Southeast Asia, too, is losing patience with King Dollar’s clout

Southeast Asia, like much of the rest of the world, is losing patience with King Dollar.

The westernization of the world’s reserve currency, as through sanctions on those deemed bad actors — such as Russia for its war in Ukraine — has pushed even the typically diplomatic Southeast Asians to warn the US of the consequences.

In a conference in Singapore on Tuesday (Jan 10), multiple former officials spoke about de-dollarisation efforts underway and what economies in the region should be doing to mitigate the risks of a still-strong dollar that’s weakened local currencies and become a tool of economic statecraft.

“The US dollar is a hex on all of us,” George Yeo, former foreign minister of Singapore, said at the conference hosted by the ISEAS-Yusof Ishak Institute. “If you weaponise the international financial system, alternatives will grow to replace it” and the US dollar will lose its advantage. 

While few expect to see the end of King Dollar’s global sovereign status anytime soon, Yeo urged that the risk of it happening be taken more seriously.

“When this will happen, no one knows, but financial markets must watch it very closely,” said Yeo, who is a visiting scholar at the National University of Singapore’s Lee Kuan Yew School of Public Policy.

After gaining 6.2% in 2022, the US dollar is down 0.67% in the first several days of this year, through the end of Tuesday, according to the Bloomberg Dollar Spot Index.

Yeo noted that in times of crisis, the US dollar rises further — as with levies on Russia that have left Russian banks estranged from a network that facilitates tens of millions of transactions every day, forcing them to lean on their own, much smaller version instead. That’s put more pressure on third-party countries, too, which have to unduly rely on US dollar use.

Following on Yeo’s remarks later in the conference, former Indonesian trade minister Thomas Lembong applauded Southeast Asia's central banks that already have developed direct digital payments systems with local currencies, and encouraged officials to find more ways to avoid leaning too hard on the greenback.

“I have believed for a very long time that reserve currency diversification is absolutely critical,” said Lembong, who’s also a co-founder and managing partner at Quvat Management Pte Ltd. Supplementing US dollar use in transactions with use of the euro, renminbi, and the yen, among others, would lead to more stable liquidity, and ultimately more stable economic growth, he said.

The 10 Asean countries are just too disparate to establish a common currency as with the euro bloc. But Lembong said he was “deeply passionate” on this subject of the US dollar as a global reserve currency.

The direct digital payments systems — which have boosted local currency settlement between Malaysia, Indonesia, Singapore and Thailand — are “another great outlet for our financial infrastructure”, he said.- Bloomberg

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US dollar downtrend seen

THERE seems to be growing expectations among financial analysts that the US dollar strength will dissipate in the medium term as the global economy recovers from the fallout of the Covid-19 pandemic.

According to an analyst survey compiled by Bloomberg, the ICE US Dollar Index, which is a gauge of the greenback’s strength, could weaken about 2% to 94.1 points by the second quarter of next year. The index is currently trading around the 96 level.

Bloomberg also notes that the Deutsche Bank’s Trade-Weighted Dollar Index, which is a gauge of the currency against the United States’ most-important trading partners, has fallen to test the trend line in place since 2011. The report says a breach of that point would be an important signal for dollar bears.

This month alone the index has dropped more than 1% amid the weakening demand for safe-haven assets such as US Treasury bonds, an ongoing rally in risk assets such as equities and a shift in sentiment towards other currencies such as the euro and yuan.

Standard Chartered Bank (StanChart), at a virtual press conference over the week in conjunction with the release of its Global Market Outlook for the second half of 2020, asserts its bearish view on the US dollar over the medium term.

The multinational financial group points to massive US dollar liquidity provision and real interest rate differentials between the United States and other countries as among the factors that should facilitate a reversal in the US dollar decade-long bullish trend.

“The longer-term cyclical US dollar uptrend that began in 2008 has likely peaked, with its downtrend expected to gain momentum over the coming year as the global economy rebounds and US exceptionalism fades, ” StanChart says.

“We expect some bumps on the road for the US dollar downtrend, particularly in the near term. These are likely to be driven by US political and policy uncertainty ahead of the November election, broader geopolitical risks and the evolution of the pandemic, ” it adds.

StanChart says it considers such events as opportunities for medium-term investors to sell US dollar rallies.

