Alyce Abdalla
INTRODUCTION
The United States has enjoyed decades of influence over the international financial system thanks to the unique role of the U.S. dollar in the international economy. This dollar dominance could even be considered an element of U.S. power, underpinning a range of political and economic tools used by policymakers to advance U.S. strategic interests. The Chinese-led development of a payment process using Central Bank Digital Currencies threatens the current role of the U.S. dollar in the global financial system, potentially eliminating a significant source of U.S. power and prosperity. The U.S. dollar has been the dominant international currency since World War II, essential for international trade and economic stability—over 88 percent of international transactions involve U.S. dollars and over 55 percent of global reserves are held in dollars.[1] The U.S. dollar’s current role both reflects and contributes to the strength of the U.S. economy; any change to this role would have far-reaching effects on the United States, including complicating the financing of the U.S. government budget. China’s push for an international payment system using Central Bank Digital Currencies threatens to weaken U.S. security, hurt the U.S. economy, and decrease the effectiveness of U.S. policy tools.
Given this threat, the United States should aggressively strengthen the current international payment system, ensure U.S. sanctions policies do not accelerate the growth of an alternative payment process, and lead the development of central bank digital currency payments to shape international norms regulating a new blockchain-based system. New technology is almost certain to transform the current financial system; the challenge for the United States, as the dominant country in the current system, is to manage this inevitable transition in a way that best serves the U.S. national interest in the face of increasing competition from China.
U.S.-DOMINATED FINANCIAL SYSTEM THREATENED BY BLOCKCHAIN ALTERNATIVE
The United States enjoys significant economic and political power from the dominant position of the U.S. dollar in the global financial system. Since the 1944 Bretton Woods agreement, international trade has been based on using the U.S. dollar as the intermediary currency. Countries hold U.S. dollars in reserve for various reasons related to political and economic stability, including covering payments for trade should their national currency weaken. No other currency has been able to compete against the dollar’s dominance, even with U.S. use of unilateral sanctions and restrictions. Blockchain technology, however, could offer a new solution by eliminating the need for an intermediary currency for international payments.[2]
Dollar Dominance Promotes U.S. Business, Oversight of Transactions, Access to Cheap Credit
Economists largely agree on the economic benefits of a global currency—U.S. companies do not have to worry about foreign exchange risk affecting their business decisions, as most international transactions are done in U.S. dollars.[3] The role of the dollar means that the SWIFT international payment system assumes that any foreign transaction is routed at some point through U.S. dollars, which makes it possible for the United States to block financial services based on unilateral U.S. sanctions, U.S. legislation against terrorist financing, and U.S. law enforcement decisions. This unique situation has also meant the U.S. monetary policy is not able to fundamentally change the market demand for U.S. dollars, and so U.S. policymakers cannot devalue the U.S. currency to make U.S. exports more competitive.[4] But consistent international demand for U.S. dollars also means that the United States can borrow internationally through loans denominated in U.S. dollars, a tremendous economic advantage over other countries.[5] The United States is able to offer very low interest rates, with returns on Treasury bills at just 1 percent in February 2022, for example, far lower than the inflation rate of 7.9 percent.[6] In essence, other countries pay the United States government for the opportunity to store U.S. dollars in their Central Bank reserves.
Increasing Use of U.S. Sanctions Policy Assumes No Threat to the Dollar’s Role
Other countries, even allies, have long resented the unique benefits the role of the U.S. dollar gives to the United States.[7] Both allies and adversaries have criticized the U.S. for its use of unilateral sanctions to create far-reaching effects on the international financial system.[8] The United States has increasingly turned to sanctions as the policy tool of choice to counter a range of violations of international norms, from an average of 435 additions to the sanctions list each year during the George W. Bush administration, to 533 per year under Obama, to 1000 under Trump.[9] The Biden Administration added 765 names to the sanctions list in its first year in office, and has relied heavily on sanctions to respond to Russia’s war against Ukraine.[10] U.S. sanctions affect almost 80% of Russia’s banking assets.[11] Individuals, companies, and organizations can be added to the U.S. sanctions list under a range of existing sanctions programs, underpinned by different U.S. legislation.[12] In general, once an individual or entity is added to the U.S. sanctions list, it is difficult to be removed, and sanctions programs last for decades, creating strong incentives for sanctioned individuals to seek alternatives to the U.S.-dollar denominated system.[13] Persistent, complicated sanctions have caused “de-risking” by international banks seeking to reduce exposure to even potential violations of U.S. sanctions, which also limits access to the international financial system by people who are not on the sanctions list.[14]
No Other Currency Can Replace the U.S. Dollar...
