How local currency trading challenges US dollar dominance

Over the past few years, there has been a trend of countries sidestepping the US dollar and choosing to use their own local currencies for bilateral trade.

In an emerging multi-polar world, Brazil and Japan, two close allies of the United States, have recently joined the trend by expanding their bilateral currency trade.

Brazil and China signed a deal last week to trade in their local currencies while Japan joined hands with sanctions-hit Russia to pay for its oil by breaching the $60 cap, thanks to a waiver from the US. 

Saudi Arabia, one of the biggest exporters of crude, is contemplating trading with China in Saudi Riyals and Chinese Yuan.

For many analysts, this shift directly challenges the dominance of the US financial system - one of Washington’s most potent tools to exert influence worldwide.

The US dollar started facing competition over a decade ago. In 2011, Japan and China agreed to dump the US dollar and trade with their respective currencies instead. 

Similarly, Brazil signed its first agreement with China to ditch the dollar in 2013. 

One of the main topics of the next BRICS summit — a bloc of Brazil, Russia, India, China, and South Africa — that will be held in South Africa in August aims to create a mechanism to trade settlements in national currencies among member states.

The US dollar has been the world’s reserve currency since 1944 following the Bretton Woods Agreement, replacing the British sterling by the end of World War 2.

Weaponising dollar

With its reserve currency status, the US can impose sanctions on any country in the world and inflict massive economic costs on them. 

“The weaponisation of the dollar system can be hugely destructive to anyone directly targeted, and hugely damaging to everyone else,” says Julius Sen from the London School of Economics and Political Science.

Political disputes and financial crises are the most common reasons why several governments are reducing their dependency on the US dollar. 

Iran, which has been disconnected from a West-led international money transfer system SWIFT over its nuclear project, has been trading with alternative payment routes for many years. 

The Ukraine conflict created an opportunity for Russia and China to boost their bilateral trade in local currencies. They are also making efforts to divert other countries away from the US-led financial system. 

So far at least  20 countries have chosen to trade with each other in their own currencies. 

In light of fast-changing dynamics in the world of trade and finance, China’s yuan has surpassed the dollar for the first time in monthly trading volume in Russia, according to data provided by Bloomberg in February. 

The US often turns a blind eye to the United Nations charter and imposes unilateral embargoes and threatens other nations to follow the suit. This ironfisted approach has made the US the top sanctions-imposing nation in the world. 

The debt accumulated by the US government has left markets vulnerable to major financial disruptions. As a result, many nations have taken the path of "de-dollarisation" to safeguard their economies from further damage. 

As of February 2023, the federal government has spent $723 billion more money than it has collected as revenues in the same fiscal year, pushing the country further deep into a national deficit. 

The US national debt stands at $31.46 trillion which is the total amount of borrowing over the nation’s history. That’s fivefold compared to the last two decades. All these data show the numbers are skyrocketing and unpayable as the global debt stands at $235 trillion.

China’s yuan (unit of renminbi) has been seen as a potential international trade currency as the Asian country is challenging US dominance. But, China’s closed economic system makes it difficult for foreign investors to access its markets. 

European Union’s currency euro is also being featured as an alternative to the free markets. The bloc is the third-largest economy in the world and accounts for one-sixth of global trade, according to Visual Capitalist.

Although Euro is the second most traded currency in the world, it faces a debt crisis in the eurozone casting doubts over its ability to become a reserve currency.

The Japanese yen is another option. As the third largest traded currency in the forex market after the US dollar and euro, the Japanese yen can hit stumbling blocks while competing with the US dollar and Euro because of Japan's heavy public debt.

The US still likes to believe that the dollar is invincible and will continue to be the main currency in international trade -- the country's top treasury official recently implied it. 

But as many nations are already on the path of diversifying their international payments with local currencies, many financial analysts foresee a grim scenario for the future of the American currency.