Carla Norrlöf
The centrality of the U.S. dollar in world affairs is mainly determined by economic factors, but geopolitical forces are threatening to weaken its top spot in the currency hierarchy. U.S. sanctions in response to Russia’s invasion of Ukraine have pushed some countries to further reduce their reliance on the dollar. The geopolitical tug of war between allies and foes, liberal and illiberal states carries high stakes. “Great powers have great currencies,” quipped the Nobel laureate Robert Mundell. If the currency system were to become multipolar, U.S. monetary perks would recede, as would the United States’ global economic influence and its ability to use dollars as an alternative to military force when policing international order.
A more fragmented global economy in which security partnerships determine economic relations is coming into view. But an end to the dollar’s dominance is still unlikely. Countries participating in the sanctions against Russia or benefiting from U.S. currency coercion aimed at upholding the liberal international order’s core principle of nonaggression have no incentives to diversify away from the dollar. Even countries opposing Western sanctions are likely to stick with the dollar to preserve their own security and U.S. security guarantees in a hardening geopolitical climate.
In today’s fraught international environment, countries are returning to Cold War logic, questioning the sustainability of systemwide economic interdependence over privileged economic ties with friends. With the United States at the center of the largest security network in the world, the dollar stands to benefit from this shift, even though it will simultaneously be counterbalanced by the currencies of geopolitical rivals. This bifurcated dynamic, in which U.S. supporters shore up dollar dominance and Washington’s detractors reduce their dollar dependence, nonetheless represents the most important threat to the dollar’s global prominence since the arrival of the euro in 1999.
The dollar is the preferred currency of governments, accounting for approximately 60 percent of central bank reserves in late 2022, compared with the euro’s 20 percent, and the yen’s six percent. Individually, the pound, the Chinese yuan, and the Canadian and Australian dollar represent less than five percent of government reserves. The dollar is also dominant, although less so, in private markets.
Yet pessimism about the dollar’s future abounds. Rana Foroohar of the Financial Times has warned of a “post-dollar world”; her colleague Martin Wolf worries that dollar dominance will give way to a bipolar international monetary system, with the United States at one end and China at the other. Gita Gopinath, the deputy managing director of the International Monetary Fund (IMF), sees sanctions ushering in a fragmented, multipolar currency order. Big banks are also skeptical about the prospects of continued dollar dominance. Zoltan Pozsar of Credit Suisse believes a multipolar, commodity-based currency order lies ahead. A year ago, Goldman Sachs’s Cristina Tessari and Zach Pandl cautioned the dollar might follow the fate of the British pound and become a second-tier currency.
If predictions about a coming multipolar currency order are correct, the United States will undergo a meaningful decline in its power base and in its ability to project power, with broader implications for international stability and order. By rethinking how it imposes sanctions, however, the West can help protect the dollar’s standing. The United States and its allies can design sanctions in a way that will prevent the unipolar currency order from further eroding. Namely, they must build broad sanctions coalitions in which participation is strictly voluntary and those who do not join are not forced to choose sides. Countries imposing sanctions should recognize the consequences these punishing measures have on third parties and, whenever possible, take steps to alleviate those unintended effects. Sanctions should be reserved for the clear-cut cases in which the international order is under threat, as in Ukraine, and should not be used for parochial purposes, as when sanctions were reinstated against Iran in 2018, even though it hadn’t broken the terms of the nuclear deal, and when the Trump administration imposed overly harsh sanctions on Cuba. Imposing sanctions to pursue narrow U.S. interests raises legitimate fears among countries that they could be targeted next and therefore motivates them to find alternatives to the dollar. But if the United States and its allies resort to sanctions to preserve the central elements of the liberal international order, the dollar should keep its place as the currency of choice.
THE RENMINBI AND THE RUBLE
China and Russia are openly taking steps to raise the attractiveness of alternative currencies for international economic and reserve purposes, building multinational financial infrastructure to promote trade and investment in renminbi and rubles. China’s Cross-Border Interbank Payment System acts as a clearing-house, similar to the U.S. Clearing House Interbank Payments System. Comparing these platforms reveals the gulf between them. The Chinese system, or CIPS, processes approximately 15,000 transactions per day, amounting to the dollar equivalent of $50 billion. Meanwhile, CHIPS, the U.S. version, processes 250,000 transactions per day, exceeding $1.5 trillion. CIPS makes it possible to clear and settle cross-border exchange in renminbi. Once China develops a financial messaging system, the cross-border settlement of yuan-denominated transactions can occur independently of the global SWIFT interbank messaging service dominated by the West. Russia, for its part, created what it calls the System for Transfer of Financial Messages after it invaded Ukraine in 2014. The express purpose of SPFS is to allow users to bypass SWIFT. There were roughly 400 users before the February 2022 invasion of Ukraine, but according to Russia’s central bank, demand increased significantly afterward.
