The Future of the Dollar as the World Reserve Currency
The U.S. dollar has been the world reserve currency for a long time now and the United States has benefited tremendously from its central position in the global economic system. About 59% of foreign currency reserves are denominated in U.S. dollars and around 90% of global transactions on foreign exchange markets are invoiced in dollars.[1] But is this about to change? Increasingly, there is more and more talk about what has now come to be known as “de-dollarization”, that is countries abandoning the U.S. dollar and leaving the dollar system in favour of other arrangements or an alternative system. When the United States weaponizes the dollar, as they did in the aftermath of Russia’s invasion of Ukraine, it forces other countries to reconsider investing in dollar-based assets and to look at other assets as an alternative. China and Russia have been particularly outspoken about America’s reckless monetary policy and Washington’s insistence on weaponizing the dollar, with many nations across the globe feeling that the United States is exploiting its position as the primary issuer of the world reserve currency, often for geopolitical reasons.
When the U.S. freezes the assets of other countries it harms its credibility as the arbiter of the global monetary system meanwhile other countries may not feel that it is wise to have all of their reserves and the majority of their asset portfolio denominated in U.S. dollars. Also, high domestic inflation in the U.S. leads to a devaluation of the dollar and erodes the value of their dollar holdings. In both scenarios it makes more sense for countries to consider other options, to invest in alternative assets and diversify their holdings.
As the world becomes increasingly more multipolar is it right that one country has so much power in this area? The current structure of the monetary system means that the U.S. is allowed to have very liberal debt, tax, trade and energy policies, spending and consuming far beyond its means, meanwhile poor countries in the global south have to invest part of their profits from trade and industry to essentially subsidise U.S. debt and consumption. Many feel that the dollar is overvalued, one study by Vanguard suggests by as much as 12%, [2] while some journalists have described the dollar as a “wrecking ball”, referring to how when the Federal Reserve raises interest rates it can cause havoc in global markets.
Indeed, Federal Reserve monetary policy leads to tremendous problems far beyond U.S. borders, from debt to volatile capital flows, from commodity price shocks to ruinous devaluations.[3] I have separate articles on the dollar weapon that deal with these very issues, I would strongly encourage people to read them.
A lot of the frustration with the dollar dates back to the 2008 global financial crisis. In the aftermath of the crisis China, frustrated at the Federal Reserve’s money printing exploits which saw the Fed flood the market with cheap liquidity, started reducing its purchases of U.S. Treasuries and instead started investing heavily in gold. Policies such as dollar liquidity swap lines, numerous rounds of quantitative easing and the zero-interest rate policy had the cumulative effect of reducing the value of the dollar, Beijing’s saw its dollar holdings fall in value meanwhile the devaluation of the dollar harmed Chinese exports. China, publicly vocal in its disapproval of the Fed’s actions was not happy so they turned to gold as better long-term investment. Brazil also expressed public anger at the Fed’s actions claiming they were distorting the global economy and reducing much needed investment in emerging markets.[4] By 2014, Japan replaced China as the country with the largest portfolio of U.S. debt assets. Alongside this, China has started to slowly internationalise the yuan as an alternative to the U.S. dollar by gradually reducing currency controls and facilitating more international trade in the yuan (more on this later). Also, China’s holdings of U.S. Treasuries are at their lowest level in decades.[5]
Gold tends to hold its value (or even rise in value) during inflationary periods and its price has risen in recent years. In 2022 we saw the biggest gold buyout in history by central banks as 1,078 metric tons of gold were purchased: countries such as China, India and Turkey making large purchases of gold and Russia, Uzbekistan and Qatar not far behind as well. The following year 1,037 tons were purchased. Investing in gold and other assets is a clear sign that countries are starting to lose faith in the dollar.[6]
