Is the World Economy Actually De-dollarizing?
Iran's insanely low fuel prices, Chinese economic data secrecy, Iraq's sustained pipeline outages and Venezuela's hope for increased exports.
10 min read
Dollar dominance refers to the disproportionate use of American dollars in the world economy, a condition which has prevailed since it overtook the British pound at the end of World War II. This means it is the most used currency for international trade and is used as a reserve currency by most nations, with central banks or treasuries holding dollars as part of their country's formal foreign exchange reserves. Countries hold these reserves to weather economic shocks, pay for imports, service debts, and moderate the value of their own currencies. As of the end of 2022, the USD accounted for 58.36% (down slightly since the start of the century) of official foreign exchange reserves, followed by the Euro.
Yet, we are seeing a growing number of press articles and pundits ranting about the end of the U.S. dollar’s dominance, especially with the rise of Chinese and Russian bilateral agreements to trade in their own currencies – most recently with oil and gas. Therefore, is the USD dominance set to decline?
The short answer is yes, it is declining slightly – but no, its dominance will remain for the foreseeable future. The dollar’s role in international payments has never been stronger, according to the latest transaction data compiled by global financial messaging service Swift, which shows that 46% of all Swift FX transactions involved the dollar. This is up from roughly 33% a decade ago. The Euro’s share however has fallen to an all-time low, but still comes in second place. Meanwhile, the Yuan has exceeded 3% and is rising, but still far from being a globally dominant currency. Then there are other factors to consider, such as (I) common accounting practices using the USD which maintains stability when measuring the value of goods and services, (II) geopolitical risks associated with other currencies (e.g. Russia-Ukraine with a tumbling Rouble, China-Taiwan posing a long-term threat to Yuan trade), fuelling the low likelihood of private and public sectors in the West to take on foreign exchange at scale and (III) the U.S. economy and military remain amongst the largest and most influential, with a long enough track record of trust in the ability of the United States to pay its debts, to maintain the dollar as the most redeemable currency.
Also let us not forget the power of U.S. financial sanctions. The majority of international trade is conducted in U.S. dollars. Even trade among other countries can be subject to U.S. sanctions, because they are handled by correspondent banks with accounts at the Federal Reserve. By cutting off the ability to transact in dollars, the United States can make it difficult for those it blacklists to do business. A cornerstone of U.S. foreign policy, whether explicit or implicit, is to maintain the U.S. dollar’s dominance, and therefore they can weaponise USD sanctions on threats abroad, be it individuals, companies or central banks. For example, in the wake of the Russia’s invasion of Ukraine last year, U.S. sanctions cut Russia off from the dollar, freezing $300 billion in Russian central bank assets and triggering a default on the country’s sovereign debt. However, sanctions should be used cautiously as the U.S. does not want to overprescribe them, which could encourage other nations to turn towards using other currencies. Following the sanctions on Russia, an increasing number of countries, including U.S. partners such as India, have explored ways to continue trading with Russia that don’t involve the dollar. In most part this was to take advantage of discounted Russian oil and gas. Meanwhile, the Chinese renminbi has become the most-traded currency in Russia, bumping up its global share.
This month the BRICS furthered discussions around a common currency, although it was not part of the official summit agenda. This probably won’t happen. If anything, China would lead the implementation of a single unit of exchange and this would be the Yuan. However, China’s currency accounts for a very small portion of foreign exchange reserves, and their policymakers’ control over the exchange rate makes it unlikely to quickly gain traction amongst international players in favour of free markets. Furthermore, why would China, an output-ran country, want to appreciate their real exchange rate which would make their exports less competitive? India’s Foreign Secretary also expressed scepticism about the idea earlier this month.
Coordination amongst the vastly different and lesser developed BRICS economies is also a long shot. South Africa cannot even maintain a functioning electricity grid in its capital(s), Russia has scared away most multinational companies indefinitely due to high risks of doing business there blended with political turmoil and one of BRICS’ newest members, Argentina, has an inflation rate of 113%. Two of its newest members, Saudi Arabia and the UAE, are more promising candidates – although both of their currencies are currently pegged to the USD.
There is simply no viable alternative to the dollar, for now… Arguably, the biggest threat to the USD dominance is actually the United States itself, namely the uncertain future of its monetary policy, political system, foreign policy and ballooning national debt.
The oil story in data
Global crude oil production: 74.20 million barrels/day (down 2.2% YoY).
Global oil supply: 100.9 million barrels/day
Global oil demand: 101.46 million barrels/day
Global oil refining capacity: between 103.0 and 104.9 million b/d
Global oil inventories: total oil inventories for crude and major refined products stand at roughly 7,092,000,000 barrels (up 0.81% YoY), with crude inventories making up 3,185,000,000 (or 45%) of this.
Oil prices: ICE Brent is at $84.48 USD/barrel (down 15.38% YoY, but near the top end of the range looking at the past six months).
