Will the yuan replace the dollar as the world's leading reserve currency? Dean Todorov to FAKTI

Geopolitical turmoil and growing tension in the global economy are increasingly raising the question of the future of the dollar as the leading reserve currency. Against this background, the Chinese yuan is gradually expanding its role in international trade and financial relations, and the topic of dedollarization is once again coming to the fore. To what extent are these processes a real change and can the yuan become an alternative to the dollar… Dean Todorov, Director for Bulgaria at iBanFirst, spoke to FACTI.

- Mr. Todorov, to what extent can the crisis surrounding Iran be considered a catalyst for changes in the world's currency balance?
- The crisis with Iran does not drastically change the world's currency balance, but acts as a catalyst that accelerates already existing processes. In any geopolitical tension, investors traditionally turn to assets denominated in US dollars, and this case is no exception. What is more interesting now is that the appreciation of the dollar remains relatively limited, while other currencies are starting to gain positions, especially the Chinese yuan. The crisis makes a broader trend more visible: the search for alternatives in the international financial system, without this meaning that the dominance of the dollar is immediately threatened in the short term.

- You point out that in geopolitical crises, investors traditionally turn to the dollar – Why is the reaction more moderate this time?
- The dollar continues to enjoy very strong structural support. What is different now is that its appreciation is relatively limited and in parallel with this, a movement in favor of other currencies is seen, most notably the yuan. In other words, the reaction remains typical, but it is no longer as one-sided as in previous periods of tension. This suggests that markets are also starting to take into account the availability of alternative channels for payment and storage of value, albeit still on a limited scale.

- According to the analysis, the yuan is starting to gain ground - is this a temporary trend or the beginning of a longer-term process?
- The process is longer-term. Since 2008, China has systematically sought to internationalize its currency and build a partially alternative financial system. There have been setbacks, but there has also been real progress:

Now, about 23% of China's trade in goods and 30% of its imports of services are now carried out in yuan.

That is, this is not just a temporary reaction to a crisis, but a process that develops gradually and is supported by trade, financing and the construction of an international infrastructure for the yuan.

- The role of US military power in the dominance of the dollar is emphasized - does this mean that the currency system is more geopolitical than economic?
- The currency system is both economic and geopolitical. The analysis clearly shows that the leading role of the dollar is supported by two structural factors. The first is economic: the US external deficit and the way in which dollars flow into the world economy and then return to American assets. The second is geopolitical: there is a positive correlation between the share of the dollar in a country’s foreign exchange reserves and its military ties with the United States. Thus, geopolitical power remains closely linked to currency dominance.

- How realistic is the idea of dedollarization, given that it has been discussed for more than a decade?
- The analysis on this topic is quite moderate. Since 2008, dedollarization has been a recurring theme in financial markets, but its actual scale remains limited. Only two countries are actively pursuing this path, mainly for political reasons:
-- Russia, since 2014, in order to mitigate the effects of US sanctions after the annexation of Crimea
-- China, which seeks to internationalize its currency and partially build an alternative financial system
A more realistic scenario remains partial de-dollarization in individual regions, especially by promoting trade in yuan and by the use of the yuan by countries that want to limit their exposure to US sanctions.

- China is actively promoting the use of the yuan in international trade – what are the main constraints to it becoming a true reserve currency?
- The most important constraint is the restrictions on capital movements. China’s attempts to develop offshore financial markets and liberalize its system have been hampered by persistent capital controls, political interference in corporate governance, and the sharp triple devaluation of the yuan in 2015, which undermined investor confidence. China has ambition and is building infrastructure, but for the yuan to become a truly leading reserve currency, much higher trust, deeper financial liberalization, and freer capital movements are needed.

- How do you assess Iran’s proposal for payments in yuan – is it a symbolic gesture or a real change in global financial practices?
- I would rather say that at this stage it is symbolic in scale, but indicative in direction. The proposal is an example of the growing perception of the yuan as a potential alternative to the US dollar and as a “sanctions-resistant” currency. That is, the proposal itself does not mean that global financial practices have already changed fundamentally. But it is an important signal because it shows how geopolitics can accelerate the use of the yuan in specific trade and financial relations, especially by countries seeking distance from the American financial system.

- Analysts point out that the yuan can more easily overtake the euro than the dollar - what are the weaknesses of the euro in this context?
- According to the analysis, there are two reasons. First, the financial markets in the euro are less liquid and less integrated than in the United States. Second, the contribution of the euro area to global growth is declining faster than that of the United States, which weakens the position of the euro in the international monetary system. That is, the weakness of the euro in this context is not related to a sudden collapse, but to a more limited depth and integration of the markets, as well as a weaker relative growth profile. That is why it may be easier for China to overtake the euro than the dollar.

- Looking ahead - what will the global monetary system look like in 10 years: will it remain dollar-dominated, or will we see a more multipolar model?
- If we stick strictly to the analysis, the most likely answer is: the dollar will remain dominant, but the system may become more multipolar. China's ultimate goal is not necessarily to replace the dollar as the world's leading reserve currency, and such a scenario remains unlikely as long as restrictions on capital movements are in place. At the same time, it is entirely possible that the yuan will significantly expand its role in trade, especially in Asia, and establish itself as a stronger alternative for countries that want to limit their exposure to US sanctions. So in ten years, we are more likely to see not the end of dollar dominance, but a more pluralistic system in which the yuan has a more visible place, and could even become the second most traded currency in the world.