RUFARO MAFINYANI: Dollar dominance and its global ripple effect, an SA perspective

The dollar has dominated the global financial system for decades, especially since the collapse of the Bretton Woods system in 1971.

When the US detached the dollar from gold it introduced a new era of fiat currencies, providing the US with unprecedented monetary flexibility. This change also introduced global volatility, which has affected SA’s monetary policy, long-term investment strategies and economic stability.

The shift to fiat currencies and financialisation, where profits are generated through financial transactions rather than productive investments, has created a divide between financial markets and the real economy. A prime example of this is the surge of stock buybacks in the US after the 2008 financial crisis. From 2009 to 2019 S&P 500 companies spent more than $5-trillion on stock buybacks, benefiting shareholders without hugely boosting economic growth or employment. 

In SA financialisation has similarly distanced financial markets from the broader economy. Foreign capital inflows have increased, but the benefits have not reached most South Africans. For example, from 2010 to 2019 foreign direct investment (FDI) inflows into SA averaged just 1.6% of GDP, while GDP growth averaged a mere 1.4%. Unemployment skyrocketed to 34.9% in 2021, highlighting the disconnect between capital inflows and real economic benefits. 

Foreign portfolio investments, mostly in stocks and bonds, contributed R94bn in inflows in 2020. However, these investments haven’t translated into significant improvements for most South Africans, as capital is concentrated in speculative financial markets rather than the productive sectors that are crucial for job creation and economic growth. 

Monetary policy, a global balancing act

The dollar’s dominance and interconnected global financial markets have made it difficult for developing countries such as SA to pursue independent monetary policies. The SA Reserve Bank often aligns its monetary policy with the US Federal Reserve or the European Central Bank (ECB) to maintain rand stability. 

In 2022, as the Fed raised interest rates to curb inflation, the Bank had to follow suit to prevent the rand from depreciating. SA’s policy rate increased from 3.5% in 2020 to 7.75% by mid-2023. However, raising rates comes at the cost of stifling domestic demand and slowing economic recovery efforts. The SA economy contracted by 6.4% in 2020 due to the Covid-19 pandemic, and higher interest rates have since dampened consumer spending, further hampering recovery. 

SA’s rising debt, which increased from 27.5% of GDP in 2008 to more than 70% in 2022, leaves the country vulnerable to external shocks, particularly those driven by US or European monetary policy. 

Global financial volatility

When the Bank of Japan (BoJ) announced a slowdown in bond purchases in June 2024 the Japanese stock market plummeted by 20%, and bond valuations sharply declined. With trillions in global financial assets benchmarked to Japanese bonds, this sparked widespread margin calls on derivative positions, causing severe market instability.

The value of collateral, especially in the $600-trillion global derivatives market, was affected as bond yields rose. In SA this led to capital outflows, a weakening rand and higher bond yields, compounding liquidity pressures and economic strain. 

The BoJ’s reduction in bond buying triggered a surge in yields, directly increasing the cost of maintaining derivatives contracts globally. As the value of Japanese government bonds decreased, institutions faced margin calls, forcing asset sales to cover their positions. These bonds are widely used as high-quality collateral, and as their value decreased market volatility increased, especially in derivatives linked to interest rates and sovereign debt.

For SA, which is highly interconnected with global financial markets, the fallout hit hard. Foreign investors, already jittery about emerging markets, began pulling capital from SA government bonds. By mid-2024 foreign bond sales amounted to R50bn, driving yields on SA 10-year government bonds to more than 11%. The increased borrowing costs placed additional strain on SA’s debt-heavy government budget, and the weakening rand (which dropped by 10% in three months) led to higher import costs, aggravating inflation. 

In addition, like others globally SA’s financial markets rely on a stable bond market to underpin corporate borrowing and investment decisions. The sell-off in Japanese government bonds led to liquidity squeezes in SA capital markets, reducing investor confidence and curbing domestic economic growth prospects. 

In 2022, as the US Fed raised rates SA experienced R40bn in foreign bond market sales, leading to rand depreciation and higher borrowing costs for government. The yield on 10-year government bonds rose to 11%, a concerning trend given that SA’s debt servicing costs account for nearly 20% of government expenditure. 

SA’s reliance on global benchmarks exposes it to risks similar to Japan’s bond market collapse. As global interest rates rise the value of assets such as government bonds decreases, creating financial turbulence. 

Threat of dollar collapse

The dollar’s dominance has provided stability for global trade and financial markets, but with US national debt exceeding $33-trillion and inflation rising a collapse in the dollar’s value would have catastrophic consequences for global markets, potentially triggering a financial crisis worse than 2008. 

For SA a dollar collapse would lead to capital outflows, a sharp rand depreciation and increased borrowing costs. Our exports, many priced in dollars, would become more expensive, worsening the trade deficit and further straining the economy. 

While SA cannot fully escape the influence of the dollar it can pursue strategies to mitigate these risks. Regional economic integration, particularly within the Brics bloc and the AU, offers a promising solution. Intra-African trade accounts for only 17% of the continent’s total trade. Encouraging trade in local currencies could reduce dependence on the dollar and provide greater stability during global financial turbulence. 

Brics partners India and Brazil have taken steps to reduce reliance on the dollar, such as currency swap agreements and diversifying foreign exchange reserves. SA could explore similar measures by promoting the use of the rand in regional trade and developing local capital markets to reduce dependence on foreign capital inflows. 

Strengthening domestic capital markets

Developing deeper, more liquid markets for bonds and equities is critical. While SA’s financial markets are well developed, concerns remain about foreign holdings concentration and capital outflows.

In 2022 SA issued green bonds worth R1.5bn, signalling a positive trend. Further developing such products could help the country diversify its investor base and reduce reliance on speculative foreign capital flows. 

More importantly, these efforts must align with broader development goals, such as embracing the digital economy, improving infrastructure and investing in skills. These initiatives will help reduce SA’s vulnerability to external financial shocks and position the country as a competitive player in the global economy.

• Mafinyani is risk advisory & financial modelling partner at DiSeFu, a specialised financial technology and risk advisory firm operating in the sub-Saharan region.