The US dollar accounts for 88% of world transactions and comprises a sizable part of the reserves of central banks and major companies, which have increased demand for US bonds in financial markets.
Dollarization of the economy happens when a country recognizes the dollar as a legal currency or medium of exchange instead of or besides its local currency. It often occurs in developing countries mainly due to the national currency’s weakness and their volatile economy.
Abdolnasser Hemmati, a former governor of the Central Bank of Iran, prefaced an editorial for the Persian economic daily Donya-e-Eqtesad with this note. A translation of the text follows:
People are likely to choose dollar for daily transactions when their developing countries experience runaway inflation, because their local currency is continuously losing its purchasing power.
Dollarization can have both costs and benefits. In some countries, it increases monetary and economic stability, but leads to the loss of economic independence in monetary policy.
Process Already Started in Some Countries
The US dollar may be the default currency in international trade today, but the process of de-dollarization in the world has started for some time.
Russia and China are working together to reduce their dependence on the dollar. Ruble-yuan trade has increased eighty-fold since the Russia-Ukraine war. They claim that gold should be the backup of a currency.
Some African countries want to trade with currencies backed by precious metals while some South American states want a currency backed by copper reserves. The UAE and India are discussing the use of the rupee for non-oil trade.
Iran is also pursuing de-dollarization in negotiations with its partners.
Reducing the impact of US sanctions is one of the main reasons behind de-dollarization. Russia and Iran are highly interested in de-dollarization in view of the US sanctions imposed on their economies.
In addition to the inflation in the United States, whose central bank officials raised interest rates and reduced the value of treasury bonds to control it, the imbalance resulting from the outbreak of Covid-19, the war in Ukraine and the energy imbalance has strengthened the call for de-dollarization in developing countries.
De-dollarization is expected to reduce the effectiveness of US sanctions in the event of a global crisis.
The US dollar continues to dominate the world’s foreign exchange reserves, but its share in central banks has declined from 70% in 1999. In the fourth quarter of 2022, the US dollar accounted for 58.36% of foreign exchange reserves. Euro ranks second with 20.5% and China’s yuan constitutes 2.7% of international reserves.
At present, China is exerting the greatest pressure to realize de-dollarization. The Asian country is the second largest economy in the world and the top importer and exporter. It is the main trading partner of 61 countries while the US is the top trading partner of 30 countries.
The US dollar continues to dominate the international reserve by accounting for 58% of foreign exchange reserves. The Chinese yuan has a long way to go to compete with the dollar, given that it accounts for as little as 2.7% of total reserves. However, de-dollarization is now part of the international perspective.
A Necessity
For Iran, de-dollarization of foreign trade is a necessity owing to the US policies and sanctions. However, note that the implementation of this policy is contingent upon strengthening the value of the national currency.
Economic instability and the continued devaluation of local currency will urge people and economic players to resort to international currencies to protect their assets.
De-dollarization without a plan to control volatility and economic instability, as well as restrictions on buying the dollar may prompt people to use other stable currencies that are pegged to the dollar like the UAE dirham. Therefore, at times when the US intends to tighten the economic noose around Iran’s neck, as it tried in recent years, it is likely to apply indirect pressure through the dirham. This also applies to the euro, the world’s second most valuable currency, granted the close relationship between the policies of the US and Europe.
In closing, trade provisions based on the national currency are controlling inflation and stabilizing the value of local currency. Otherwise, there will be no need for an intermediate currency for trade settlement with countries and that will benefit Iran’s trading partners.
