The US dollar vs. Crypto (Bitcoin) as Global Reserve Currency

The US dollar vs. Crypto (Bitcoin) as Global Reserve Currency

It is almost a foregone conclusion that the era of the US dollar serving as a global reserve currency is coming to an end.

And it is not the Rouble, the Yuan nor the Euro that will replace it. Technology is giving us more viable options, of which Bitcoin stands out the most.

The transition is not going to be easy, though. Far-reaching adverse effects are going to be felt.

That could be the case, especially in the US, where things have worked so well, economically speaking, since 1945.

Meanwhile, to the rest of the world, it will be a reprieve. Other countries will no longer be forced to acquire dollars to engage in international trade.

But before we look at how the US dollar is losing its power, and what to expect, let’s first look at how it came to be a global reserve currency in the first place, and how it has performed in that capacity.

Before 1945, gold and silver served as the undisputed global currency. For thousands of years, governments, states, companies and individuals had settled cross-border trade using precious metals.

But just out of the second world war, and with a lot of desire to rearrange how the world functioned to avoid another world war, in 1945, the allies countries met at the Bretton Woods Conference in New Hampshire.

Close to 44 countries were represented.

It was at this meeting that the United Nations and other global institutions such as the IMF and the World Bank were created.

One other treaty, which is often not much talked about, that the delegates at the conference agreed on was that the US dollar was going to be the global reserve currency.

That meant countries around the world were to drop gold and silver and instead embrace the US Dollar to settle their cross-border transactions.

It is hard to tell the rationale behind this decision, especially for delegates not representing the US. But it was agreed upon and ratified along with the other Bretton Woods treaties.

One of the conditions that other countries had for the US was that the Dollar was to remain backed by gold.

That meant any country that held the dollar money could at any time present it to the US Federal Reserve and redeem gold that is equivalent to the amount.

But there was a problem with this arrangement from the get-go.

How the US dollar has performed as a global reserve currency

It seems the US was not keen on keeping its side of the bargain.

It wanted all the benefits of giving the world reserve currency, but not the responsibilities that came with it.

While the US Federal Reserve technically became the global central bank in 1945, it opposed any steps by the global community of countries to audit or supervise it.

So the rest of the world had to trust that this US central bank was to do the right thing by them.

For a short while, all seemed to go well.

Countries around the world acquired dollars by making exports to the US. They then used these dollars to trade amongst themselves.

But in the late 60s, as the Vietnam war raged on and the cold war was at its peak, some countries began to have second thoughts about the global dollar-denominated economic arrangement.

In the late 60s and early 70s, they made requests to return the dollars they held and be given the equivalent amount of gold from the Federal Reserve.

Among the most persistent countries was France, which was in the process of taking back its global standing after the humiliation of the second world war.

It occurred to President Nixon that if the demands were granted, there was going to be a run on the Federal Reserve.

And that could lead to the ultimate collapse of the system, and thus the US losing control over the global financial system.

His administration had to act quick. And so in 1971 came the presidential decree that the Dollar was to be a free-floating currency.

It was no longer going to be backed by gold, and therefore, other countries could not offload the Dollar they held for gold.

But it was clear to the Nixon administration that if the Dollar was to remain a global reserve currency, something else had to be done.

A new asset or system to back it had to be identified and set in place.

The Petrodollar recycling system

Around this time, oil was becoming a precious commodity. The global economy had become dependent on it.

The Nixon administration saw it as a great alternative to gold.

And so negotiations began with oil-producing countries.

In 1973, President Nixon officially unveiled parts of an agreement with King Feisal of Saudi Arabia.

The Saudis would be compelled to accept only the Dollar for their oil exports. And in exchange, the US would provide military protection to the kingdom.

The Saudis would also be allowed to hold a supermajority in the company that drilled oil on their lands.

Each of the other major oil producers was offered a similar offer. And all members of the Organization of the Petroleum Exporting Countries (OPEC) accepted this offer.

And the petrodollar was born.

Meanwhile, other countries around the world had to acquire dollars to use for purchasing their oil supplies from Saudi Arabia and other oil producers.

To get the dollars, they had to pay the US with commodity exports, such as steel, gold, silver, coffee…… and so forth.

This arrangement has benefited the US a lot, as all it had to do to get commodity supplies is to print more money and ship it overseas.

Indeed, the goods heading to the US for newly printed dollars have contributed immensely to the wealth the US has accumulated over the years.

Meanwhile, when the oil-producing countries receive their dollars, they have to give US companies contracts, including the supply of military supplies.

They also have to invest in the US treasury securities and other similar investment tools.