“We expect a 5%-7% US dollar decline over the next 12 months, with the euro, Australian dollar and British pound being the primary beneficiaries. There may be a more difficult passage for emerging-market currencies that are sensitive to an uneven global recovery and idiosyncratic risks, ” it says.

Viable alternative

Similarly holding a bearish view on the US dollar, Nomura says it expects the greenback to follow a path of reduced dominance and weaken over the long term.

In its recently released report titled “The World After Covid-19”, the multinational brokerage projects the US Dollar Index (DXY) to see a sharp depreciation of up to 20% in the coming years.

“Macro drivers include the significant deterioration of the US twin deficits, scope for European Union fiscal coordination, the undermining of the US dollar by US President Donald Trump through verbal and potential policy actions, and substantial foreign exchange (FX) overvaluation, ” Nomura says of what will lead to the weakness of the greenback.

“However, there are other developments that could reduce the role of the US dollar, some of which are structural, such as deglobalisation, yuan internationalisation, digital FX, Bitcoin and Facebook Libra, ” it adds.

Nomura also points out that the end of the US dollar’s role as the world’s reserve currency has long been foretold, but it has yet to materialise due to the lack of a viable alternative. For instance, it notes, the greenback accounted for 88% of all global FX trades last year, up from 85% in 2010.

Nevertheless, Nomura says, the process of creating a viable alternative is gathering momentum, thanks to innovations from other global central banks and private financial institutions.

“Combined with worsening fundamentals for the US dollar, the risk over the coming years is not only one of a reduced role, but also what could be a relatively sharp DXY depreciation, possibly 20%, ” it says.

According to Nomura, the US dollar is overvalued by an average of 17.5%. The greenback on the real effective exchange rate model is overvalued by about 22%, while on the fundamental equilibrium exchange rate model, it is currently overvalued by about 15%.

Positive for emerging market

A weakening US dollar, Nomura says, will provide some breathing space for emerging-market currencies, especially those of countries with sizeable current account deficits. This is because they tend to be more vulnerable to capital outflows and hence, FX volatility.

The brokerage expects in a world of low interest rates in developed markets and ample liquidity due to global central bank easing, investors will be on the lookout for economies that offer higher risk-adjusted returns.

“Emerging markets, which offer a relative growth advantage, could benefit from such easy developed-market policies, by tapping low cost funds for high-return investment projects, ” Nomura says.

StanChart is positive on the FX of Asian emerging markets as US dollar weakness feeds through.

“Gradual emerging market FX appreciation should continue amid a recovery in global growth, easing restrictions and a broadly weaker US dollar, ” it says.

Nevertheless, it reckons a pick-up in US-China trade tensions and an uneven global economic rebound could pose a risk to its optimistic view on emerging-market FX.

Gradual ringgit recovery

On the ringgit, StanChart says further policy rate cuts by Bank Negara could potentially weigh on the performance of the Malaysian note. It points out that the ringgit remains relatively more exposed to external financing shocks.

At present, StanChart expects Bank Negara to keep the overnight policy rate at its current level through 2020. The central bank early this month cut the benchmark interest rate for the fourth time this year by another 25 basis points to 1.75%, the lowest since 2004.

Meanwhile, the longer-term valuations for US dollar to the ringgit remain attractive, StanChart says, adding that this should limit a sharp sell-off in the ringgit, while a stronger-than-expected rebound in commodity prices will bode well for the Malaysian currency.

Year-to-date, the ringgit is among the worst-performing currencies in Asia.

It has weakened by around 4% against the US dollar since the start of the year due to a number of factors, including political uncertainties following the fall of the Pakatan Harapan-led government, and risk aversion amid geopolitical tensions and the Covid-19 pandemic.

The ringgit is currently trading around 4.27 against the US dollar, compared to around 4.09 to the greenback at the start of 2020.

According to Hong Leong Investment Bank (HLIB), the still positive yield differentials between Malaysia and the United States should be supportive of the ringgit over the medium term. A potential return to emerging-market assets as risk appetite improves should also support the local note, the brokerage says.

HLIB projects a gradual improvement in the ringgit, which it expects to end this year at 4.20 against the US dollar, before improving further to 4.15 against the greenback by end-June 2021.

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Break free of US dollar hegemony: What’s next?

