Uruguay latest country hoping to ditch the Dollar

Uruguay is the latest country hoping to ditch the U.S. dollar.

That won’t be an easy task, given that Uruguay ranks as the most dollarized Latin American nation. However, the fact that the government is even trying to limit dollar dependence reflects a growing de-dollarization trend that threatens the primacy of the greenback.

Uruguay Central Bank President Guillermo Tolosa recently announced policy changes designed to de-incentivize dollar use and boost the Uruguayan peso. The measures include increasing local currency capital requirements on banks to back dollar loans. The plan also calls for eliminating some reserve levels for peso deposits to incentivize loans in the local currency. According to Bloomberg, other measures under consideration include requiring businesses that price goods in foreign currencies to also list prices in pesos.Uruguayans flocked to the dollar during inflationary periods in the 20^th century. Today, nearly two-thirds of Uruguayan bank accounts are denominated in dollars.

Tolosa says Uruguayan reliance on the greenback is an old habit that has outgrown its usefulness. He also threw shade at the growing devaluation of the dollar, noting that dollar-denominated checking accounts have lost half their purchasing power over the last two decades.

Let’s give up the pacifier once and for all. Your purchasing power when you invest in dollars is going to be very volatile. Investing in dollars in a context like this is a form of gambling, like a casino.

The De-Dollarization trend

Uruguay isn’t alone. De-dollarization is a growing global trend. Central banks worldwide are diversifying away from dollars and buying gold. We’ve seen central bank gold buying eclipse 1,000 tonnes for three straight years. To put that into context, central bank gold reserves increased by an average of just 473 tonnes annually between 2010 and 2021.

We’ve also seen declining dollar reserves.

As of the end of last year, dollars made up 57.8 percent of global reserves. That is the lowest level since 1994, representing a 7.3 percent decline over the last decade. In 2002, dollars accounted for about 72 percent of total reserves.

Why are so many countries spurning the dollar?

Many are concerned about the weaponization of the U.S. currency. In an article published by the Atlantic Council, Kimberly Donovan and Maia Nikoladze point out that “central banks that are worried about getting sanctioned, want to protect themselves from a potential global financial crisis, or both have been stacking up gold at record levels.”

There are also growing worries about the U.S. government’s fiscal irresponsibility. In October, the national debt pushed above $38 trillion, and there is no sign that the borrowing and spending will slow down anytime soon. At some point, people become wary of loaning their fast-spending, drunk uncle more money.

Ramifications

The Dollar isn’t in danger of collapsing or even losing its reserve status – at least not yet. However, even a modest de-dollarization spells trouble for the federal government and the U.S. economy.

In a nutshell, the United States needs the world to need dollars.

The U.S. depends on this global demand for dollars supported by its reserve status to underpin its massive government. The only reason Uncle Sam can borrow, spend, and run massive budget deficits to the extent that it does is the dollar’s role as the world's reserve currency. It creates a built-in global demand for dollars and dollar-denominated assets. This absorbs the Federal Reserve’s money creation and helps maintain dollar strength despite the Federal Reserve’s inflationary policies.

WolfStreet summed up the risk the U.S. faces as the dollar’s status continues to erode.

The status of the U.S. dollar as the dominant global reserve currency has helped the U.S. fund its twin deficits and thereby has enabled them: the huge fiscal deficit every year and the massive trade deficit every year. The reserve currency status comes from other central banks (not the Fed) having purchased trillions of USD-denominated assets such as Treasury securities, other government securities, corporate bonds, and even stocks. The dollar's status as the dominant reserve currency has been crucial for the U.S., and as that dominance declines ever so slowly, risks pile up ever so slowly.

While the threat isn’t immediate, a slowly growing pile eventually turns into a giant pile.

But again, even a modest de-dollarization will have significant impacts. If the world needs fewer dollars, they will begin to return to the U.S., causing a dollar glut. This will increase inflationary pressure domestically as the value of the U.S. currency further depreciates. In the worst-case scenario, the dollar could collapse completely, leading to hyperinflation.