The future of dollar dominance: threats and alternatives

Although there is no immediate threat on the horizon that could end the dominance of the dollar in the near future, the hegemony of the greenback is increasingly under threat, according to Vikram Rai, senior economist at TD Bank.

Possible Changes in the Global Monetary System

Although still in the early stages, there are alternatives emerging that could one day weaken the power of the dollar, creating a less concentrated currency regime.

“Over the next few decades, there is a great potential for the emergence of regionally dominant currencies and a multipolar international regime, in which the roles currently played by the dollar will be shared with the euro, a more open yuan, future central bank digital currencies, and potentially other options we have not yet seen,” Rai wrote in a letter to clients on Tuesday.

Dollar Still on the Throne

For now, the dollar still reigns as the most widely held reserve currency, a trend that has remained unchanged since World War II. It also represents 50% of global trade invoicing and is a key asset in bond issuance and cross-border banking.

Growing Frustration with Dollar Dominance

Although the United States benefits from these characteristics, frustration with dollar dominance is growing, Rai noted.

Analyzing this situation, Rai and other analysts point to the West’s decision to freeze Russia’s foreign exchange reserves after the country attacked Ukraine last year.

Since then, central banks around the world have been filling their reserves with gold to reduce their exposure to the dollar. Meanwhile, China is promoting the use of the yuan in numerous global transactional agreements, such as with Brazil, India, and Russia.

Petrodollar Under Pressure

Rai also noted China’s efforts to use the yuan in oil trading, which threatens the long-standing reliance on the dollar in commodity markets.

“The threat to the ‘petrodollar’ is significant, both economically and symbolically. The convention of Saudi Arabia and other OPEC exporters pricing their oil exports in dollars has supported demand for dollars, as every country that trades in oil markets must hold them,” he said.

Difficulties in Dethroning the Dollar

However, a full dethroning of the dollar would require time. Although the euro is another serious rival to the greenback, both it and the yuan struggle in comparison to the reliability of the dollar. Compared to the safe haven attribute of US bonds, euro-denominated bonds often do not come from the same government, reducing their credibility.

Meanwhile, the yuan is neither freely convertible nor widely accessible, Rai added. Other analysts also point out that it is hampered by China’s tight controls, making it ill-suited to free market flows.

Factors Accelerating the De-dollarization Process

Some factors can accelerate the de-dollarization process. Central bank digital currencies are one such threat, with many countries already working on this technology. If adopted, such tokens could eliminate the need for the dollar in payment settlements.

Simultaneously, disruptive events also pose a threat to the dollar, according to Rai. Although recent US defaults have been averted, similar episodes in the future could shake international confidence in the currency and hasten its decline.

Further Challenges on the Horizon

Other challenges may also arise in the coming years, such as the idea of a common currency among BRICS countries.

“A full-fledged currency union among such diverse economies is unlikely, but the announcement signals a commitment to conduct a greater portion of their trade and finance without the dollar,” Rai said.