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What is driving de-dollarisation?

By Philip Saunders - Co-Head of Multi-Asset Growth
Russell Silberston - Co-Head Developed Market FX & Rates, Fixed Income
Mike Hugman - Fixed Income Portfolio Manager
Sahil Mahtani - Investment Institute Strategist*

The fast view

  • The dominant position of the dollar has been an “exorbitant privilege” for the US, in the words of then finance minister of France, Valery Giscard d’Estaing.
  • Yet the geopolitical shock from US President Trump’s unilateralism and especially the growing use of the dollar to enforce sanctions, revived a push towards de-dollarisation in 2018.
  • Meanwhile, emerging Asian economies have a long-standing desire to look for ways to reduce the boom-and-bust cycle associated with the dollar. They may get that opportunity as trade in Asia becomes less dependent on the US.
  • Moreover, structural economic shifts in China mean the country may require an internationalised currency sooner than later, giving a boost to the renminbi.
  • Changes in energy market dynamics have seen the yuan starting to gain traction as a means of payment in the international oil market.
  • After spending six of the last seven calendar years on the up, another dollar down cycle may begin this year which may accelerate de-dollarisation moves.

History provides us with a valuable roadmap to understand the rise of the US dollar to a position of unipolar global dominance, as highlighted in our papers, Exploring the history of dollar dominance, and Why the US dollar remains centre stage. But while history informs, context matters more. This paper looks at the structural and cyclical drivers that could see de-dollarisation gathering pace over the next few years.

“First gradually, then suddenly.” Hemingway’s famous line on bankruptcy applies also to international currencies, where transitions can happen both over decades but also overnight. The US abandonment of gold convertibility to the dollar in 1971, or, before that, sterling’s departure from the gold standard in 1931, was initially far-fetched, then plausible, then inevitable.

Today, it is the arrival of the renminbi as a currency of equal importance to the dollar that seems far-fetched. After all, China’s capital account is still partially closed. Moreover, renminbi use has stalled at a low level in recent years, and China has well-known economic imbalances. Nevertheless, even in this context an acceleration of renminbi use globally could happen very quickly.

Why de-dollarisation is gathering pace:

Geopolitical shifts

The geopolitical shock from US President Trump’s unilateralism and especially the growing use of the dollar to enforce sanctions, revived a push towards de-dollarisation in 2018. This trend can be traced back to the early noughties, and since then economic sanctions have been placed on North Korea, Russia, Venezuela and Iran, among others. These actions have prompted a predictable blowback.

In the second quarter of 2018, Russia re-allocated US$101 billion of its US holdings from its reserves into renminbi, euros and the yen.1 More importantly, Germany, France and Britain have created a special purpose vehicle called Instex to permit some payments with Iran in euros.2 Similarly, China made progress in 2018 to de-dollarise commodity markets, launching petroyuan futures on the Shanghai International Energy Exchange.

US sanctions are a proximate but not an ultimate cause for the shift. As European Commission President Jean-Claude Juncker put it, “it is absurd, ridiculous, that European companies buy European planes in dollars instead of euro.” 3

Exorbitant privilege across time
Measuring exorbitant privilege

  • 1

    The United States economy surpassed the UK in economic size in 1872 and the British empire sometime between 1901 and 1913, but the dollar’s use relative to the size of its economy surpassed sterling only in the mid-1920s.

    Note that this metric here counts the pound sterling’s ratio as including the area of the British empire. Australia, New Zealand and South Africa are included in 1900 data. India is included until 1929 data. The key factor is when each territory becomes self-governing, i.e. is granted dominion status.

  • 2

    The rise of the dollar relative to the size of the US economy occurred in the 1930s and especially after World War One when the US economy and financial system just became too large to ignore. Eichengreen puts the date of the dollar surpassing reserves in the mid-1920s. However, the dollar lost its crown after a sharp devaluation in 1933, when sterling regained its place as the leading reserve currency.

  • 3

    By our metric, sterling became the most important currency in the 20th century relative to its diminished size after the second world war, when the UK lost India as an imperial possession. Nevertheless, most Indian reserves were still in sterling as late as 1950.

  • 4

    The Swiss franc also became important in the 1970s and 1980s as a result of the monetary turbulence in the US, the UK and elsewhere. Germany and Switzerland eliminated capital controls in the mid-1970s but maintained twin surpluses, and as a result, became leading alternatives. Sterling still had capital controls and could not be used for international financial transactions.

  • 5

    The rise of the Japanese yen, which prompted such concern in the 1980s, turned out to be less relevant in currency matters. Yen use in reserves peaked in the early 1990s and diminished until only very recently.

  • 6

    By this measure, the US dollar is more important than it has been at any time since the second world war. The liberalisation of global finance has been kind to the dollar. Meanwhile, the UK staged a remarkable recovery throughout the 2000s and 2010s, and became as important as the euro relative to the size of the economy during this time. The euro stagnated after the euro crisis in the 2010s.

  • 7

    This is the renminbi, which is less important relative to the size of China’s economy. Nevertheless, the only direction is up. How far will it go?

