De-dollarization: Between Speculation and Reality

Economics may be excessive. It has a dream, and maybe also pride, to try to explain various things, including issues of marriage, gossip, and others.

Gary Becker, winner of the 1992 Nobel Memorial Prize in Economic Sciences from the University of Chicago, for example, wrote "A Theory of Marriage"; Esther Duflo and Abhijit Banerjee, both winners of the Nobel Prize for economics from MIT, wrote the treatise "Using Gossips to Spread Information" (Banerjee, Chandrasekhar, Duflo, and Jackson, 2019).

I do not want to add to the list and could be wrong, but the concept of dating may be a simple example of what economists call “a double coincidence of wants” (reciprocal desire of both parties).

Dating generally happens when both parties "equally want" it, or possess reciprocal interest. It reminds me of the barter economy: exchange, or transactions, between two parties occur because what the first offers is suited to what the second party is asking for, and vice versa. In practice, finding this compatibility is not easy. Imagine: someone who wants to exchange rice for meat may not be able to find another party that wants to exchange meat for rice.

Also read:

> Indonesia Continues 'De-dollarization'

> Relationship between US Dollar and Oil Prices

The complexity of living in the barter era can be imagined. Transactions can only occur if there is a double coincidence of want. Making trade transactions is almost as difficult as finding a partner. Maybe I am excessive, but the barter economy has a complicated process of transaction and coordination. People then look for a way by creating an intermediary as a medium of exchange that can be used by all or many parties.

It is said this was the start of the history of money. The sentence "used by all or many parties" is important. The smaller the number of parties "that uses money as a medium of exchange", the higher the level of difficulty, or transaction and coordination costs.

De-dollarization trigger

The illustration above is important in the recent appearance of the issue of de-dollarization. Geopolitical tension between Russia and Western countries has led to sanctions against Russia. Russia cannot conduct international transactions in United States dollars. It then looked for other exchange tools, such as renminbi (RMB).

The ball kept rolling. In addition to Russia, several countries also began to draft memorandums of understanding (MoUs) on bilateral cooperation using RMB. Argentina and Pakistan, for example, agreed to use RMB in their trade with China.

The ball kept rolling. In addition to Russia, several countries also began to draft memorandums of understanding (MoUs) on bilateral cooperation using RMB.

President Xi Jinping also visited Saudi Arabia and discussed the possibility of using RMB for Saudi oil exports to China. Brazil and China also announced the opening of offshore RMB clearing banks to facilitate clearing RMB in Brazil.

In April 2023, Alexander Babakov, a deputy chairman of the Russian parliament, the State Duma, said Russia had pushed the use of new currencies based on a basket of currencies consisting of the Brazilian real, Russian ruble, Indian rupee, Chinese RMB, and the South African rand. These currencies are to be used by Brazil, Russia, India, China, and South Africa, or BRICS countries, in their transactions.

This series of events raised questions and speculation over whether there will be de-dollarization. This speculation was further strengthened on seeing the data that the role of US dollars in foreign exchange reserves at many central banks in the world had declined.

Is this true? It seems we must be careful about drawing conclusions from this phenomenon.

The important question that must be answered is whether de-dollarization will occur. Will RMB replace the role of the US dollar as a reserve currency? To answer this question, a number of things must be considered.

First, the data does show that the share of the US dollar in foreign exchange reserves at many central banks around the world decreased in 2022. Is this a sign that de-dollarization has happened?

Also read:

> Energy Crisis, US Dollar and Recession

> Direction of US Central Bank Policy

Barry Eichengreen, a professor of economics at the University of California, Berkeley, pointed to two reasons for this decline, namely (1) the appreciation of the US dollar forced many central banks in the world to intervene in order to maintain exchange rates. Interventions to prevent the depreciation of local currencies resulted in the banks releasing their dollars, so of course the dollar foreign exchange reserves dropped as a result.

Then, (2) US interest rate hikes resulted in a decline in the price of US dollar bonds. Because many foreign exchange reserves are placed in assets that are sensitive to interest rate hikes, such as bonds, foreign exchange reserves in US dollars also decreased. Therefore, the decreased share of US dollars is not due to de-dollarization.