Complementing these systems is a series of bilateral treaties that intend to facilitate trade and investment in non-Western currencies. China and Russia signed a bilateral treaty in 2019 with the goal of promoting their national currencies for trade settlement. India has created a Special Rupee Vostro Account, which countries can credit to encourage settlement of trade and investment with India in Indian rupees. India and Russia have also tried to encourage trade denominated in their currencies by reintroducing the rupee-ruble Cold War currency mechanism shortly after the sanctions against Russia were imposed in 2022. Under this scheme, settlement would occur directly between Russian banks holding rupees in India and Indian banks holding rubles in Russia.
After the 2008 financial crisis, China began funneling renminbi to other countries by extending bilateral swap lines, allowing foreign central banks to acquire Chinese yuan in exchange for their own currency. Making renminbi available to foreign governments is a prerequisite for its use by governments and private actors, and the ability to act as the lender of last resort in times of crisis is an important aspect of reserve currency status. China’s largest line, amounting to $24 billion, is with Russia. More recently, China has collaborated with the Bank for International Settlements to create a renminbi liquidity arrangement to support contributing central banks during emergencies. The central banks of Chile, Hong Kong, Indonesia, Malaysia, and Singapore have pledged $2 billion each to the reserve pool held in Basel, Switzerland, where the BIS is headquartered. China’s reserve and liquidity provision remains small, compared with the supply of the U.S. Federal Reserve, but it is sure to grow. In 2016, the International Monetary Fund updated the reserve basket of currencies that defines its so-called Special Drawing Rights (SDRs), the reserve asset in which the IMF denominates its loans to governments, to include the Chinese yuan.
Pessimism about the dollar’s future abounds.
China is also promoting the use of renminbi by creating digital payment alternatives, such as the e-CNY, a digital currency the country’s central bank began to offer in 2016 and introduced as a payment option for anyone attending the 2022 Olympics in Beijing. When fully implemented, the e-CNY will function independently of other payment and financial messaging systems. By promising cheaper, faster, and safer transactions, a Chinese digital currency can speed up the internationalization of the renminbi. All these developments will make the renminbi more widely accessible and liquid and, therefore, will promote its use for trade and investment.
Joint efforts to decimate the dollar are also being discussed by Brazil, Russia, India, China, and South Africa, known as the BRICS. Together, these countries have explored issuing a joint reserve currency with the explicit purpose of bypassing the dollar and other major Western currencies. The common currency would be based on a basket of BRICS currencies and would serve as an alternative to the IMF’s reserve basket of currencies, although little progress has been made since its June 2022 announcement. China, India, and Russia, however, agreed to expand trade and promote their national currencies in international payments at a September summit of the Shanghai Cooperation Organization.
Dollars remain the currency of choice for governments, firms, and financial institutions to conduct trade and investment, but cross-border exchange in alternative currencies is progressing. Oil is one of the world’s leading export products. Using dollars to pay for oil is therefore seen as an important element in maintaining the dollar’s role as the default currency for international payments. China, Russia, and countries in the Middle East and South Asia are trying to move away from oil settlement in dollars. China and Russia are promoting their national currencies in oil trade. China and Saudi Arabia are drawing up plans to invoice oil in renminbi. Russia and India are exploring the use of the dirham, the currency of the United Arab Emirates (UAE), to settle oil deals among them. Russia and Iran are considering the use of a gold-backed stablecoin for international payments.
If oil producers insist on settling oil transactions in Chinese renminbi, Russian rubles, Indian rupees, the UAE’s dirham, or non-dollar-backed stablecoins, the dollar’s role will decline. The use of renminbi to trade oil among countries not involving China also stands to raise the significance of the renminbi as an international currency. Third-party use of the dirham will likewise raise its international role, although it is unlikely to become a major international currency. The rupee is a more likely contender as an international currency, but so far it is used only in bilateral trade. The ruble is also used in bilateral trade and highly unlikely to join the currency major league. Even if these currencies are primarily used for bilateral trade, the dollar will be used relatively less frequently, undermining its status.
CHOOSING SIDES IN AN ECONOMIC SHOWDOWN
As China and Russia are making moves to promote the use of their currencies, the United States is pressuring countries to join the sanctions regime against Russia, with consequences for the dollar’s primacy. U.S. dollar dominance depends on the disproportionate use of dollars relative to other currencies by governments and private actors. Governments use and hold dollar reserves in order to intervene in foreign exchange markets and to defend the prices of their currencies, particularly during times of crisis. Governments with difficulty instilling confidence in their own currencies “peg” the value of those currencies to the dollar to stabilize their exchange rates. Private actors, including individuals, businesses, and financial institutions, also use dollars to conduct trade and investment.
