The US dollar has been able to retain its position as the world’s number one trade and reserve currency for quite some time, and there had been little reason to think we would see any dramatic change in that regard, not anytime soon anyway. However, the war in Ukraine, with all its geopolitical and economic ripple effects amongst other interesting developments, has given many analysts and investors cause to reconsider and reassess that certainty as of late.

Talk of de-dollarization and efforts by China and Russia to shake up and rearrange the world currency order are certainly nothing new. For over a decade, the challenger superpowers have been trying to dethrone the greenback, especially in the energy market, but the results have thus far been underwhelming. However, as we highlighted in our latest ,Fireside Conversation, we are moving away from a uni-polar to a multi-polar world, and China, amongst others, have taken notice!

China has been paving the road to de-dollarization for years… very patiently, very diligently and at great cost. Initiatives such as the Belt and Road (a plan to build transportation infrastructure from China to other countries in Asia, Europe, and Africa) and the Shanghai Cooperation Organization have certainly help lay the groundwork, while the Asian superpower’s “special relationship” with Russia helped expand its sphere of influence. Allied in their mission to chip away at the USD’s relevance, China and Russia have found new opportunities and new partners that can help them further their agenda and perhaps expedite the downfall of the dollar.

Russia’s Growing Reliance on China for Reserve Currency

Russia’s raised yuan’s share in reserves in recent years

Source: Russia’s central bank, estimates by Bloomberg

For years, China has been trying to shift the dynamics in the energy market, by increasingly buying oil and gas from Iran, Venezuela, Russia and various African nations in its own currency. The efforts to establish the “pertroyuan” intensified at the end of last year, as the Chinese President met with Saudi and Gulf Co-operation Council leaders.

As the FT highlights, “over the past year, China and India have been paying for Russian commodities in renminbi, rupees and UAE dirhams. India has launched a rupee settlement mechanism for its international transaction while China asked GCC countries to make full use of the Shanghai Petroleum and Natural Gas Exchange for the renminbi settlement of oil and gas trades over the next three to five years. With the expansion of Brics to beyond Brazil, Russia, India and China, the de-dollarization of trade flows may proliferate.”

As Credit Suisse analyst Zoltan Pozsar pointed out, “Russia, Iran and Venezuela account for 40 per cent of Opec+ proven oil reserves, and all of them are selling oil to China at a steep discount while the GCC countries account for another 40 per cent of proven reserves. The remaining 20 per cent are in regions within the Russian and Chinese orbit.”

There are of course counterarguments and reasons to expect the de-dollarization push to fail, like it has so many times in the past few years. For one thing, the Chinese currency doesn’t enjoy the same level of trust that the USD does. It’s hard to imagine a world where national governments were convinced, en masse, to switch their reserve currency to the renminbi.

This trust issue could be ameliorated, however, especially in the oil market, given China’s apt recognition of its reputation problem and its very practical solution. In 2018, the country launched renminbi-denominated oil futures contracts on the Shanghai International Energy Exchange, and since 2016 the renminbi has been convertible to gold on the Shanghai and Hong Kong Gold Exchanges. As Pozsar sharply notes: “Money is as money does, and convertibility to gold beats convertibility to dollars.”

Such a drastic change in the global monetary order might be hard to imagine from our present vantage point. However, it is important to remember that there were many other tectonic shifts that nobody saw coming until they were actually underway. The war in Ukraine is a prime example. Among the countless other consequences it had on the geopolitical, economic, and fundamental humanitarian levels, the conflict also played an important role in the de-dollarization campaign. The wave of sanctions imposed on Russia by the West and the “weaponization” of the dollar gave a lot of countries reason to consider alternatives.

And lest we forget, many questions are being raised as to what impact CBDCs (central bank digital currencies) may play, as they could serve as a catalyst to transition away from the dollar-centric world. Seeing as how sanctions are carried out through western banks and a correspondence system that fully supports the dollar, a “go-around network” could be used to circumvent dollar authority. CBDCs, in essence, could recreate the very correspondence bank system that the US dollar system is supported by, although being able to do so without so much a nod to the western banking system or the dollar. (For more on CBDCs, and the issues they could pose to investors, check our BFI Bullion’s latest ,quarterly Digger.)

While it might be too early to tell whether or not China’s mission to dethrone the mighty dollar will be a success, we can rest assured that Beijing will not stop trying. Another thing we can be sure of is that this shift will not happen overnight. At most, it might be a gradual, incremental process.

Not a Contender

The yuan accounts for a miniscule share of global payments even though China has the world’s second-largest economy.

Sources: SWIFT, Bloomberg (Bloomberg Opinion)

And one has to wonder how certain China’s ascent and victory as a superpower really is. China has challenges at multiple levels – dismal demographics, dependence on Russia for natural resources and food, the need to feed its industrial complex by exporting to the west, etc… Moreover, as China has turned more centralistic and autocratic, with the CCP under an increasingly single-handed leadership, the chances of China’s economic rise derailing appear greater today than even just a few years ago.

There are many unknowns. Investors are wise to keep a close eye on the developments and to position themselves in time. The possibility of de-dollarization is real and highly relevant, perhaps more so than ever before. But it certainly should not be considered a forgone conclusion.