Second, the role of RMB in global transactions and assets is still relatively small. Look at the data submitted by Eichengreen (2023): The shares of the US dollar and euro in the Society of Worldwide Interbank Financial Telecomunicatons (SWIFT) transactions were still 40 percent each. The same holds for global export transactions, where the shares of US dollars and euros are 40 percent each. RMB? Its share is still very small in both SWIFT and global exports.

US interest rate hikes resulted in a decline in the price of US dollar bonds.

The data also shows that the share of RMB in foreign exchange reserves held by various central banks around the world is still very small. As much as 60 percent of the world’s foreign exchange reserves are still in US dollars, while RMB is less than 3 percent. In terms of portfolio investment, China's external assets and liabilities are only 4 percent of total global assets.

The various MoUs that have been signed are unlikely to make RMB shares rival the US dollar in a short time. The role of RMB, which is still relatively small, will make it difficult for many countries to use RMB in their transactions. If we want to make transactions in RMB while the currency is not widely used, conducting transactions will be difficult.

It is just like my story above about exchange tools "used by many parties". The key to a currency becoming an international currency is that it is “used widely". The smaller the number that uses a particular currency, the higher the transaction and coordination costs, and vice versa.

Third, the use of RMB is still relatively limited because China imposes foreign exchange control. To put it simply: How can people make transactions or invest in RMB if RMB is not easily traded in the international market? China has indeed started to relax, but its foreign exchange control is still significant. This explains why the share of RMB in global assets is only 4 percent.

Eichengreen says RMB could be obtained through Chinese loans for Belt and Road Initiative (BRI) infrastructure projects. This way, according to Eichengreen, the role of RMB will increase gradually.

The international monetary architecture would become multipolar, less institutional and less transparent.

In line with this, Carmen Reinhart, an economist from Harvard Kennedy School, showed at a seminar at Harvard University last month that the role of China in global swap transactions was increasing. China had also started trying to become an international lender of last resort, or ILLR (see the initial treatise of Horn, Parks, Reinhart, Trebesch, to be published). Reinhart expresses concern that as an ILLR, China will be less transparent. Other concerns are that the interest rate will also be relatively higher, and that the scheme will be almost exclusive for BRI countries.

Reinhart said that in such a situation, the international monetary architecture would become multipolar, less institutional and less transparent.

Multipolar system?

Fourth is the Triffin dilemma. Economist Robert Triffin once put forward a theory that a country that wants its currency to become a world currency (reserve currency) must be able to supply its currency for use in other countries. How to do this? Triffin said a country must be willing to run up a current account deficit (CAD). Why? CAD occurs if a country exports more goods and services than it imports. If a deficit occurs, the amount of outgoing money is greater than incoming money. This is how a country can supply its currency to the world.

In short, Triffin said a country that wants its currency to become a world currency must be willing to accept CAD. Is China willing to import more and change its current trade surplus to a deficit? Triffin's argument is indeed material for debate.

Triffin is right in the case of US dollars. The US supplies dollars to the world as a result of current account transactions.

However, this argument is not entirely true. Eichengreen showed that in the case of the eurozone and Japan, both have a current transaction surplus, but these could still be in international currencies, even though their role is not as big as US dollars.

Also read:

> The Collapse of SVB and Its Impact on Our Economy

> Global Recession and Policy Choices

Then, is de-dollarization occurring? Will RMB replace the US dollar? I agree that in the future, the role of RMB will increase slowly. But it will take a long time for RMB to become a reserve currency.

At present, it might be too early for us to conclude that RMB will replace the US dollar. I agree with Reinhart that in the long run, the international financial architecture might become multipolar, where there are several international currencies.

Another scenario? Eichengreen wrote about a "gloomy scenario" in his treatise: that tensions between China and the US will peak, for example if China attacks Taiwan. In this scenario, it is not impossible that the US will apply sanctions. China will retaliate. The implication is that countries that have trade and financial relations with China or the US will be forced to follow their respective financial systems.

I find it hard to imagine what kind of world we will face in such a circumstance. Separate financial systems will lead to very transaction and coordination costs. The world economy will be divided. Transaction costs are very high. Doing transactions might be difficult, as difficult as finding a suitable partner.

KOMPAS/RADITYA HELABUMI

Muhamad Chatib Basri

Muhamad Chatib Basri, Lecturer at the Faculty of Economics and Business, University of Indonesia

This article was translated by Hyginus Hardoyo.