Somewhat ironically, Russia being removed from the SWIFT banking system by the U.S. has marked a broader departure away from the dollar in the international community (with many countries seeking bilateral payment schemes between each other in their own currencies). In response to Russia being sanctioned, China has stepped in to fill the void by offering up its own financial network as an alternative destination for Russian money. Since 2010, China and Russia have settled the majority of their oil transactions in yuan and rubles, not dollars. Both Moscow and Beijing have been moving closer diplomatically, with both countries having pledged to increase agricultural exports to each other, while in May 2014, Vladimir Putin and Xi Jinping agreed that VTB (Russia’s second biggest bank) and the Bank of China would start conducting transactions in their own currencies. Meanwhile, Gazprom signed a thirty-year deal worth $400 billion to supply gas to China again with payment in yuan and rubles.[7] Putin has publicly spoken out against the dollar on numerous occasions, most recently in a sit down interview he did with Tucker Carlson.[8]
The sanctions against Russia have backfired to some extent as they have succeeded in moving large volumes of trade in oil, gas and other commodities off the dollar and on to other currencies. Sanctions by the U.S. have increased by 900% since 2000 and many believe that the threat of sanctions has probably accelerated movement away from the dollar.[9] As a result of Washington’s ongoing use of sanctions, many countries who have been removed from the dollar system have started traded among each other in a collective bid to by-pass U.S. sanctions, among these include: Venezuela, Iran, Cuba, North Korea and more who, while being anchored by Russia and China, have created a parallel trading network among themselves.
China and Brazil have reached an agreement to move away from the dollar and to trade in their local currencies with Brazilian premier Luis Ignacio Lula de Silva a vocal critic of the dollar system.[10] Lula famously once remarked that “Every night I ask myself why all countries have to base their trade on the dollar” even going so far as to ask “Why can’t we do trade based on our own currencies? Who was it that decided that the dollar was the currency after the disappearance of the gold standard?”[11] China is now Brazil’s number one trading partner with bilateral trade estimated to be worth hundreds of billions of dollars and rising, the successive governments of both Lula and Dilma Rousseff have sought closer ties with Beijing. China and Brazil collaborated on the bi-oceanic railway from the Atlantic in Brazil to the Pacific in Peru to provide more efficient routes for the transport of commodities.[12]
Recently, China completed a currency swap deal with Argentina, worth approximately ¥130 billion ($19 billion) and Buenos Aires now settles its imports in Chinese yuan and has discarded the dollar from these transactions in a bid to safeguard their dwindling supply of dollars after unprecedented droughts led to a decline in exports. Bilateral trade between India and Russia is estimated to be $45 billion and the two countries use their own currencies to conduct trade in, bypassing the dollar altogether.[13] Meanwhile ASEAN (The Association of Southeast Asian Nations) has pledged to gradually move away from the dollar as well with Malaysia, Singapore and Thailand having all agreed to trade outside of the dollar. Already, Russia and Iran pay for roughly 60% of their trade in Russian rubles or Iranian rials and Europe is settling energy deals with Russia in rubles as well. Much more could be said about cross-border trade being conducted around the world, this is only a small sample of what is taking place, in real time the contours are changing all the time
Shockingly, in 2023 the Saudi Arabian finance minister Mohammed Al-Jadaan said the country was open to doing oil deals in currencies other than the U.S. dollar.[14] Saudi Arabia and China are moving closer and closer together as a result of both the belt-and-road initiative and the fact that China now purchases about 25% of Saudi Arabia’s oil. Saudi Arabia is the most influential member of OPEC, so Riyadh and Beijing moving closer together may spell bad news for the future of the petrodollar, one of the key components of dollar hegemony.
The BRICS trading bloc (BRICS is an acronym for Brazil, Russia, India, China and South Africa) have agreed to conduct transactions using their own currencies and potentially creating a unified BRICS currency. Iran, Argentina, Saudi Arabia, Egypt, Indonesia and many others have pledged to join the organisation too. The BRICS coalition have spearheaded the New Development Bank (sometimes referred to as the BRICS Development Bank) as a rival to the U.S.-led IMF and World Bank. The BRICS countries have a trade surplus, they are forecasted to have a combined GDP greater than that of the G7 and they have fairly healthy demographic projections as well. Where this will lead, we cannot say, only time will tell, but the momentum is building.