The dollar is central to the global monetary system – used worldwide as a unit of account, store of value and medium of exchange. Most commodity and forex contracts are denominated in it. It represents more than one-half of all cross-border interbank claims (a proxy for international payments). That’s five times US share of world goods imports, and three times its share of exports. About two-thirds of world reserves is held in US dollars.

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The yuan’s stability is partly by design, and by good luck; backed by foreign exchange reserves held steady at US$3.1 trillion since mid-2016.

TODAY, the world’s financial rhythm remains American. The US dollar assumed the role of the world’s dominant reserve, payment and settlement currency after WWII. The country’s position as the sole financial superpower gives it extraordinary influence over the destinies of nations.

For 70 years, the United States has used this power rather routinely, as a matter of reality. Of late, however, it has been engaged in “financial warfare” in the service of its foreign policy. This has prompted nations to “break free” of US dollar hegemony, including preventing “US sanctioned nations” free access to US dollar-based financial system with devastating impact.

The dollar is central to the global monetary system – used worldwide as a unit of account, store of value and medium of exchange. Most commodity and forex contracts are denominated in it. It represents more than one-half of all cross-border interbank claims (a proxy for international payments). That’s five times US share of world goods imports, and three times its share of exports. About two-thirds of world reserves is held in US dollars.

It is the preferred currency of central banks and capital markets (accounting for 65% of global securities issuance). The irony is people rushed to buy dollars during the subprime crash, even though Wall Street caused it. They did so again in March this year despite US bungled response to Covid19. The global finance plumbing is US dolarbased – most international transactions are ultimately cleared in US dollars through SWIFT (banks’ main cross-border messaging system) and CHIPS (Us-centric clearing house network) through New York by US “correspondent banks.” Denied access to this infrastructure, the institution is isolated and financially crippled. The United States began flexing its financial muscles (including imposing hefty penalties) after the terrorist attacks of September 2001.

Trump has since “weaponised” it to a new level – to-date, it has over 30 active financial and trade-sanctions programs. Early this year, it used this dominance to cut-off support to the Iran and Iraq regimes, adversely affecting their use of oil revenues.

This use of the dollar to extend its policy reach is “an abuse of power,” i.e. bullying; Russia refers to its use, a “political weapon.” Even allies (EU, Japan, UK) are concerned Trump is undermining US role in maintaining orderliness in global commerce and finance. There is already widespread talk to “dethrone” the US dollar, through the dedollarisation of assets; more use of domestic currencies in its trade workarounds and swaps; and new banking payments mechanisms and digital currencies.

Also, nations have expanded settlement of bilateral trade in their own currencies, or gold; even barter. Russia has gone the furthest, including dedollarising parts of its financial system; reducing US dollar share of its foreign reserves (40% to 24%); cutting its bank’s holdings of US dollar Treasuries to under Us$10bil from Us$100bil; bringing down its exports denominated in US dollar to 62%; and shifting US dollar trade with China and India to non-us dollar settlements; and denominating over 40% of its crude oil tenders in euros.

Like Russia, China has begun to set-up “building blocks” to become more autonomous, including a yuan-denominated crude oil futures contract (“petroyuan”) on the Shanghai exchange. US allies are flirting with it, too. But, EU first has to reform the inner workings of the euro and complete work on banking union, fiscal integration, etc., before it is ready to create a global electronic invoicing euro currency.

Reserves option

US dollar’s role as a reserve currency point to three distinct benefits: (i) lower transactions cost; (ii) macroeconomic policy flexibility, including foreign financing of its deficits; and (iii) leverage to benefit allies. Of course, it carries costs: (a) tends to hurt exports by being strong and stable; (b) overhang of debt overseas opens domestic economy as hostage to sudden capital movements; and (c) needs to bail-out the system.

That’s why the UK, Japan and Germany shied away. However, because the world has changed, EU has since started to push for a stronger international role for the euro. But becoming a serious reserve currency requires: (a) large, deep and liquid capital markets; (b) a secure bonds infrastructure, especially in government bonds; (c) wide use in world trade; and (d) a big economy that’s integrated into global markets.

