The soul of global trade
Is de-dollarization of commodities even possible?
Analogy
The Simpsons episode entitled ‘Treehouse of Horror IV’ has Homer sell his soul for a doughnut (or ‘donut’). Thinking he could outwit the Devil if he didn’t quite finish the doughnut, Homer chanted ‘I’m smarter than the Devil’. To which the Devil answered: ‘You are not smarter than the Devil. I’ll see you in Hell.’ It is as difficult to escape the dollar’s contractual reach in trade as it was for Homer to escape his promise to the Devil.
The dollar plays an outsized role in international trade, both in an absolute sense and relative to the U.S. share of global output. So dominant is the dollar that the ‘end of dollar hegemony’ that posits a rebalancing away from dollar is a comically distant prospect. The Devil’s contract is here to stay.
A role accepted, not a role imposed
A potted history of how dollarization began helps frame the likelihood of de-dollarization. After WWII the United States was both the largest economy in the world and the only major economy to emerge unscathed. Choosing payment in dollars was the only rational response of international traders, as the economies of alternatives such as British pounds or French francs were badly damaged. In most cases, dollars were the first and only choice to inspire the trust of sellers.
Nor was it only commodity producers that adopted the dollar. As European economies re-opened all of them aimed at generating dollar earnings through exports to America. The process of dollarization emerged at the behest of non-American traders, rather than as a US government plan to embed its currency into the world economy. All these benefits remain, despite the passage of nearly 80 years. Just because we have economies that rival the size of America doesn’t mean their currencies can rival the dollar. Impartial acceptance is key.
There’s only one (trade) currency
According to the Federal Reserve, over 80% of all international trade is invoiced in dollars. Only Europe bucks the trend, and this is due to invoicing in Euros within the Euro-area. That is a big box of doughnuts. Even if some trade redenominated, the dollar is currently so dominant as that little effect would be seen for a very long time.
Share of invoicing in dollars[1]
[1] https://www.federalreserve.gov/econres/notes/feds-notes/the-international-role-of-the-u-s-dollar-20211006.htm
Who would redenominate?
But who would re-denominate away from dollars? If it was attractive to do so, there is no reason why intermediate or manufactured goods are not already invoiced in another currency. They have not done so because the benefits don’t match the costs. In fact, the only sectors incentivised to redenominate are those involving primary goods traded into geo-strategic rivals of the United States. Trade denominated in a non-dollar currency, for entirely political reasons, is certain to account only for a portion of total trade in that commodity. The nascent trade in renminbi is likely to remain nascent for decades, possibly forever.
Total exports of agricultural and extractive commodities (mostly ores and energy) amounts to US$4. 9 trillion in 2019 according to WTO and UNCTAD estimates[1]. Total combined commodity trade amounts to about <20% of the value of total exports. About 50% of exports of agricultural commodities are from ‘developed’ countries and about 35% of extractive commodities.
Some developed countries may strive to replace commodity contracts with their own (or other) currencies. But this would simply amount to an accounting exercise and would probably barely affect the dominance of the dollar. For developing countries there may be some benefits from switching to renminbi, but the proportion of trade so denominated is likely to remain low.
What does the US get in return?
Does the US benefit from dollarization? Surprisingly, benefits may be relatively modest. Dollarization slightly increases the demand for dollars at the time of transaction. Trade is a flow, not a stock. All dollars are ultimately linked back to the US banking system, so once a trade is completed the dollars are free to circulate anywhere. The value of the dollar is barely affected. And when compared to total international trade, and in particular total turnover of foreign exchange, the amounts are large, but not significant compared to total daily turnover.
No threat in sight
So, recent suggestions by Saudi Arabia they may switch some of oil contracts into yuan, are to be taken with a pinch of sprinkles. The excited talk that the dollar was losing its grip as a reserve currency misses the point. Any switch away from the dollar would, in terms of economic impact, barely be measurable, even if it generates energetic headlines. And note, the Saudi proposal is for ‘some’ contracts to redenominate. The announcement seems a geo-political backslapping ruse rather than a serious threat to the dollar. The dollar commands such widespread usage that only a multi-decade shift is likely to have any impact. No one is smarter than the Devil.
[1] https://unctad.org/system/files/official-document/ditctab2020d4_en.pdf