A significant amount of the money is also lent out at interest to countries that need it to build infrastructure or support their economies in other ways.

The loans are facilitated through commercial banks as well as the Bretton Woods institutions, in particular, the IMF and the World Bank.

This system has been referred to as the ‘petrodollar recycling system.’

Using the Dollar to control the world

And aside from financial benefits, the system has also given the US even more political control over the rest of the world.

Unilaterally, the US can impose tough sanctions on whichever country it deems unfriendly.

And all it has to do is to deny it access to the dollars it needs to make imports.

The US can also force other countries and companies not to do business with the country under its sanctions.

If any country or business that defies this, they risk being thrown out of the global dollar system as well.

It seems like the US, through the Dollar as a global reserve currency, has a leverage for bullying other countries to get what it wants.

But it is not like other countries have not realized that this is a system that mostly works for the interest of the US.

Almost every other country recognizes the globe can have a better and fairer financial system.

And indeed, many have attempted to lead the way in finding a replacement for the petrodollar recycling system.

But recognizing what it means to lose this system, the US had taken a tough position to defend the Dollar as a global reserve currency vigorously.

Sadly that has involved using military might.

Using war to protect the Dollar as a global reserve currency

Any country that has attempted to get out of this system has always received a ferocious backlash from the US.

For example, in October 2000, the Iraq government started accepting Euros for the payment of its oil exports.

In response, a massive propaganda campaign was launched, and the world was persuaded that the country had weapons of mass destruction (WMD).

Saddam was toppled in 2003, and the Dollar was reinstated as the currency accepted for Iraqi oil exports.

Then Libyan dictator Muammar Gaddafi, started an initiative to lead African countries in creating a continental currency that would be backed by gold.

In a war purported to protect citizens in an uprising against the government — so-called the Arab spring — Muamar was toppled and murdered in 2011. A single gold-backed currency for Africa died along with him.

For years there has been mounting pressure on Iran. The US and its allies have many times come very close to launching a military attack.

Iran has been under economic sanctions from the US since 1979 when the Shah was overthrown through an Islamic led revolution.

In part, that sanctions have been in place because Iran turned out to be a significant oil producer that wasn’t abiding by the rules in the Petrodollar recycling system.

In early 2012, Iran announced that it would accept gold as payment from a few countries that were willing to defy the US and buy oil from them.

Of course, this infuriated the US, and more sanctions have since been applied.

Another oil-producing country that has shown little support for the petrodollar system is Syria. And they’ve paid dearly for it.

The country came under a military invasion led by the US in 2011. About half a million people have been killed in the war, and millions of others displaced.

The primary goal of the war was to overthrow the Bashar Al Assad regime, which would give the US more control over how the country’s oil is sold internationally.

It is, however, turning out to be a war that is, to some extent, is proving that protecting the petrodollar system through military might is not guaranteed to succeed.

That is in particular given that Russia and China have chosen to begin aggressively protecting countries that are rebelling against the petrodollar system.

Aside from Syria, Russia and China have also come to the aid of Venezuela, another oil-producing country that has taken steps to drop the petrodollar.

Venezuela has been under pressure to get rid of President Maduro, and have US-friendly opposition leader Juan Gerardo take over.

The fact that the US seems to have failed to get their way in Syria, Iran and Venezuela, could be a sign that military force is not an effective strategy to protect the petrodollar.

Also, in countries where it has been successful at changing political leadership through military intervention, the US has failed to maintain enthusiasm for the petrodollar in the new administrations.

For example, a few years after the toppling of Saddam Hussein, the government that is in power now seems to be open to working with Russia and China.

It is also important to point out that Russia and China have grown both their economies and military capabilities to levels that make the US cautious about antagonizing them.

The more these two countries expand their influence around the world, the more the task of defending the Dollar as a global reserve currency becomes difficult.

The Bitcoin option

But perhaps what is not so apparent to the defenders of the Dollar as the global reserve currency is that the most potent threat to its current position is not the rebelling countries like Syria, Iran, Venezuela, Russia and China.

What is most likely to topple the US dollar from the position of a global reserve currency is a new technology that offers more efficiency, fairness and agility as a means for settling international trade.

And Bitcoin is the early application of that technology. The technology is blockchain, which makes it possible for many independent actors to maintain a shared ledger with no chance for cheating.

After Bitcoin, close to three thousand other cryptocurrencies have been created on this technology.

Everything is in place for the creation of a digital global reserve currency.

Indeed, Bitcoin itself is robust enough to take that role.

Bitcoin as a currency is almost entirely out of the control of any single power.