Without fiscal union, EU lacks a supranational, liquid euro bond; its capital markets are not robust enough – a real banking union would help. Euro’s share of global reserves is down to 20%. Russia also tried – cuts US dollar share of its reserves to 24%. Issues most debt in roubles and euro; only 60% of its exports is settled in US dollars, and 40% of its oil sales contracts is denominated in euros. It has still a long way to go.

China had longed wish to internationalise. But, its capital controls remain a serious problem: it limits how much outsiders can access its currency. In 2017, Bond Connect was launched – allowing foreigners to invest in offshore bonds through Hong Kong, and scrapped investment quotas.

China has since made good progress: (i) offshore yuan deposits are rapidly rising; (ii) issues of yuan “dim-sum” bonds are getting popular; (iii) boom in forex transactions suggests growing usage, especially in hubs like Hong Kong, London, New York and Paris; (iv) more offshore investment products are denominated in yuan; and (v) Hong Kong today lists ETFS, gold futures and property investment trusts in addition to Chinese equity. China’s advances are global: it has a vast global trade and investment network; Chinese FDI is mainly in yuan; it settles 15% of its foreign trade in yuan. Today, more globally yuan payments are processed by banks.

One-fifth of European trade with China is settled in yuan, as is 55% of payments among them. Since 2018, yuan-denominated oil futures were launched in Shanghai, as are margin deposits on iron ore futures in Dalian. China’s commodity exchange is emerging. Most of all, central banks are warming up to the yuan – since inclusion in IMF’S SDR (a basket of five elite currencies), its share of global reserves has risen to 2.1%;

China has already signed currency swap arrangements with over 60 nations. Today, the “yuan bloc” accounts for 30% of global GDP – second only to US dollar (at 40%). China opened up its US$13 trillion bond market (world’s second largest), which accounts for 51% of all bonds issued by EMES.

Foreigners now hold 3% of this market and 9% of its government bonds. Its main attraction: good yields and diversification benefits. Further, the yuan has been among the most stable currencies in the world since mid-2016. Its real effective exchange rate – against the basket of currencies of its trading partners, adjusted for inflation – has risen by just 0.2% over the past four years. The yuan’s stability is partly by design, and by good luck; backed by foreign exchange reserves held steady at US$3.1 trillion since mid-2016.

New initiatives

US geopolitical rivals’ desire to escape the dollar dominance is real. In designing its new e-yuan, China wants a head start on the dollar; it is reported to be considering creating a common cryptocurrency with other BRICS nations (Brazil, Russia, India and South Africa). Similarly, on its part, EU is determined to encourage its members to eliminate “undue reference” to US dollars in payments and trade invoicing.

EU’S main initiative has involved Iran. It tried to create a way for its banks and firms to trade with it through Instex (a clearing house created for this purpose by Britain, France and Germany, with European Commission’s support) by-passing US dollars or SWIFT.

The stuttering performance of Instex reflects the sheer scope of the dollar reach: US claims jurisdiction if a transaction has any American “nexus,” even though not denominated in dollars. Despite this, more EU states are determined to join Instex. It’s EU’S intention to expand its financial reach – through a network of global electronic central bank digital monies that serves as a global invoicing currency, excluding US dollars. Also, its capital market needs greater depth and liquidity, key factors in choosing a currency for commerce. As Trump continues to use sanctions aggressively, efforts to circumvent them will accelerate. The reality is that US does not have a monopoly on financial ingenuity.

What then are we to do

There’s no question the world urgently needs a multinational currency reserve regime. The dollar is being weaponised to bully. This won’t do. Nations, including US allies, are looking for and working on an effective but viable and sustainable option. This will take time. The search is still very much work-in-progress. Euro and e-yuan look promising. But they have a way to go. Like it or not, any e-currency has to be central bank-backed to be credible, and where the public can readily access it.

Still, central banks face hurdles in offering dedicated digital currencies and related accounts to the public. Understandably, many central banks have been hesitant in creating digital currencies. As I see it, they remain worried on how to monitor transactions to prevent fraud and hacking, and whether digital currencies should be linked to interest rates. It’s a responsibility, I think, central banks really don’t want to take-up.


By Lin See Yan, Kuala Lumpur, June 22, 2020

Former banker, Harvard educated economist and British chartered scientist, Prof Lin of Sunway University is the author of “Trying Troubled Times Amid Trauma &Tumult, 2017–2019” (Pearson, 2019). Feedback is most welcome.

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