The U.S. dollar’s importance cannot be overstated. As the world has witnessed, many economic shocks have started in the U.S., including the 2008 great financial crisis, which later moved outward to Europe and emerging markets. A less dominant dollar would have decreased impact on emerging markets as shocks inevitably occur. Global markets might be particularly keen to limit their use of the dollar with the rapidly increasing debt levels in the United States, which create additional risks domestically which can also spread throughout the globe.
Although experts often treat complete de-dollarization as a slow, long-term, and unlikely outcome, the COVID-19 pandemic certainly accelerated the process, especially for U.S. adversaries that seek greater resilience from Washington’s financial pressures.
Global imperial powers weaponized the world reserve currencies throughout history. Portugal, Spain, France, the UK, and now the U.S., all weaponized financial strength to exert pressure on adversaries.
Before the U.S.’s rise to complete dominance over the last 80 years or so, the dollar, the pound, the French franc, and the deutsche mark often shared the status of global reserve currency. The weaponization of the dollar began after September 11th when Washington imposed fines on foreign banks for money-laundering. The Trump administration then re-purposed this use of the global financial system to pressure adversaries and competitors.
At least half of cross-border trade invoices across the world are in dollars, which is five times America’s share of global good imports, and three times its share of exports. Most central banks use the dollar, and it serves as the primary currency for capital markets. Dollar dominance elevates the importance of American monetary and fiscal policy, since interest rates, markets, and currency swaps all influence the flow of USD for global transactions. The U.S. also controls SWIFT, the primary cross-border messaging system used by banks, as well as CHIPS, a clearing house that processes 1.5 trillion dollars daily. When Washington decides to isolate a potential individual or country from the global financial infrastructure, the consequences are devastating.
Examples of USD Weaponization
All wire transactions settled in U.S. dollars must go through U.S. banks, which Washington can freeze through a variety of tools. In practice - in 2018 America’s Treasury imposed legal measures to prevent the Russian aluminum firm Rusal from accessing the dollar-centric financial system, making it unable to access counterparties and Western clearing houses. Since then, the U.S. developed over 30 active financial and trade sanction programs.
The U.S. also imposed measures on Iran, after Trump treasury secretary Steven Mnuchin, said he would “cut off billions of dollars of support to the Iranian regime.” Similar statements were made regarding Iraq, which restricted its use of oil revenues. The State Department reiterated that Iraq could lose access to its government account at the Federal Reserve Bank of New York, which would flatten its economy.
Responses to Washington’s Pressure
In response to the weaponization of the USD, we see a mild trend toward ‘de-dollarization,’ which includes shifts to local or national currencies, swaps, bank to bank payments, as well as use of digital currencies. States that wish to pursue de-dollarization also reduce U.S. debt holdings, and drop the USD from its anchor currency status, with the goal of increasing non-dollar bulk trade and growing reserves of non-dollar currencies.
Since the U.S. government is issuing more debt, the Fed changed its inflation target framework, which slightly favors more inflation. Instead of using taxes to pay for the debt burden, inflation will undermine the real value of the growing debt. The other reason for dollar weakening is that countries simply want to avoid being pressured by it through financial coercion.
The share of USD in foreign exchange reserves of all IMF members fell from about 72 percent in 2000 to about 61 percent by 2020. The dollar is slowly waning, and we could witness a multi-currency reserve system in the future. Especially with incremental changes made by other countries to take on greater self-reliance over the next decade. This future could be one in which the euro and renminbi, and to some extent gold, share dominance on global markets.
Countries that are vulnerable to U.S. punitive measures are most likely to head toward ‘de-dollarization.’ Iran, Malaysia, Turkey and Qatar considered using cryptocurrencies, national currencies, precious metals, or barter for trade policies, while China and Russia conducted 90 percent of bilateral trade in USD back in 2019, but recently dropped this figure to below 51 percent.
Russia and China
Since 2013, Moscow has consistently limited exposure to the U.S. dollar by settling fewer transactions in USD. In 2019, 62 percent of Russian goods and services exports were settled in USD, which was down from 80 percent in 2018. This shift included most trade with India, in addition to trade in sanctioned sectors like defense. Russian trade also avoids settlements in USD because ‘sanction checks’ take weeks, which makes ruble settlements more attractive in the short term, while also limiting dependency on the USD during the medium to long term. Since 2013, Russia’s central bank also cut USD in its foreign-exchange reserves from 40 – 24 percent and decreased American Treasury debt from $100bn to $10bn.
After the great financial crisis (GFC) from 2007- 2009, China tried to encourage the international use of the yuan and its inclusion as an International Monetary Fund ‘Special Drawing Rights.’ Beijing also set up over 35 currency swap deals with other central banks, but the yuan still sits at only 2 percent of global payments share.
After years of the Trump’s administration’s efforts to use the dollar as a weapon, Beijing’s firms and counterparties struggled with the global dollar-centric financial system. Washington has sanctioned a handful of Chinese tech firms over the years and threatened to block listings of Chinese companies in New York.
However, even before Trump, the use of the renminbi for Chinese cross-border trade grew significantly between 2010 and 2015. As long as confidence grows, this trend will likely continue at a slow rate. It is also likely that the renminbi will become a currency of record for a number of commodities and futures contracts, notably liquid gold and crude oil. There is also a consistent effort to internationalize the renminbi through the Belt and Road Initiative (BRI).
Despite the slow trend toward renminbi internationalization, China uses its own domestic payments and settlement unfractured, Cross-border Interbank Payment System (CIPS), which gives banks access to easier cross border payments technology in yuan.
Although still modest, China hopes to slowly take over the global consumer-finance system through its promotion and use of Alibaba payments with merchants in 56 countries. In capital markets, China promoted its ‘petroyuan’ as a potential alternative to the dollar. China encourages big Chinese companies to list their shares closer to Asia in either Hong Kong or Shanghai. China has also begun work on a digital yuan.
China pursues its own Central Bank Digital Currency (CBDC) development for several key reasons, most of which allow the Chinese government to monitor its domestic financial system with a supreme degree of authority and insight. The People’s Bank of China (PBOC) could control firms within the country with greater financial transparency. Ultimately, a switch to a digital currency would allow greater control over anyone or any firm operating within China, with data as its cornerstone.