Source: Eichengreen, B., Mehl, A., Chitu, L., How global currencies work: Past, present, and future, Princeton: Princeton University Press, 2018, and data for 1899 and 1913 from Lindert, P., “Key currencies and gold, 1900-1913,” Princeton Studies in International Finance 24, International Finance Section, Department of Economics, Princeton: Princeton University, 1969. Currency share of reserves for the period 1960-2018 are directly provided for from IMF Annual Reports for years 1970, 1983, 1990, 1997 and 2018. The currency shares reported here exclude unallocated foreign exchange reserves post-1994. Share of world output data in PPP terms from Maddison Historical Statistics up to 2008, then IMF World Economic Outlook. PPP data prior to 2008 calculated in Geary-Khamis international dollars. UK territory  in 1899 includes Australia, India and New Zealand. UK in 1913 and 1929 includes India while the euro area counts Austria, Belgium, Finland, France, Germany, Italy, Netherlands, Ireland, Greece, Portugal and Spain.

It was only after the second world war that the dollar cemented its position as leader among international currencies. The dominant position of the dollar has brought exorbitant privileges over time for the US. These include lower funding costs, less exposure to foreign economic shocks and huge economic and political influence in the world. The US government also profits financially from printing dollars, which are in high demand.

In stark contrast are many emerging markets that are subject to the fortunes of the dollar. Meanwhile, emerging Asian economies are looking for ways to reduce the boom-and-bust cycle associated with the dollar, and they may get that opportunity as trade in Asia becomes less dependent on the US. Currently, for instance, a 10% US dollar appreciation takes about 1.5 percentage points off GDP growth in emerging market economies.4 Such countries therefore may find it to their advantage to sign swap agreements with the Chinese central bank and conduct trade in a currency like the renminbi, which increasingly reflects their trade patterns.

Growth in Asia is becoming less dependent on the US
Percentage of East Asia ex-China value added by final export destination

Figure 2

Source: OCED, 2015

Structural shifts in China

Structural economic shifts in China mean the country may require an internationalised currency sooner than later, giving a boost to the renminbi. China’s current account surplus has been on a downward trend since it touched 10% in 2007, driven by investment growth, currency appreciation, weak demand in advanced economies, and recently, a widening services deficit.5 Meanwhile, the International Monetary Fund (IMF) changed its External Balance Assessment ‘norm’ of China’s current account balance to -0.3% in 2018. The IMF’s figure reflects an assessment of what China’s current account would be without distortive economic policy.

China's working age population has peaked

Figure 3

Source: UN, 2018

That ‘norm’ is unlikely to increase. China’s working age population share of the total peaked in 2016, and between 2015 and 2050, its working age population will shrink by about 250 million.6 Given that positive demographic trends accounted for half the increase in household savings in China since the 1970s, their reversal will put pressure on the current account surplus as aging households dissave.7 It is thus not impossible to foresee that by the mid-2020s, China could indeed be consistently running a current account deficit.

As China’s current account deficits become more frequent, it may have to run down foreign assets or borrow more from abroad to pay for its consumption. China would naturally prefer to borrow in its own currency rather than incur foreign debt. As a result, if current account deficits become the norm, China has an incentive to continue with the internationalisation of the yuan and reduce reliance on the dollar.

China's vanishing current account surplus

Figure 3

Source: State administration of Foreign Exchange, 2018

China has a history of material sweeping reforms that have corrected past imbalances, for example, the clean-up of state-owned enterprises in the 1990s. The country’s external policy roadmap has been likened to the Marshall Plan, which was adopted by the US after 1945. Under that architecture, the US economy derived benefit from investments and exports into Europe, allowing the dollar to gain increasing prominence while countering the strategic goals of the Soviet Union. Our paper, Exploring the history of dollar dominance, discusses how the US cemented its position after 1945.

China is accelerating efforts to reduce reliance on the dollar and boost foreign investment and exports through initiatives like the Belt and Road, the China-led Asian Infrastructure Investment Bank and Made in China 2025. Ultimately, any Chinese-led system will be underpinned by strong use of the yuan. Although this is likely to be a gradual process, the potential strategic investment implications are profound.

Oil is a key commodity in the de-dollarisation process.


Changes in energy market dynamics

Oil is a key commodity in the de-dollarisation process. One reason for the dollar’s historical dominance is the US-Saudi settlement in the 1970s to invoice oil in petrodollars, which underpinned a dollar-based network of trade and finance. Yet today, China has overtaken the US as the world’s largest importer of crude oil, driven in part by the rise in US domestic oil production over the last ten years. US oil production, which has surged since 2010, is expected to continue growing by around one million barrels a day for each of the next five years. Indeed, it is remarkable the degree to which the production trend has continued rising despite the oil price crash in 2015-2016. Rising production has already led to lower imports into the US, with imports falling roughly 25% since 2010. Consequently, the US will buy less Middle Eastern and international crude, at precisely the same time the Chinese are buying more.

It is the resulting Chinese trade deficit from oil imports that provides the impetus for de-dollarisation, since China would prefer to settle its trade bill in renminbi if possible. Petroyuan futures launched in March on the Shanghai International Energy Exchange have already overtaken dollar-denominated oil futures traded in Singapore and Dubai in volume terms.8 The first physical shipments tied to petroyuan futures began last summer.