Alternatives to the dollar
The East Asian countries – China and Japan - have traditionally been against large volumes of their own currency building up overseas and outside of their national borders. When capital accumulates outside of their borders that means it accumulates outside of their control and this is a situation that both Beijing and Tokyo seek to avoid. China is often touted as a country that could assume the mantle as the incumbent leader of the world’s financial system but the structure of the Chinese economy makes it difficult to integrate other countries. Strict capital controls in China mean that citizens are not allowed to send more than $50,000 a year out of the country. The mercantilist structure of the Chinese economy is also something that would have to be addressed if the Chinese yuan were to replace the U.S. dollar.[15] That being said, China is slowly liberalising, allowing more transactions to be done in the yuan and with an increasing volume of foreign currency reserves in central banks held in yuan. One last point regarding China, so much of the Chinese economic model, and indeed its success, is predicated on their bilateral trade with the United States. At a simple, fundamental level, much of China’s power comes from its wealth and its wealth is largely held in dollars so any fundamental change to the current system is going to have consequences for Beijing.
Up until the global financial crisis of 2008 the euro was doing very well. However, the European sovereign debt crisis the following year exposed considerable flaws within the broader Eurozone area and the euro has arguably yet to fully recover. Bitcoin and central bank digital currency offer up some kind of alternative but they are still in their infancy and are fraught with various structural problems and difficulties and talk of them replacing the dollar right now is far-fetched at best. In the modern era, gold has been used as either a reserve asset or an anchor to the main currency and though it proves useful as a store of value and a unit of account it is not fungible and thus not a good medium of exchange. The previously mentioned BRICS countries have floated the idea of a unified BRICS currency but the stumbling block is always the same, finding an effective exchange rate mechanism where all parties are happy and content. Also, the more countries that pledge to join the group the harder it will be to solve this problem. For various reasons, the alternatives to the dollar are not especially good but scepticism about the future of dollar hegemony persists. Influential think tanks such as Chatham House and the World Economic Forum have even called for a second Bretton Woods, a chance to rethink the global monetary system in light of new challenges and an increasingly multipolar world.[16]
A default for the United States could potentially be disastrous and could accelerate de-dollarization. A default would lead to a downgrade of America’s credit rating, this would undermine international faith and confidence in the dollar, meaning that the U.S. could no longer monetise its debts at such low interest rates. Even coming close to reaching the debt ceiling can lead to problems for the U.S., as it did in 2011 when S&P downgraded America’s credit rating just days before they hit the ceiling.[17] The same happened more recently in August 2023 when a last-minute deal was struck by President Biden, the point being that even coming close to the debt ceiling is enough to cause panic in global markets.[18]
There is a slow geopolitical realignment that is taking place, that is undeniable, but that doesn’t mean the dollar system is going away anytime soon. After all, the U.S. dollar is the global reserve currency for a reason. People trust the U.S. government and American institutions are generally regarded as honest, transparent and subject to the rule of law in a way that, for example, Chinese and Russian ones are not. The U.S. is not autocratic and corruption, fraud, bribery and other financial crimes are subject to heavy penalties and strong reprisals. During the 2008 global economic crisis, capital inflows into the United States surged as investors saw U.S. Treasuries as a safe haven for capital, illustrating the extent to which the international community sees the dollar as safe, secure and reliable, especially in times of crisis and uncertainty.[19] The hard reality is that in an increasingly unstable world countries look to the dollar for stability and security, whilst a certain line of argument maintains that global elites do not want the dollar system to end precisely because their wealth is in dollars.
Aside from a total collapse of the dollar system, there is another scenario worth considering and that is a slow and gradual devaluation of the U.S. dollar over time. To me this is what most likely given the current climate and everything we have seen.
