Key takeaways
- De-dollarization entails a significant reduction in the use of the U.S. dollar in world trade and financial transactions.
- Some signs of de-dollarization are evident in the commodities space, where energy transactions are increasingly priced in non-USD currencies.
- Globally, new payments systems are facilitating cross-border transactions without the involvement of U.S. banks, which could undermine the dollar’s clout.
- USD’s share of FX reserves — the most commonly analyzed barometer of dollar dominance — has decreased, notably in emerging markets.
- However, while diversification away from the dollar is a growing trend, the factors that support dollar dominance remain well-entrenched, and meaningful de-dollarization will likely take decades.
The U.S. dollar is the world’s primary reserve currency, and it is also the most widely used currency for trade and other international transactions. However, its hegemony has come into question in recent times due to geopolitical and geostrategic shifts.
“The narrative that the U.S. dollar’s reserve currency status is being eroded has gained momentum as the world is dividing into trading blocs in the aftermath of Russia’s invasion of Ukraine and heightened U.S.–China strategic competition,” said Joyce Chang, chair of Global Research at J.P. Morgan. “Further complicating the discussion, the strong dollar is in the headlines, with talk of devaluation to restore U.S. competitiveness now part of the daily U.S. election campaign vernacular.”
What are the potential implications of de-dollarization, and how is it playing out in global markets and trade?
What is de-dollarization?
In short, de-dollarization entails a significant reduction in the use of dollars in world trade and financial transactions, decreasing national, institutional and corporate demand for the greenback. This would diminish the dominance of the dollar-denominated global capital markets, in which borrowers and lenders around the world transact in dollars.
There are two scenarios that could erode the dollar’s status. The first includes adverse events that undermine the perceived safety and stability of the greenback — and the U.S.’s overall standing as the world’s leading economic, political and military power. For instance, increased polarization in the U.S. could jeopardize the perceived stability of its governance, which underpins its role as a global safe haven.
The second factor involves positive developments outside the U.S. that boost the credibility of alternative currencies — economic and political reforms in China, for example. “A candidate reserve currency must be perceived as safe and stable and must provide a source of liquidity that is sufficient to meet growing global demand,” said Alexander Wise, who covers strategic research at J.P. Morgan.
What would be the impact of de-dollarization?
Fundamentally, de-dollarization would shift the balance of power among countries, and this could, in turn, reshape the global economy and markets. The impact would be most acutely felt in the U.S., where de-dollarization would likely lead to a broad depreciation and underperformance of U.S. financial assets versus the rest of the world.
“For U.S. equities, outright and relative returns would be negatively impacted by divestment or reallocation away from U.S. markets and a severe loss in confidence. There would also likely be upward pressure on real yields due to the partial divestment of U.S. fixed income by investors, or the diversification or reduction of international reserve allocations,” Wise said.
However, the effect of de-dollarization on U.S. growth is uncertain. While a structurally depressed dollar could raise U.S. competitiveness, it could also directly lower foreign investment in the U.S. economy. In addition, a weakening dollar could in principle create inflationary pressure in the U.S. by raising the cost of imported goods and services, though benchmark estimates suggest these effects may be relatively small.
De-dollarization in commodity markets
Some signs of de-dollarization are evident in the commodities space, where energy transactions are increasingly priced in non-USD currencies. For example, Russian oil products exported eastward and southward are being sold in the local currencies of buyers, or in currencies of countries that Russia perceives as friendly. Elsewhere, India, China and Turkey are all either using or seeking alternatives to the greenback.
“Most of the world’s oil still sells for dollars. But with Russia, the world’s second largest exporter of oil, selling its petroleum exports in the local currencies of its customers, other producers might find themselves following suit,” said Natasha Kaneva, head of global commodities strategy at J.P. Morgan.
In addition, central banks, especially those in emerging markets (EM), are increasing their gold holdings in a bid to diversify away from a USD-centric financial system. According to J.P. Morgan’s global commodities research team, central banks collectively bought a net 1,136 tonnes of gold in 2022, the highest annual demand on record, and another 1,037 tonnes in 2023. “This reduces their need for precautionary reserves of U.S. dollars and U.S. Treasuries, which in turn frees up capital to be deployed in growth-boosting domestic projects,” Kaneva said.
Gold holdings by global central banks have increased
Gold holdings by central banks around the globe have increased following the global financial crisis in 2008.
De-dollarization in payments
Globally, new payments systems are evolving rapidly and facilitating cross-border transactions without the involvement of U.S. banks. This could undermine the dominance of the dollar and, on a broader level, western financial infrastructure.
For instance, Project mBridge is a multi-central bank digital currency (CBDC) platform that connects central and commercial banks across China, Hong Kong, Thailand, the United Arab Emirates and Saudi Arabia without relying on the dollar. “The drive for payments autonomy, fueled by technology, is perhaps the most underappreciated risk to USD hegemony,” Chang said.
In addition, China’s role as a major e-commerce player could further challenge the dollar. “While we are far from a multipolar financial system, China continues to dominate the e-commerce market, raising concerns about a global digital divide,” Chang said. The global e-commerce market was sized at around $5.8 trillion in 2023, with China accounting for around half of the pie. Correspondingly, China’s digital payments market, which is largely off-limits to foreign payment networks, is expected to grow around 10% annually.
“Diversification away from the dollar is a growing trend, but we find that the factors that support dollar dominance remain well-entrenched and structural in nature.”
Joyce Chang
Chair of Global Research, J.P. Morgan
De-dollarization in global trade and FX
The U.S. is the second largest goods exporter in the world, but its share of global trade has declined in recent years. However, this should not be conflated with de-dollarization, as Chang noted.
“More likely, the slight weakening in trade intensity reflects some convergence in cost differences across countries, maturation of existing trade liberalization initiatives, more intra-country trading on rising demand from domestic customers and growing service intensity of economies,” Chang said.
Similarly, USD’s share of FX reserves, the most commonly analyzed barometer of dollar dominance, has decreased, notably in EM. Central bank FX reserves are typically held in U.S. dollars, but the latter is now being supplanted by other currencies. “However, FX reserves offer an incomplete picture of foreign asset accumulation. The rise in EM dollar-denominated bank deposits, sovereign wealth funds and private foreign assets more than offsets the decline in overall dollar share of EM FX reserves,” explained Saad Siddiqui, EM fixed income strategist at J.P. Morgan.
All in all, while global trade and FX reserves have flatlined, the dollar still retains its influence in this space, especially when taking into account other factors including dollar-denominated bank deposits, FX volumes and trade invoicing. “Overall, the dollar’s transactional dominance remains undisputed,” Chang said.
The dollar’s share of FX reserves has fallen
USD’s share of FX reserves has fallen over the past two decades. However, FX reserves are still mostly held in DM currencies.
Is de-dollarization imminent?
Overall, despite changes in cross-border flows and the rise in alternative financial architecture for global payments, de-dollarization risks appear exaggerated.
“Diversification away from the dollar is a growing trend, but we find that the factors that support dollar dominance remain well-entrenched and structural in nature. The dollar’s role in global finance and its economic and financial stability implications are supported by deep and liquid capital markets, rule of law and predictable legal systems, commitment to a free-floating regime, and smooth functioning of the financial system for USD liquidity and institutional transparency,” Chang said. “All in all, meaningful erosion of dollar dominance is likely to take decades.”
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