollar
With de-dollarisation likely to play out in some form, it will create disturbances across the globe. Any upheavals spurred by the transition towards a less dollar-reliant world are likely to play into the hands of gold. Investors will seek a safe haven amid the turmoil, which can only be offered by the yellow metal. As already pointed out, global central banks are beefing up their reserves with gold. This is indicative of their trust in the precious metal as a store of value. Mehta asserts, “The void left by the dollar will be positive for gold. The share of gold in countries’ forex kitty has been rising and that trend is here to stay.”
“It was unthinkable before but today countries that would not even consider it are exploring alternatives to the dollar.” VIKAS GUPTA, CEO AND CHIEF INVESTMENT STRATEGIST, OMNISCIENCE CAPITAL
Kirtan Shah, Founder and CEO, Credence Wealth Advisors, reckons gold can also play a role in de-dollarisation as it is per- ceived as the only alternative safe haven asset. The ongoing banking crisis in the US is already driving worried investors into the safety net of gold. If the perception about dollar weakens further, it is natural that sentiment will keep gold prices buoyant for some time. Experts insist on maintaining 10-15% allocation towards gold as a diversifier in the portfolio. Ashar points out, “Whenever the world has gone through such phases of turmoil, gold has always performed. In recent weeks, everyone fled towards gold when banks started failing.” Further, any transition away from the dollar is likely to bring exchange rate fluctuations, which will feed into asset prices.
Only Euro is a viable challenger in global payments
After the emergence of Euro, less than half of global trade is invoiced in dollars.
Currency swings may be pronounced, impacting any foreign investments. If you have dollar-denominated investments in the form of international equity funds, be prepared for higher volatility in returns. The dollar has been trading weaker amid banking troubles in the US and possibility of rate cuts by the Federal Reserve in the coming year. A weakening dollar may even shave off some of the returns. “If the dollar recedes, value of investments held in that currency will fall,” comments Shah. But this does not necessarily weaken the case for having US centric funds in your portfolio. The US continues to offer investors the chance to tap into high-growth, innovative businesses with wide geographical reach. Investors can explore other alternatives but only after building adequate allocation to the US market. Shah says, “To achieve global diversification in the portfolio, I don’t think there is a better alternative than US dedicated funds.” However, Mehta wants investors to give more prominence to gold as a diversifier and risk mitigant.
But it has slipped against global currencies in past 18 months
Bypassing the dollar
- In December 2022, China and Saudi Arabia signed a new partnership agreement with future energy purchases paid in yuan. For the fi rst time in decades, Saudi Arabia said it is open to trading its oil supplies in currencies other than the US dollar
- In January 2023, Iran and Russia agreed to connect their interbank messaging systems and bypass the US denominated SWIFT banking communication and transfer system. Argentina and Brazil proposed a common currency for trade.
- In March, the world’s second largest economy China and Latin America’s biggest economy Brazil announced that they will conduct bilateral trade in local currencies, circumventing the dollar.
- In April, India and Malaysia agreed to settle trade in Indian rupees. India already pays Iran in rupees for crude and compensates Russia in rubles for crude and defence systems.
- In May 2023, South Korea and Indonesia signed a MoU to promote bilateral trade in national currencies, moving away from the US dollar.