Oil companies in Russia, Iran and Venezuela have already begun accepting yuan as payment for Chinese imports, and were Saudi Arabia to follow, the impact could be substantial. A Saudi decision to invoice oil not in petrodollars but in petroyuan could underpin the rise of a substantial petroyuan network of trade and finance and may therefore turn out to be significant.

The new crude buyers on the block

Figure 4

Source: BP Statistical Review, 2017

A dollar down cycle

Finally, there is a cyclical component to timing de-dollarisation. The next few years may well coincide with a dollar down cycle, which typically accelerates the adoption of other currencies. The dollar tends to move in long cycles, typically around six to ten years each time. It declined through most of the 1970s, rose until the Plaza Accord of the mid-1980s, fell from the late 1980s to 1992, rose again until 2002, and then declined until the global financial crisis of 2008. Currency adoption is procyclical, and during each of these periods, other currencies increased their share against the dollar. For instance, pound sterling use accelerated in sovereign reserves between 2002 and 2008 to 4.8% from 2.7%. Even if one considers revaluation effects, sterling’s share of sovereign reserves increased materially during this period.

After spending six of the last seven calendar years on the up, another dollar down cycle may begin this year. Expensive fundamental valuations and poor technicals, which include significant foreign ownership and waning cash repatriation by US companies, will likely undermine support for the dollar. Moreover, growing concerns about budgetary trajectories in the US mean that the next cycle may offer an indication of the potentially higher risk premia investors will apply to US assets. Forecasts of the US Congressional Budget Office show US debt hitting 152% of output by 2048 from 78% today on the current fiscal trajectory, as social spending and Trump’s tax cuts cement that long-term deterioration.

Given the historical lags between the dollar’s market price behaviour, and current account and budget deficits, it seems likely that the dollar could fall materially in less than two years. Of course, interest rate differentials are still in favour of the dollar, and while that may change as the European Central Bank and the Bank of Japan normalise policy, there is also every chance that it is US rates that converge lower.

US twin deficits are a leading indicator of dollar weakness

Figure 5

Source:  Investec Asset Management, 2018

Where to from here?

The emergence of a genuinely multipolar world will have a profound impact on markets and portfolios. We are already seeing the world starting to de-dollarise in important ways, a trend aggravated by the strategic rivalry between China and the United States. This movement could gather pace with the next dollar down cycle, which could begin as early as this year. Structural economic shifts in China mean the country will need an internationalised currency sooner than later. This would require the Chinese authorities to continue undertaking bold capital market reforms and other policy changes. But how far will China go with its reforms? Given the uncertainty of any currency transition, our research looks at three potential scenarios and their investment implications. This key topic is covered in our paper, The next global currency shift: scenarios and investment implications.

1 Doff, N., Andrianova, A., “Russia buys quarter of world yuan reserves in shift from dollar,” Bloomberg, 10 January 2019.
2 Peel, M., “Can Europe’s new financial channel save the Iran nuclear deal?”, Financial Times, 4 February 2019.
3 “EU Chief aims to boost euro’s role in world markets,” Associated Press, 12 September 2018,
4 Martin, F.E., Mukhopdhyay, M., and Hombeeck, C., “The global role of the US dollar and its consequences,” Quarterly Bulletin, Bank of England, Fourth Quarter 2017, p.1.
5 “People’s Republic of China: 2018 Article IV Consultation-Press Release; Staff Report; Staff Statement and Statement by the Executive Director for the People's Republic of China,” International Monetary Fund, July 26, 2018.
6 Reid, J., Mahtani S., Templeman, L., “Tomorrow’s robots and economic history—Not a job killer,” Konzept #13, June 2018.
7 “Chart of the week: China’s thrift, and what to do about it,” International Monetary Fund, 26 February 2018.
8 Mathews, J.A., Selden, M., “The rise of the petroyuan,” Project Syndicate, 3 December 2018.

*Other contributing authors
Greg Kuhnert | Peter Eerdmans | Michael Spinks | John Stopford | Iain Cunningham | Wilfred Wee | Tom Nelson | Michael Power | Imran Ahmed

Important information

This content is for informational purposes only and should not be construed as an offer, or solicitation of an offer, to buy or sell securities. All of the views expressed about the markets, securities or companies reflect the personal views of the individual fund manager (or team) named. While opinions stated are honestly held, they are not guarantees and should not be relied on. Investec Asset Management in the normal course of its activities as an international investment manager may already hold or intend to purchase or sell the stocks mentioned on behalf of its clients. The information or opinions provided should not be taken as specific advice on the merits of any investment decision. This content may contain statements about expected or anticipated future events and financial results that are forward-looking in nature and, as a result, are subject to certain risks and uncertainties, such as general economic, market and business conditions, new legislation and regulatory actions, competitive and general economic factors and conditions and the occurrence of unexpected events. Actual outcomes may differ materially from those stated herein. All rights reserved. Issued by Investec Asset Management, March 2019.

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