Dollar Won’t Remain Almighty Forever — Or Die Quickly
Talk of ”de-dollarizing,” or at least shrinking the dollar’s international role, is suddenly everywhere. So is often highly defensive and emotional criticism of any suggestion the dollar won’t remain almighty for the foreseeable future. What’s going on?
The dollar’s role in international trade, finance, and foreign exchange reserves is unquestionably under assault, as are many aspects of the US “superpower” role and the global infrastructure that backs it up. It’s all linked, and it’s all part of the transition to a multipolar world.
Let’s not exaggerate. The dollar is not about to disappear from the international stage in a puff of smoke. Neither, however, does overwhelming dollar dominance today ensure its overwhelming dominance tomorrow or forever.
Washington’s ability to enforce sanctions against nations that irritate it, smooth functioning of oil and other commodity markets, and perhaps the US’s ability to live on cheap credit are all at some level of risk.
What has set so many US economic commentators on edge is that much of the world wants to weaken the dollar’s near-monopoly status as the currency for international trade and foreign exchange reserves and are willing to accept some inconvenience and cost to do that. It’s not how economists think the economically rational world should work.
No one serious is aiming to replace the dollar with the Chinese yuan or any other single currency, but to create means of bypassing increasingly feared and hated US sanctions — means that can be scaled up quickly when sanctions land on a particular country or company.
In some cases, a second goal is to weaken Washington’s power and prestige. For others, a weaker US would simply be a side-effect. Either way, lower US prestige and power is part of the deal.
What Has Happened
The Middle East and the oil and natural gas sales that support that region are a major front in the dump-the-dollar jousting. In December, Chinese President Xi Jinping, on a visit to Saudi Arabia, offered the Arab Gulf countries guarantees that China would buy their oil and natural gas, and help them develop and even manufacture renewable energy and digital technologies. The only catch: payment should be in yuan — not dollars.
Just three months later, Saudi Arabia and its longtime top regional adversary Iran traveled to Beijing to sign an agreement to re-establish diplomatic relations. It was a pointed affront to the US, as were two earlier oil production cuts by Opec-plus aimed at boosting oil prices. The Saudis are definitely not part of Team USA any longer.
Big Saudi investment in Iran has even been mooted. This would have to be in some currency other than dollars, since Iran is still under comprehensive US sanctions. Justifying those debilitating sanctions to the rest of the world, perhaps even Europe, will become harder if the Saudis’ Arab neighbors no longer feel threatened by Tehran. But getting Congress to reduce, much less remove, the sanctions would be impossible. So the US and Israel will likely continue to hammer on Iran, even if others do not.
Meanwhile, Saudi Arabia has taken yet another poke at Washington by following Iran into preliminary membership in the Chinese/Russian/Pakistani/Central Asia security and economic bloc known as the Shanghai Cooperative Organization (SCO).
An important result of all this may be to end the dollar’s monopoly in Mideast oil sales. Already in February, Iraq’s central bank announced it would allow trade with China to be settled in yuan. Both the UAE and Qatar have used the Chinese currency extensively in trade with China.
Why It Has Happened
The first reason this is happening is, in a word, sanctions. Countries want to reduce their vulnerability to Washington’s often heavy-handed and impulsive use of unilateral and third-party sanctions and its reliance on international financial institutions to enforce those sanctions. Slapping heavy sanctions on a country as big as Russia and seizing half of its foreign exchange reserves without international legal justification brought this once-simmering resentment to a boil last year.
China sees its exposure to US sanctions as out of line with its new-found national confidence, and is determined to remove this powerful weapon from the US arsenal.
The second big cause of disaffection with the dollar is the same Federal Reserve Board interest rate policies that brought down Silicon Valley Bank and sent tremors rippling through the domestic US financial system. The Fed’s breakneck runup in dollar interest rates over the last year after more than a decade of near-zero rates caused the dollar exchange rate to soar against virtually all free-floating currencies, as investors moved funds out of other currencies and into dollars to capture the high interest.
This virtually forced central banks across the globe to raise their own interest rates to try and stop the outflow of foreign capital, not least because a weak national exchange rate adds to domestic inflation. Several developing economies were hit hard. As many saw it, the Fed was ignoring the negative impact of its actions outside the US and focusing only on US domestic economic and political considerations.
What Happens Next
The yuan and other currencies are gaining from the dollar in terms of both trade finance and foreign exchange reserves — albeit off a very low base compared to the dollar. The yuan doubled its share of the value of trade finance last year, for example. It still has just 4.5%, compared to 86.8% for the dollar. But more and faster shifts away from the dollars to pay for imported goods and services arelikely.
Dollars are indisputably more convenient to use in international trade than any other currency. But more and more countries are willing to accept inconvenience and extra cost in order to avoid the risk of US sanctions. And more are experimenting with digital communications systems to bypass the SWIFT financial communications system that will make non-dollar transactions faster and less burdensome.
China’s instrument for this, its Cross-border Interbank Payment System(CIPS), has more than 1,300 participants in over 100 countries and regions, according to reports out of China. Central Bank digital currencies (CBDC) are seen by many as the preferred bypass of Swift over the longer-term. China and the UAE have participated in a multi-CBDC pilot that worked on a small scale. The question is whether and when the scaleup comes.
While oil has been the most visible in non-dollar pricing, other commodities are lining up for a role. Brazil could be major player in this, as could the BRICS grouping of Brazil, Russia, India, China and South Africa. All the BRICS have expressed interest in alternatives to the US currency’s international functions, and something on this could come out of a BRICS summit set for this August in South Africa. Argentina and Iran have applied to join BRICS, and Saudi Arabia, Turkey, and Egypt have expressed interest.
China and Brazil have agreed to do all their bilateral trade in their own currencies, a big deal since China is Brazil’s largest trading partner and Brazil is a major supplier of agricultural commodities, oil and metals to China. Lula also recently called on BRICS to create a new currency to replace the dollar in world trade.
That would take a long time if it can be agreed on at all, and does not pose any immediate danger to the dollar. What it does do is indicate the breadth of international dissatisfaction with the dollar-based global financial system — and that is a danger to the US.
China isn’t aiming to make the renminbi a dollar substitute on its own. China wants to run its monetary policy to suit China, not the broader world, and anger at the recent Fed interest rate moves shows how controversial that can be for a dominant reserve-currency country.
What China and other countries want is the same multilateral approach on the financial side that they call for on the diplomatic side. They want out from under the threat of US sanctions and of US monetary policy run amok.
What that will mean for the US remains to be seen and will depend partly on the speed and extent of move away from dollar use. Barring war between the US and China, it probably won’t play out quickly. But it’s doubtful it will feel like fun in Washington.
