Economic sanctions imposed by the U.S. on Russia and its other adversaries might threaten the dollar's global dominance over time, according to Treasury Secretary Janet Yellen.
"There is a risk when we use financial sanctions that are linked to the role of the dollar that over time it could undermine the hegemony of the dollar," Yellen said.
Yellen insisted that sanctions could prompt other countries to seek an alternative currency. Sources said Brazil, Russia, India, China and South Africa — known as BRICS — are trying to establish a new currency to reduce their reliance on the U.S. dollar.
"Of course, it does create a desire on the part of China, of Russia, of Iran to find an alternative."
Janet Yellen, U.S. Treasury Secretary
Yellen, however, also said that it would not be easy for other nations to find an alternative that resembles the U.S. dollar, which is backed by the country's rule of law and "deep" capital markets.
The dollar's status as the leading reserve currency offers several advantages to the U.S., including strong demand for dollar-backed securities, reduced borrowing costs to U.S. entities and cheaper imports. However, the U.S. dollar's movement can easily influence other economies, especially those highly dependent on the greenback.
The U.S. attempted to weaken Russia's financial system by rolling out various sanctions after the Kremlin initiated the invasion of Ukraine last year. Russian banks and other business entities have difficulty closing international transactions because the U.S. blocks their access to the dollar.
Chinese yuan rising in global market
The International Monetary Fund (IMF) reported that China's yuan accounted for 2.7 percent of the total global currency reserve in Q4 2022, up from 1.08 percent when the currency was first added to the IMF's special drawing rights basket six years prior.
The number was still significantly lower than the dollar's 58.4 percent allocation in the currency reserve, but China is working to improve its global dominance by forming trade agreements with other countries.
China recently inked an agreement with Brazil to replace the dollar with the yuan and real for their bilateral trade. The Xi Jinping administration is also in talks to purchase oil from Saudi Arabia and other oil-producing countries with the yuan.
The Chinese currency also took over the U.S. dollar's spot as the most-traded currency in Russia last February. The lack of access to the dollar has prompted Russian companies to use alternative currencies to continue their business trade.
Last month, Russian leader Vladimir Putin also told Xi that Russia was committed to mainly using the yuan as its foreign trade currency. Denmark-based research institution Steno recently published a report saying that China aimed to replace the U.S. as the world's financial hub and "center of pivot."
Analysts have pointed out several issues that may limit the yuan's ability to grow as a leading reserve currency, primarily related to its capital control. Investors will be more cautious in trading with the yuan due to the government's tight hold on the currency.
The People's Bank of China employs a specific trading mechanism to stabilize the currency's value against its peers. China uses this method to boost its exports, which are responsible for its rapid industrialization over the past decades.
The mechanism prevents residents from moving money out of the country. At the same time, the Chinese government has limited foreign investment, especially in its bond market, by using quotas to limit in-flows. The system makes China prone to liquidity risks, analysts believe.