China, Russia, and other countries that have been subject to U.S. sanctions have actively sought alternatives to the U.S. dollar-dominated SWIFT international payment system, seeking economic independence from U.S. government interference. Even U.S. allies have criticized unilateral U.S. use of “secondary sanctions” that target any entity trading with a sanctioned entity.[15] China has sharply criticized and challenged the dominant role of the United States in the international financial system, arguing that the United States should not have the capability to unilaterally disrupt international trade and payments.[16]
But no other currency in the current system has been able to provide the political stability and economic benefits of the U.S. dollar.[17] Contenders such as the Euro and the Japanese Yen have not come close to replacing the dollar, and no country has the wide-ranging and sophisticated capital markets to compete with the United States.[18] China does not allow companies or individuals to freely move Renminbi in and out of China; its strict control of the exchange rate precludes the Renmini’s viability as a globally dominant currency.[19] China is therefore faced with the challenge of how to end U.S. dominance of the financial system without replacing the U.S. dollar with the Renminbi. Its suggestions to date, such as using the International Monetary Fund’s Special Drawing Rights to create a new currency for global reserves, have not gained traction.[20]
Adversaries have also sought alternative payment systems to avoid dollar interactions, as a means of avoiding the effects of U.S. sanctions. These systems, however, have been expensive and limited, reflecting the competitive incumbent advantage of the globally interconnected SWIFT system.[21] The Russian System for Transfer of Financial Messages (SPFS) for instance conducted just 2 million transactions in all of 2020, compared to the 41 million transactions per day in the Belgium-based SWIFT interbank transfer network, which includes over 11,000 institutions.[22] China’s Cross-Border Interbank Payment System (CIPS), launched in 2015, has not been an attractive alternative for international companies given its limited reach, though Russian banks cut off from SWIFT are now exploring the CIPS option.[23] Iran’s convoluted systems to avoid U.S. sanctions is an illustration of the significant costs incurred by U.S. sanctions, requiring an expensive and slow process using shell companies.[24] International banks face stiff penalties for allowing sanctioned individuals or entities to use their system, and often “overcomply” with U.S. sanctions.[25] The U.S. dollar is the most useful currency in the current global financial system.[26]
...But a New System Could Eliminate the Role of A Global Currency
But cryptocurrencies, and specifically Central Bank Digital Currencies, could eliminate the need for any global currency in international financial transactions.[27] Over eighty percent of central banks are exploring options for government-backed digital currencies that could eliminate intermediary banks, which would sharply decrease the use of U.S. dollars.[28] While China banned all private cryptocurrencies in 2021, it launched its Central Bank Digital Currency now in use by 100 million people in 10 cities.[29] China’s system allows for surveillance of every transaction, in support of its domestic priorities, and China is contributing to developing Central Bank Digital Currency international norms and standards by the Bank for International Settlements in Switzerland.[30]
China is part of a small Bank of International Settlements working group, along with Hong Kong, Thailand and the United Arab Emirates, that is developing a pilot program to use Central Bank Digital Currency exchanges to end the need for correspondent banks for international payments. The Bank of International Settlements estimates this new payment process could be instantaneous (as compared to a day or more via SWIFT) and cut the cost of international transactions by half.[31] This process would remove the role of a global currency from international financial transactions.
Industry Leaders Are Poorly Placed to Recognize Technology-Driven Disruption
Experience from other industries transformed by technology, such as journalism or photography, suggests that the dominant institution in the traditional industry is poorly placed to identify and exploit the new technology. Existing organizational incentives make it difficult for the dominant institution to accept and adapt to emerging technology. The United States is deeply invested in the international system that currently exists. In contrast to China’s early launch of a Central Bank Digital Currency, U.S. officials do not agree on whether the United States should issue a digital currency.[32] U.S. government expertise on cryptography, blockchain, and other cyber tools is not concentrated within federal agencies responsible for economic issues and financial sector priorities. The Biden Administration issued an Executive Order on the Responsible Development of Digital Assets on March 9, 2022, noting the sector’s $3 trillion value and calling for agency recommendations by September 2022 on the potential for a Central Bank Digital Currency and proposals for regulation of cryptocurrencies.[33] The Federal Reserve has not issued a position on whether such a currency is warranted, but has said any Central Bank Digital Currency should be “privacy-protected, intermediated, widely transferable, and identity-verified.”[34] There is no U.S. consensus on how to address digital assets and digital currencies, with disagreement on how to classify cryptocurrencies and how to maintain protections against money laundering and terrorist financing.[35] U.S. banks have resisted consideration of a new system that could eliminate the need for some of their financial services; one Harvard economist estimated the United States is at least a decade away from a launch of a Central Bank Digital Currency.[36]
Blockchain Could Merge Private Sector and Adversary Interests
If China succeeds in developing a fast, cheap, and reliable blockchain-based payment system, under the auspices of the Bank of International Settlements, the effects on the U.S. economy and its political influence would be rapid and intense. Any country affected by U.S. sanctions would have a strong incentive to use the new system, and so, even more importantly, would any profit-seeking private sector enterprise. A shift away from using correspondent banks would immediately remove the effectiveness of unilateral sanctions. It would also sharply decrease the demand for U.S. dollars, which would no longer be necessary for international transactions. The price, therefore, of a dollar would decrease – interest rates on Treasury Bills would have to be higher in order for the United States to borrow money. U.S. debt, already at historically high levels, would suddenly become more expensive to finance, which could sharply reduce U.S. economic growth, U.S. government spending, and U.S. political power.[37]
POLITICAL AIM—RELIABLE U.S. LEADERSHIP OF THE GLOBAL FINANCIAL SYSTEM
This strategy aims to protect the U.S. role in the global financial system by ensuring that any new blockchain-based system supports U.S. national security and prosperity within the international rules-based order. The United States should immediately strengthen and broaden the current payment system, to prevent an abrupt change and reduce the incentives for finalizing a new system. The United States should also shape the development of a new system that protects core U.S. interests, working closely with European and other allies to ensure that any new system mitigates risk in line with international norms by reducing the potential for money laundering, terrorist financing, sanctions evasion, and other malicious use of the system.
