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Dollar Dominance, Dollar Dependence

Relative prices track the strength of competing national currencies.

If you make your currency less usable — say, by running aggravatingly high inflation, by closing services outside of banking hours, by burdening users with insultingly silly paperwork and know-your-customer requirements, by freezing accounts over minor infractions, or by confiscating your geopolitical enemy’s assets — fewer people will end up using it. No matter its other virtues, by aggressively weaponizing the global currency you issue, you make it worse.

Since money wants to be one and since once established a given money is kept in place by strong network effects, when fewer people hold and use your money, those network effects unravel exponentially.

The benefits that America has derived from its unrivaled monetary empire include cheaper financing, both for governments and the private sector; a larger, more captured audience for dollar-denominated securities; and the ability to, in mid-century economist Jacques Rueff’s words, run “deficits without tears,” by which he meant acquiring real and costly resource with cheap-to-produce dollar notes and bonds.

“Confidence in the dollar is permanent,” sings Remy ironically in Reason Magazine’s 2021 Dogecoin rap parody. If only that were the case.

Take this opening of a Foreign Affairs article:

The world economic system is in deep trouble. The threat to the international economic system has been a long time in the making: the growth of the world economy has depended overwhelmingly on the strength of the US economy and the dollar.

The mid-century economist and policymaker Charles Kindleberger, a lifelong proponent of the dollar, eventually admitted defeat: “the dollar is finished as international money,” he wrote.

The kicker? Kindleberger wrote that in the mid-1970s, and the Foreign Affairs article above is from 1988. The dollar is always on the verge of dying.

Skeptics to the global monetary hegemon have long called for its demise — on causes of design or ideology, theory or empirics. And for decades, they have been proven wrong.

“The US dollar is the closest thing there is to a global currency,” begins a Bloomberg report from May 2024. That’s a statement that requires more qualifications and asterisks than it has in a long time.

The authors of the report, and economists in general, mostly look at three things when assessing a given money’s global reserve currency status: foreign exchange trades, invoicing and global trade flows, and portfolio shares in central banks’ foreign exchange (FX) reserves.

In global FX markets, the dollar is unmatched; it is usually present on one side in some 85-90 percent of all trades (depending on weighting, volume, and calculation methods used). This doesn’t seem to show much change.

The dollar is also disproportionately used in global trade and in cross-border commerce, even between firms that operate in countries where the dollar doesn’t occupy a legally privileged role. Here, too, it seems almost permanently entrenched, its share of global cross-border trade has been flat over the past twenty-something years, but it can also shift very quickly when vendors and workers alike want to get paid in other monies.

It doesn’t directly follow that a country’s central monetary authority holds foreign reserves in the currencies in which most of its international trade is conducted. For example, even though Swedish foreign trade is mostly with Germany (euro) and Norway (Norwegian krone), and that the overwhelming majority of businesses conduct import and export in euro or the Swedish krona, 63 percent of the Riksbank’s currency reserve is in US dollars. One reason is the Nordic country’s bloated banking sector, and the central bank’s pretty explicit guarantee to support its financing if needed. Another is that dollar assets are both more liquid and more safe, often even appreciating during crises (a rush-to-safety phenomenon).

Institutional FX reserves is where we can most clearly glimpse a pullback of the dollar’s dominance, from its 1990’s high of above 70 percent, to the around 59 percent that dollar-denominated assets make up of central bank foreign reserves today.

Gold has rallied this year and last, explicitly on strong purchases by both central banks and Asian retail savers. The reasons are directly related to sanctions risk and holding sanctions-immune and debasement-resistant assets that don’t have custodial or counterparty risks.

When you make your money worse, fewer people want to use it.

This Time Is… Kind of… Different?

Monetary sanctions make the global money worse. Indeed, the extent to which they are at all effective indicates the power that US officials wield over the globe’s money flow.

Even banks that channel non-USD payments have important corresponding accounts with American banks, which “US regulators have become experts at using […] to get jurisdiction over the whole financial world,” as Matt Levine observed for Bloomberg last year. The heavy American policing of money flows has incentivized foreign institutions to hold money and assets far away from the long, snooping arm of the US. While you abuse your monetary privilege, the defectors and pariahs are busy finding ways to construct or bootstrap alternatives.

And busy, they have been.

“To a muscovite banker,” reported The Economist in a May special report on the deglobalization of finance. “Globalization is not dead. It simply no longer involves America and its allies.” There are separate monetary spheres in the making, chipping away at the dollar’s monopolistic money flows, eating its reserve-asset portfolio lunch, and replacing its role in global trade and financing.

After the 2014 Crimea annexation by Russia, sanctions imposed by the US “created an incentive to diversify away from the US dollar to avoid these sanctions when exporting to target countries such as Russia,” concluded Antoine Berthou, in a working paper for Banque de France last year. The numbers seemed fairly small, but more importantly, the Russians went to work dedollarizing their assets, both public and private.

In fact, concludes the report, the global shift away from dollar dependence has long been underway, with functional alternative payment and bank clearing systems now operating in Russia (Mir and SPFS), China (CIPS, UnionPay, and Alipay), and India (UPI).

As the EU negotiated a twelfth(!) sanctions package in December last year — the definition of insanity and all that, doing the same thing expecting different results — the Russians agreed to take payment in a third-party currency (Emirati dirhams) in exchange for oil delivered to India.

(The proposal has run into delays precisely because of correspondent banking accounts in the Middle East. Circumventing, and by extension replacing, the legacy global money system is proving more difficult than one might have imagined.)

America’s enemies are on the hunt for workable monetary avenues outside the dollar system — BRICS cooperations, and Russia-China trade workaround, and neutral trading partners in the Middle East. There are reports of gold swaps in Turkey. And then there’s the pesky issue of bitcoin, with Russia now (probably) having the world’s third-largest mining fleet. Last month, Elvira Nabiullina, head of the CBR, told the Russian parliament that “we have long agreed to use digital currencies for foreign economic settlements.”

Bitcoin is an obvious candidate for a monetarily hostile globe — money for enemies and all that — but authoritarian leaders aren’t exactly a natural fit for apolitical freedom money: On one hand, they greatly disdain bitcoin because it lessens monetary control over their own citizens. On the other hand, it does mostly liberate them from sanctions and limitations imposed by other major powers.

Writing for Project Syndicate, Barry Eichengreen is right that “international currency status can be lost.” He suggests that whether that happens depends more on the mismanagement of the issuing country than mere “geopolitical circumstances beyond its control.” In the past, the world currency status shifted between the dominant economic powers of the world with a large lag, but it’s a shift we have only witnessed six or seven times in the last 500-600 years, so we might not know much about its universal properties.

The slow, zombie-like decline of the previous monetary regime (pound sterling to dollars) suggests that even today’s incremental loss of the dollar’s uses should worry those who think a dollar-based world is preferable to its alternatives.

The Bloomberg report mentioned above concluded that “the world once regarded the Florentine florin and the Dutch guilder as pillars of international finance, and now those currencies are footnotes in history books.”

Combined with the readily available bitcoin alternative — for individuals, firms, banks, and nation-states to opt out — the financial and monetary rise of a multipolar world might be what ultimately knocks the dollar of its century-long unchallenged position as top-dog.

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