The rules that govern its functioning are a protocol that is agreed upon through consensus.

Indeed, as it is right now, it is ready for use among countries, companies and individuals to settle crossbody transactions.

Perhaps all it will take is for two or more bold countries to begin using it, and the rest of the globe will join in.

But Bitcoin has a cap of 21 million. Will those be enough to serve the growing global population?

Each Bitcoin is divisible up to eight decimal places. Indeed, a bitcoin is divisible to 100 million units known as satoshis.

That means, in total, we have enough units in Bitcoin to drive global commerce. It can be a global reserve currency.

There is also room to build other applications on top of Bitcoin, such as smart contracts, which will make it even more useful for international trade.

But if for whatever reason, it doesn’t sit well with some stakeholders, Bitcoin has brought to us blockchain, a technology we can use to build whatever form of global reserve currency we want.

But what makes a digital international trade settlement system more acceptable?

Bitcoin has shown us that it is possible to have a decentralized payment system that is entirely controlled by a foolproof mathematical protocol that no one can tamper with.

Using the same technology, countries can create a similar cross-border settlement solution that no one of them can manipulate for their selfish national interests.

The US can’t accept crypto without a fight

Of course, the US, or at least some in the political leadership, know about this threat.

In a congressional hearing on cryptocurrencies in May 2018, Congressman Brad Sherman gave perhaps the most candid view of the political class about the threat of Bitcoin to the Dollar’s position as the world’s reserve currency.

“It (Bitcoin) hurts the US government in …… …our ability to have the dollar as the chief means of international finance, which is what has underpinned our ability to impose sanctions.”

And his solution is simple; ban Bitcoin and other cryptocurrencies. He invited his colleagues to introduce a bill that would outlaw the use of cryptocurrencies by Americans.

“An awful lot of our international power comes from the fact that the dollar is the standard unit of international finance and transactions clearing through the New York Fed,” he stated, “and it is critical for major oil and other transactions.”

In his opinion, supporters of cryptocurrencies want to take away the power the US wields globally.

He is further quoted saying that leaving Bitcoin to flourish “puts us in a position where the most significant sanctions we have on Iran, for example, would become irrelevant.”

But not everyone in the capital hill of out of touch with the crypto reality. For example, representative, Patrick Mchenry from North Carolina is one of the legislators who have seen the impossibility of stopping Bitcoin.

The challenge for those who don’t want to give up the legacy petrodollar, though, is that it is almost impossible to stop Bitcoin.

The most effective way to do it is to shut down the entire internet, something that is also impossible to do.

Already some oil-producing countries have shown an interest in using cryptocurrency as a means to facilitate oil trade.

In December 2017, Venezuela unveiled Petro, a cryptocurrency backed by its oil reserves.

In February 2018, the government claimed to have sold around 38 million Petro tokens for about $3.3 billion.

In total, the currency is to have 100 million tokens.

The coin was supposed to enable Venezuela to circumvent the sanctions imposed on it by the US.

However, by large, the Petro coin seems to be a flop. And there are questions whether it even qualified to be considered a cryptocurrency.

But the fact that a government tried to set up a cryptocurrency backed by oil, which could be used for international trade, was a huge statement.

It was also a precursor of what could be coming.

In February 2019, reports came through that the Russian parliament (the Duma) was working on legislation that would prepare the path for the state to launch a cryptocurrency that is backed by oil.

If this turns out to be accurate, then the US has a more significant challenge at hand. While it can intimidate and arm-twist Venezuela to dropping or failing to launch an effective crypto, it can’t use the same tactics on Russia.

Perhaps the world does not need to create another currency to serve as the global reserve currency. Maybe we already have one, and it is just a matter of adopting it for that purpose.

Bitcoin has shown that it can become the global reserve currency.

It has been tested for the last decade, and its systems have proven to be robust enough.

It is deflationary while at the same time divisible to eight decimal points, making it enough to serve the global trade.

Perhaps it is time the US acknowledged that the petrodollar is dying, and it will be replaced by superior technology.

And that calls for preparation.

In particular, the rearrangement of the economy. The country will have to prepare for a time when it will not be exporting paper money.

And maybe perhaps accommodate in its system the likelihood of the need to buy a third party currency for its imports.

The US also needs to discover new ways of being an influence on the global stage.

Using sanctions is bound to be less effective, and military campaigns will only alienate the country from the rest of the world.

Unfortunately, the US might miss the opportunity to invest in new technology like Bitcoin.

It might get caught up with fighting vigorously to defend legacy technology that the Dollar is while the rest of the world overtakes it.