Sanctions stop most of these activities dead in their tracks. Sanctions may be limited to preventing certain government officials, private individuals, or entities from accessing dollar-denominated assets or making dollar-based transactions. Sanctions can also be more comprehensive, locking banks and other key entities out of using dollars. Extreme forms of economic coercion, such as freezing central bank reserves, deny a foreign government the ability to use reserves to intervene in foreign exchange markets and provide dollar funding to its economy.
Since last February, 44 countries—Australia, Canada, Japan, New Zealand, South Korea, the United States, and nearly all of Europe—have imposed sanctions on Russia for violating Ukraine’s territorial integrity and waging war on its population and institutions. These countries stand united in seeking to uphold an international environment free from military coercion, terrorism, human rights abuses, and authoritarian coups. Western sanctions include freezing Russia’s central bank reserves, disconnecting major Russian banks from SWIFT, restricting foreign currencies, and placing sanctions and asset freezes on more than 10,000 individuals, entities, vessels, and aircraft. Additional measures include export controls on dual-use goods, an oil-price cap, a ban on gold imports from Russia, superyacht confiscations, travel bans, and the exodus of many Western countries from Russia.
By rethinking how it imposes sanctions, the West can help protect the dollar’s standing.
The sanctions against Russia are contributing to a realignment of global currency holdings. The countries supporting sanctions on Russia have strong geopolitical incentives to continue holding and using dollars for international reserve and payment purposes since doing so reinforces the constraining impact of the sanctions and helps ensure their future effectiveness. Any economic incentives these governments previously had to diversify away from traditional currencies, particularly the U.S. dollar, by increasing the proportion of other currencies in their reserves and international transactions must now be weighed against the geopolitical incentives to hold dollars. As security concerns eclipse economic ones, the United States and Europe are limiting their economic dependence on foreign adversaries and pushing to relocate manufacturing and supply chains to allied nations in what has come to be known as “friend shoring.” Just as countries are beginning to source goods and inputs from friendly nations, they are likely to adopt the currencies of friendly nations. The size of the sanctioning coalition, the number of nonparticipating sanctions supporters, and the number of countries under the U.S. security umbrella, make large-scale currency diversification away from the dollar unlikely, as shown by two recent studies.
Together, the coalition arrayed against Russia accounts for more than 90 percent of global currency reserves, approximately 80 percent of global investment, and 60 percent of world trade and world economic output. Overcoming that dominance would be difficult even if every country that has declined to sanction Russia fell in line behind an organized anti-dollar coalition.
Countries not participating in sanctions against Russia do not necessarily disagree with the goals behind them: ending the war in Ukraine and deterring future territorial aggression. And many of those countries still have incentives to strengthen the global dollar-centered system. Fully half of the United States’ formal security allies are not participating in the sanctions regime against Russia. Together, this group of countries, which includes Argentina, Brazil, Chile, Pakistan, the Philippines, Thailand, and Turkey, represents six percent of the world’s GDP, seven percent of global trade, and two percent of global investment. Developing countries that have not sanctioned Russia are feeling the brunt of the sanctions’ secondary effects: inflation, currency depreciation, and supply chain shortages. Still, they are unlikely to respond to this fallout by siding with Russia unless the West inflicts further pain on them—for example, by diverting aid to Ukraine and cutting off foreign aid to them.
With geopolitical tensions rising, it is likely that an old security logic for the use of the dollar will take hold. Historically, allies have offered currency support in exchange for defense commitments. Most famously, the United States stationed 200,000 troops in West Germany during the Cold War. In return, President John F. Kennedy asked Berlin to procure military equipment as a way of reducing the U.S. current account deficit, supporting the dollar, decreasing the outflow of gold, and bolstering the credibility of the fixed dollar-gold regime arising from U.S. military spending. When security concerns receded after the Cold War, economic calculations took over, with geopolitics taking a back seat in determining dollar holdings and transactions. But with Russia’s invasion of Ukraine, the security drivers of economic exchange have returned with a vengeance.
BUCK UP
Great-power competition poses serious risks to the dollar’s dominance in the global economy. Geopolitically induced dollar support is, however, working to stabilize and increase dollar holdings. The coalition behind the sanctions against Russia is broad, wealthy, and militarily powerful, and its objective of ending Russia’s barbarous war is widely shared, even by those not participating in the sanctions. And even though many countries look on the sanctions against Russia with alarm, they have other geopolitical reasons to support the dollar. For in a less secure world, countries privilege survival and are more likely to support states capable of helping them secure their territorial integrity, giving the United States an edge because of its vast security network.
The dollar-centered financial system is becoming less widespread but more entrenched where it persists. To safeguard the existing currency hierarchy and limit the long-term trend toward currency multipolarity, the United States must use economic statecraft in ways that promote the public good of a liberal international order. The United States will not be able to afford to alienate key allies or a large portion of the international community and still preserve the unipolar dollar era.
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