There is also a clear negative objective to this strategy: to prevent the development of a financial system that abruptly diminishes the U.S. role and reduces U.S. influence. A system that aligns the interests of the private sector with those of U.S. adversaries would present an immediate and challenging threat to the United States.
BOLSTER EXISTING SYSTEM WHILE LEADING THE DEVELOPMENT OF A NEW ONE
Policymakers should consider two complementary approaches to address the threat to this element of U.S. power. First, the United States should strengthen the existing system and reduce incentives for the development of a new system in order to prevent an abrupt change to a new adversary-led system. Second, the United States should manage and lead the development of a new system based on international norms, through U.S. involvement in the development of a new blockchain-based system and increasing information about the risks of other payment systems. Increasing international understanding of the potentially exploitative nature of a system dominated by an authoritarian state also contributes to building support for U.S. influence in a new blockchain-based system.
Line of Effort 1: Strengthen and Invest in Existing U.S.-Dominated System
The United States should encourage use of the existing SWIFT system by investing in a program to accelerate payments and reduce transaction costs. This system is led by the G-10 central banks (Belgium, Canada, France, Germany, Italy, Japan, The Netherlands, UK, United States, Switzerland, and Sweden), and the European Central Bank. A multilateral working group should consider what G-10 investments might decrease the costs of transactions and what new technology could accelerate completion of transactions. The United States should also consider multilateral a G-10 fund to contribute resources to strengthening the SWIFT program, with a goal of reducing the costs of transactions by 75 percent.
Line of Effort 2: Build Inclusivity of Current Payment System
The United States should make the current financial system as broad and inclusive as possible, and carefully consider the effect on the payment system before imposing any sanctions outside of those authorized by the United Nations. This recommendation does not suggest ending the use of sanctions; instead, it advocates for accounting for the long-term risk to the United States into the decision-making process regarding additions to the sanctions list. The U.S. government should consider and develop alternative policy tools to counter violations of international norms, preparing for circumstances where denouncing and deterring this activity is important but does not outweigh the costs of using unilateral standards. Alternative actions might include visa bans, cyber-connectivity consequences, and U.S.-based asset freezes to counter activities that do not meet the criteria for sanctions. The United States should also develop a range of positive incentives for cooperation. Certain sanctions will, of course, still be appropriate policy responses even under this new standard. Sanctions, in fact, will be more effective at imposing costs when used less frequently, as there will be increased credibility of the seriousness of U.S. action and fewer incentives globally to develop evasive alternatives.
Line of Effort 3: Shape New Blockchain-Based System
The United States should lead the development of a Central Bank Digital Currency payment process and related regulations in coordination with the existing G-10 countries involved with SWIFT, contributing $10 million to build U.S. leadership of this process. The United States should launch a SWIFT-based study of the potential for a Central Bank Digital Currency payment program, to ensure that a new system is developed by SWIFT, building on its existing network and experience.
As this work affects the core U.S. interest of prosperity, and to some extent security, the full range of U.S. tools should be used to secure this agreement to mitigate money laundering, terrorist financing, and U.S. law evasion. The European Union and its member states have a strong focus on data privacy, and should be considered natural allies to this work, as an authoritarian-led payment system would reinforce surveillance and control goals. The United States should promote data privacy, cybersecurity, and financial sector integrity.
