The U.S. dollar has long been the global reserve currency and the pillar of international trade, thanks to its stability, robust U.S. capital markets and the rule of law. However, as the world continues to evolve in terms of economic power, a significant shift has been taking place in the form of de-dollarization.

Several factors have contributed to this process, which involves countries moving away from using the U.S. dollar in international trade and looking for alternatives. Below, we highlight those factors:

Geopolitical Tensions

As tensions between the United States and other major economies like China and Russia increase, these countries have started reducing their reliance on the U.S. dollar in order to reduce vulnerability to U.S.-imposed economic sanctions.

The greenback’s share in global reserves declined last year at 10 times the average speed of the past two decades as many countries explored alternatives after Russia’s invasion of Ukraine led to sanctions, Jen and his Eurizon SLJ Capital Ltd. colleague Joana Freire wrote in a note, as quoted on Bloomberg, published on Yahoo. Adjusting for exchange rate movements, the dollar has lost about 11% of its market share since 2016 and double that amount since 2008, they said.

The U.S. currency now makes up about 58% of total global official reserves, down from 73% in 2001 when it was the “indisputable hegemonic reserve,” the Eurizon pair said in the above-mentioned source. U.S. Treasury Secretary Janet Yellen has also confirmed that the premium status of the U.S. dollar is at risks now, as quoted on Firstpost.

BRICS economies have been taking an important step toward de-dollarization. Brazil's president has recently urged the BRICS countries (Brazil, Russia, India, China, and South Africa) to develop a new currency and move away from the U.S. dollar in their transactions.

This development comes as Brazil and China are forging stronger connections, having recently agreed to utilize the yuan for cross-border transactions. China’s U.S. Treasury holdings declined to a 12-year low in 2022. The Indian government, last month, said about 18 countries, including Russia, Sri Lanka, and the UK, have shown interest in conducting international trade with India using the Indian rupee as the settlement currency.

Fed to Cut Rates Soon on Easing Inflation?

The significant downside surprise in the latest U.S. inflation metrices — both CPI and PPI — has led people to believe that the Fed will soon be done with policy tightening and may even start to cut rates before the end of the year. This may undermine the greenback’s strength. Meanwhile, the global health crisis is ebbing. This fact is not helping the U.S. dollar’s safe-haven status either.

Concerns About High U.S. Debt

High national debt has led to worries about the long-term stability of the U.S. dollar, prompting countries to diversify their reserve currencies. United States Government debt made up about 123.4% of the country's Nominal GDP in Dec 2022, compared with the ratio of 123.6% in the previous quarter. The U.S. government debt to GDP ratio reached an all-time high of 132.4 % in March 2021.

The Rise of Digital Currencies

The increasing popularity of cryptocurrencies and the development of central bank digital currencies (CBDCs) have provided countries with new alternatives to the greenback

ETF Investment Strategies to Follow

To navigate the de-dollarization process, investors should consider the following ETF strategies:

Tap Inverse Dollar ETF

Needless to say, if the dollar is falling, a short position on the currency would result in positive returns. Invesco DB US Dollar Index Bearish Fund (UDN Quick QuoteUDN - Free Report) should thus be tapped.

Focus on Commodities & Gold

The decline in the U.S. dollar is good for raw materials and commodities as these are priced in the U.S. dollar. SPDR Gold Shares (GLD Quick QuoteGLD - Free Report) has gained about 10% this year due to a sudden dollar weakness and the banking crisis in the United States. Broader commodities ETF Invesco DB Commodity Index Tracking Fund (DBC Quick QuoteDBC - Free Report) has also added about 7.9% past month.

Opportunities in Emerging Markets

De-dollarization can create opportunities for investors in emerging markets, as countries that were previously reliant on the greenback may develop stronger financial systems in their own networking circle. This could lead to increased investment in these countries, boosting their economic growth. Pacer Emerging Markets Cash Cows 100 ETF (ECOW Quick QuoteECOW - Free Report) is thus an option to think about. The fund is up about 8% past month. The fund yields 6.53% annually.

Time for Large Caps?

Since large-cap stocks have greater foreign exposure, the weakening dollar is positive for this capitalization. BofA Global Research once estimated that every 10% drop in the U.S. dollar translates into about a 3% boost to S&P earnings, as quoted on Reuters. SPDR S&P 500 ETF Trust (SPY Quick QuoteSPY - Free Report) should thus be closely watched.

Should You Tap Opportunities in Digital Currencies?

De-dollarization can create new opportunities in digital currencies. Investors with a strong stomach for risks may be open to exploring these options but a great caution is warranted. Digital currency is a very volatile area. Global X Blockchain ETF (BKCH Quick QuoteBKCH - Free Report) , which deals with the mining of cryptocurrencies are in vogue now as bets over slower interest rate hikes by the Federal Reserve are rife.

Bottom Line

Overall, while there are certainly challenges to the U.S. dollar's dominance as a global reserve currency, it is unlikely that it can be dethroned in the near term. Any changes in the international monetary system would likely be a gradual process. Plus, not many countries have a solid institutional infrastructure that would position its currency to assist the world trade like the U.S. dollar, per Yellen.