The problem is that no one really knows what comes after de-dollarization and although it is unclear how all of this will play out, what is clear is that more and more countries are moving away from the U.S. dollar, effectively resulting in a slow but steady realignment of the current world order.
Notes
[1] Lahiri, U. (2023) 'The future of dollar hegemony,' Council on Foreign Relations, 22 August. https://www.cfr.org/blog/future-dollar-hegemony.
[2] The U.S. dollar is unlikely to continue defying gravity (9th January 2024). https://corporate.vanguard.com/content/corporatesite/us/en/corp/vemo/vemo-us-dollar.html.
[3] Khanna, V. (2022) 'The US dollar has become a wrecking ball,' The Straits Times, 28 September. https://www.straitstimes.com/opinion/the-us-dollar-has-become-a-wrecking-ball.
[4] Prins, N. (2019) Collusion: How Central Bankers Rigged the World. Bold Type Books. P.81
[5] China cuts US Treasury holdings to lowest level since global financial crisis (2023). Available at: https://www.scmp.com/economy/china-economy/article/3213701/chinese-holdings-us-treasury-securities-falls-us8594-billion-lowest-2009-amid-rate-hikes-and-tension.
[6] Central banks keep buying gold as dollar sanctions shift long-term strategy on foreign currency reserves (21st May 2023). https://finance.yahoo.com/news/central-banks-keep-buying-gold-201500477.html.
[7] Prins, N. (2019) Collusion: How Central Bankers Rigged the World. Bold Type Books. P.112
[8] Fox, M. (2024) ‘Vladimir Putin takes aim at the US dollar's dominant position as the world's reserve currency’, https://markets.businessinsider.com/news/currencies/vladimir-putin-us-dollar-tucker-carlson-yuan-ruble-reserve-currency-2024-2
[9] The Treasury 2021 Sanctions Review (2021) http://www.treasury.gov. U.S. Department of the Treasury. https://home.treasury.gov/system/files/136/Treasury-2021-sanctions-review.pdf.
[10] AFP (2023) “China, Brazil reach Deal to Ditch Dollar for Trade”, Agence France Presse, https://www.barrons.com/news/china-brazil-strike-deal-to-ditch-dollar-for-trade-8ed4e799
[11] Brazil’s Lula calls for end to dollar trade dominance (13 April 2023). https://www.ft.com/content/669260a5-82a5-4e7a-9bbf-4f41c54a6143.
[12] Prins, N. (2019) Collusion: How Central Bankers Rigged the World. Bold Type Books. P.79
[13] Briefing, R. (2023) India and Russia: The 2023 trade and Investment Dynamics - Russia Briefing News. Available at: https://www.russia-briefing.com/news/india-and-russia-the-2023-trade-and-investment-dynamics.html/#:~:text=In%20turn%2C%20India%20exported%20goods,textiles%20and%20footwear%20(7.31%25).
[14] Saudi Arabia says it’s ‘open’ to trading currencies besides the US dollar (19 May 2023). https://finance.yahoo.com/news/saudi-arabia-just-said-now-213200817.html.
[15] Ezell, S. (2013) 'China’s economic mercantilism,' IndustryWeek, 24 July. https://www.industryweek.com/the-economy/public-policy/article/21960801/chinas-economic-mercantilism.
[16] Pickford, S. (2022) ‘Renew the Bretton Woods System’ (3rd March 2022) https://www.chathamhouse.org/2019/06/renew-bretton-woods-system
[17] Riley, C. (2011) S&P downgrades U.S. credit rating. https://money.cnn.com/2011/08/05/news/economy/downgrade_rumors/index.htm.
[18] Lahiri, U. (2023) 'The future of dollar hegemony,' Council on Foreign Relations, 22 August 2023. https://www.cfr.org/blog/future-dollar-hegemony.
[19] Prasad, E. S. (2014) The Dollar Trap. Princeton University Press. P.5