The United States should also lead the global effort to develop a robust cryptocurrency sector, through efficient and appropriate regulation. Building on the March 9, 2022 Executive Order on Responsible Development of Digital Assets, Congress should consider legislation to clarify and streamline the regulation and promotion of this sector. This support for cryptocurrency and technological development also serves as an example of the freedom and innovation available in the United States, contributing to public messaging regarding a system run by a surveillance-focused authoritarian state.
As the center for cryptocurrency innovation, the United States should lead work to develop norms and standards for cryptocurrency use and regulation in line with the liberal international order—with data protection and privacy, transparency, and measures to counter illicit use of the international financial system by criminals and malicious actors. The United States should explore how to both protect privacy while also allowing for oversight to prevent illicit use of the global financial system.
Line of Effort 4: Track and Interrupt Illicit Use of Alternative Payment Systems
The United States should track the use of alternative payment systems that avoid U.S. dollars, in order to identify, deter, and stop illicit activity. Using this information, the U.S. government should coordinate international law enforcement engagement to stop illicit activity, including terrorist financing, money laundering, and sanctions evasion. The Treasury Department should work with the international Financial Action Task Force to ensure that illicit use and availability of alternative payment systems are added to its criteria for assessment of responsible financial systems. The U.S. government should also work with U.S. companies and international partners to explain the risks associated with involvement in alternative payment systems that seek to avoid U.S. legal oversight.
RISKS AND ASSUMPTIONS
The United States has been slow to consider the development of a digital currency and faces the challenges of an incumbent dominant industry during the emergence of a potentially disruptive technology—the benefits and incentives of the current dominance can complicate efforts to investigate and advance potential disruptors. The U.S. financial sector benefits tremendously from the current system, with business services designed for the current payment processes. The U.S. government is accustomed to U.S. dominance of the financial system, as demonstrated by the frequent use of unilateral sanctions. These incumbent interests could prevent the U.S. from managing this new technology, which would allow China to dominate a new system.
This strategy, even if successful, risks a long-term decrease in U.S. oversight of, and U.S. dollar involvement in, the global financial system as blockchain becomes the basis of the SWIFT payment process. This use of blockchain-underpinned transactions would also lead to a decrease in use of U.S. dollars, but this strategy would manage the transition to slow the effect on the value of the U.S. dollar and include as much U.S. oversight and involvement as possible in the new system. Similarly, the strategy’s acknowledgement of the costs to the United States of unilateral use of sanctions might risk public criticism in the United States, given the relative popularity of this policy tool.
COUNTERARGUMENTS—MANAGE THE DISRUPTION
One potential critique of this strategy is that no digital currency or cryptocurrency can replace the U.S. dollar in terms of trust and reliability, an argument that rests on U.S. stability and power alongside a fundamental misunderstanding of how blockchain technology could change the payment system. It is not that cryptocurrency or China’s Central Bank Digital Currency would replace the U.S. dollar as the currency of choice; instead, there would no longer be a need for any international currency to serve as an intermediary in foreign transactions. The U.S. dollar might well retain its position as the global reserve currency, but the demand for dollars would still decline sharply as the financial payment system would no longer need an international currency to work.
Another argument against this strategy is that the United States should work against any use of blockchain technology in payment systems, and instead use its power to maintain the existing system. This approach would focus on the first part of the strategy, where the United States strengthens and modernizes the existing SWIFT payment process while ensuring it is as inclusive as possible. Advocates of this approach might suggest that the United States would “legitimize” the use of blockchain technology in international transfers by sponsoring the investigation into its use. This analysis is the common response of industry leaders facing disruptive technology. The Kodak corporation, for instance, invented digital photography in 1975, and even held the patent for this technology until 2007. But internally to the company digital photography was seen as a competitor of the Kodak monopoly on print photography, and the company blocked digital camera products in spite of growing market demand. Kodak filed for bankruptcy in 2012.[38] A strategy that fails to account for the potential efficiency gains of a new financial payment system runs the risk that the market demand for efficiency will be served by a system developed and run by a U.S. adversary.
Finally, it is possible that the new blockchain-based system, even if developed with U.S. leadership and within the SWIFT payment process, will also result in a decline in demand for U.S. dollars. This outcome depends on the technological process that is tested and developed, but certainly seems likely. In this case, the strategy would not prevent this technological change from affecting demand for the U.S. dollar; U.S. debt financing will still become more expensive, and the value of the U.S. dollar will decrease. But the strategy is designed to delay this process, manage the transition, and mitigate the potential for illicit use of the global financial system in line with international norms. The new system might not serve U.S. interests as well as the current one, but it would still be much more likely to serve U.S. interests than one designed and promoted by U.S. adversaries.
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