Luiz Inacio Lula da Silva and Uday Kotak have little in common. One of them is the President of Brazil, while the other presides over India’s financial giant Kotak Mahindra Bank. Both, however, have railed against the dollar’s continued dominance in recent weeks.
Speaking in Shanghai last month, the Brazilian president noted that he had asked himself “every night” why all countries have to conduct their trade in dollars. “Why can’t we do trade based on our [own] currencies?” he asks. “Who was it that decided that the dollar was the currency after the disappearance of the gold standard?”
Uday Kotak, self-effacing and low profile at the best of times, raised a lot of eyebrows in Mumbai and beyond recently by describing the dollar as “the biggest financial terrorist in the world.” Although he later moderated his comment by saying that he was referring to the greenback’s disproportionate power, it raises some important questions. What explains emerging market anger about the dollar’s dominance as a reserve currency, and what are the viable alternatives that countries should be exploring?
The proximate trigger for the latest round of dollar hand-wringing is surely Russia’s brutal and unprovoked invasion of Ukraine, which triggered unprecedented financial sanctions by America and the G7 against Moscow. It was certainly a shock and awe moment for many emerging market central banks whose foreign reserves are primarily held in the greenback.
The delicate question, which central bankers are asking themselves is what would happen if their country ran afoul of U.S. foreign policy? Just as Russia’s central bank has faced since last March, would the country not be able to access its dollar reserves as a result?
The weaponization of the dollar has sent a collective chill across many emerging markets with political and business leaders in the largest of those economies, notably Brazil, Russia, India, China and South Africa (the famous BRICS grouping) doing some public soul-searching.
The hunt for alternatives has included calls for creation of a “BRICS currency,” which presumably would allow emerging markets to trade and invest in a basket of of their own currencies, or to encourage the use of the yuan, the Chinese currency which in the pre-Xi Jinping era briefly harbored ambitions of becoming a viable reserve currency. Those plans have evaporated due to President Xi’s command-and-control leadership approach. While the use of the yuan in international transactions has been rising, it still modestly accounts for less than 2% of global payments and around 4% of global trade finance, according to SWIFT (Society for Worldwide Interbank Financial Telecommunication). Whether emerging markets like it or not, the dollar will remain the only game in town for the foreseeable future.
What makes the dollar the dominant and attractive reserve currency today are three compelling factors. First, the dollar, and the pound before it, is a true safe haven currency. During times of trouble, perversely including America’s own recent ructions concerning regional banks which spooked global markets, investors turn toward the dollar for protection. Second, an overwhelming portion of global trade and payment transactions (including commodities like oil) are still denominated in the dollar. China has been attempting to peel away by offering to settle oil imports from Russia and the GCC in its currency, but it is arguable whether the Saudi central bank will want to substantially increase its yuan holding, particularly since it cannot be used to buy trophy assets in London or New York. Finally, and this directly speaks to Lula and Kotak’s complaint, the dollar is ubiquitous in the global economy and while emerging countries and companies have to bear the exchange rate risk, the depth, availability, and liquidity of dollar-denominated markets remains formidable.
All of this does not mean that dollar dominance is pre-ordained, as countries will tire of American currency exceptionalism and hunt for viable long-term alternatives. This may well include the yuan, if President Xi is prepared to give up control over where the currency is traded. Or it could be a tech disruption, via one of the many private sector-led cryptocurrencies and stable coins, whose rise global central banks have desperately attempted to curtail and control.
The uncomfortable truth for emerging markets, and others who rail against dollar dominance is that the country with a viable, alternative reserve currency to the dollar will behave exactly like America has done these past few decades. Hegemony is in the reserve currency issuer’s DNA. Message to Lula and Kotak: Be careful what you wish for.