Iran has unsustainably low petrol prices
Iran has extremely cheap petrol due to heavy state subsidies. Prices start at only $0.03 per litre, a tiny fraction of prices in Western nations such as the $1.10 paid at American pumps or the $1.88 in the UK.
However, Ali Ziyar, deputy head of the National Iranian Oil Refining and Distribution Company, told local reporters this month that consumption had risen 20% since March to 124 million litres/day, but domestic refining capacity was capped at 107million litres. This growing gap between supply and rising demand has led Iran to tap into its strategic reserves and import petrol for the first time in a decade. This move comes as Iran's hardline government under President Ebrahim Raisi is grappling with economic challenges due to U.S. sanctions and is wary of potential public unrest. Despite the need to end the ultra-cheap petrol policy, raising prices is politically sensitive after past price hikes in 2019 led to violent protests. Violent revolts in response to increased fuel prices have also been seen in other countries this century, including Kenya earlier this year and Nigeria in 2012.
Current fuel subsidies are a burden on the government, and while analysts see the situation as unsustainable, there is hesitation to make the necessary changes due to potential backlash. It puts the government under pressure to speed up development projects to increase refining capacity, although refining expansion projects can take years to be completed.
China toys with further economic data secrecy
Zhang Jianhua, Director of China's National Energy Administration, has called for stricter secrecy in the energy sector to protect national security. He noted that foreign forces are closely monitoring China's energy transformation efforts, aiming to distort its strategic plans and stability. China is the largest energy consumer and faces challenges in achieving carbon neutrality due to high carbon emissions from energy use.
To achieve this, Zhang recommended integrating secrecy into government agendas and coordinating protection measures across all levels. He proposed regular inspections, personnel screening, and risk assessments to prevent secret leaks.
Notably, while this initiative seeks heightened security, it may not lead to a complete ban on energy-related data release. Steps can be taken to ensure security without compromising necessary data for economic analysis and decisions.
This comes after China's decision to suspend reporting its July youth unemployment rate (to reconsider the methodologies used) stirred up heated public debates, as many perceive it as a cover-up for an unflattering statistic. It came after a spate of record-high readings had been released over the past few months, with the latest showing more than one in five (21.3%) young Chinese were jobless in June.
The Iraqi Ceylon pipeline remains offline
Meetings between the Iraqi and Turkish oil ministers this week failed to restart the northern Iraqi pipeline to Ceyhan, which had a capacity of 470,000 b/d before its late-March shutdown. A longer disruption leaking into next year wouldn't be surprising. Turkey's use of its export terminal control for negotiations over past Kurdish exports, transit fees, and economic matters is evident. Increased runs and trucked exports offset roughly 100,000 b/d of the outage, and southern exports grew by 125,000 b/d from March to July. This contributes to an expected total Iraqi crude production of 4.39 million b/d in August, 170,000 b/d above Iraq's OPEC+ pledge, encouraging the continuation of keeping Kurdish exports offline.
Will Venezuelan oil production increase?
Press reports this week highlight ongoing discussions between the U.S. and Venezuela, focusing on potential additional sanctions relief for PDVSA, Venezuela’s national oil and gas company. These talks, while not new within the Biden administration, have gained attention due to emerging indications of diplomatic progress, however despite these optimistic signs, there is a degree of skepticism surrounding President Nicolas Maduro's willingness to make the required political concessions necessary to ease all trade restrictions and foreign investment related to PDVSA. Given the prevailing uncertainty about the possibility of "free and fair" elections in 2024, Venezuelan crude production will likely maintain a relatively flat trajectory, hovering around current levels of 770,000 b/d.
Nonetheless, there exists a glimmer of potential upside in the supply outlook for Venezuelan oil if the U.S. were to implement targeted waivers similar to those extended to Chevron in November 2022. The restricted but notable bilateral trade with the US Gulf Coast, coupled with Chevron's re-engagement in the country, has already contributed to a noteworthy increase in production by approximately 100,000 b/d. Expanding trade activities with the US and Europe, particularly through enhanced diluent supply, could potentially pave the way for a modest growth trajectory beyond 800,000 b/d. It is important to note that while complete relief from PDVSA penalties seems unlikely, such a scenario could still raise Venezuelan crude supply to 1.1 million b/d within 12-18 months. However, this projected increase would still fall short of the pre-sanctions levels witnessed in late 2018.
It is important to acknowledge the significant challenge posed by the U.S. opposition to the Maduro government, especially as the country moves closer to a presidential election in 2024. This political context adds complexity to the prospects of the projected supply increase. The interplay of international diplomatic dynamics, economic considerations, and political motives shapes a multifaceted landscape for Venezuela's oil future. Although I wouldn’t hold my breath as Venezuela has been digging itself a grave since their crisis began in 2010.