For over 75 years, the dollar has essentially been getting a free ride, courtesy of the fact that it’s the world’s most popular currency. Because so many global transactions are settled in dollars, businesses in every country need to exchange local currency for dollars to pay debts and transact business.
The domination of the dollar is so complete that more than 58% of global currency reserves held by central banks are dollar denominated. It’s true that in 2000, that number was 70%. But the dollar remains the world’s dominant currency by far, and for this reason, the greenback is often referred to as the world’s “reserve currency.”
The dollar’s reserve currency status came about as a result of a 1944 conference in Bretton Woods, New Hampshire. At the meeting, a group of finance ministers and other high-ranking officials from 44 countries declared that the dollar would be “good as gold.” Henceforth, global central banks could exchange dollars they accumulated with the US Treasury at a fixed price of $35 per ounce.
We all know how that worked out. To avoid depletion of US gold reserves, President Nixon in 1971 suspended the dollar’s convertibility into gold. Yet Nixon’s move actually entrenched the greenback’s preeminent status. Since central banks could no longer exchange dollars for gold, they were forced to accumulate dollars.
That situation hasn’t changed fundamentally since 1971, even though the dollar’s value in relation to gold has fallen more than 98%.
Having the world’s reserve currency has numerous benefits. The biggest one is that it’s given Congress the ability to borrow trillions of dollars to finance the country’s welfare-warfare state while simultaneously cutting taxes. Meanwhile, no matter how much money its politicians borrow, central banks still need to accumulate dollars since so many global transactions are settled in dollars. Companies everywhere that conduct business internationally need to exchange their local currencies for dollars to pay for goods and services.
With reserve currency status secure, American politicians have also found ways to weaponize the dollar against Uncle Sam’s enemies. For instance, one of the ways the US enforces sanctions against its long list of adversaries is by making it difficult for them to use or accumulate dollars.
The hammer comes in the form of US domination of the international payments settlement system called SWIFT – the Society for Worldwide Interbank Financial Telecommunication. This organization offers over 11,000 financial institutions in more than 200 countries a network enabling them to send and receive payment orders in a secure, standardized format.
Even though SWIFT is headquartered in Belgium, Uncle Sam has a great deal of influence over it. A whisper from Washington, D.C. is all that’s needed to cut a bank – or an entire country – out of the global dollar clearing network.
The threat is real, although not generally acknowledged. For instance, in 2017 former Treasury Secretary Steven Mnuchin warned China it would face being cut off from the dollar clearing system if it failed to adhere to UN sanctions against North Korea.
And in 2020, the head of the Economic Cooperation Department in Russia’s Foreign Ministry, Dmitry Birichevsky, warned of threats, “primarily from the United States, to disconnect Russia from the SWIFT system.” That’s exactly what happened two years later. Within days of Russia’s invasion of Ukraine on February 24, SWIFT ejected most Russian banks from its network. Russia now joins Iran and North Korea as countries effectively isolated from the global dollar clearing network.
Yet, Uncle Sam denies that it uses the dollar as a weapon.
Not surprisingly, countries targeted by dollar sanctions don’t like them. In 2018, the Shanghai International Energy Exchange (INE) launched a Chinese yuan denominated crude oil futures contract. That means any country – including those subject to US sanctions – can sell their oil in exchange for yuan.
In 2019, Russia and China agreed to increase trade using their own national currencies. Since then, the dollar’s share of payments of Russian exports to China has plummeted from nearly 90% to 33%.
That same year, Shanghai Gold Exchange (SGE) President Wang Zhenying proposed a new super-sovereign currency that would replace the greenback. In a thinly veiled swipe at US efforts to weaponize the dollar, Wang says the new currency would be designed to ensure that no one country can freeze the international assets of another country.
Then there’s BRICS – an acronym for the countries of Brazil, Russia, India, China, and South Africa. BRICS isn’t an organization as such, but rather a group of countries pursuing common goals. And at the 14th BRICS summit in June 2022, Chinese President Xi stated in his keynote speech:
We should expand BRICS cooperation on cross-border payment … to facilitate trade, investment, and financing among our countries.
Russian President Putin disclosed another crucial BRICS objective – setting up a new global reserve currency. It would consist of a basket of BRICS countries’ currencies.
The anti-dollar momentum continued in 2023. In January, the finance minister of Saudi Arabia, the world’s third-largest oil producer, declared:
Saudi Arabia is open to discussions about trade in currencies other than the US dollar, according to the kingdom’s finance minister.
And why not? China imports more oil than any other country. About one-quarter of China’s oil imports come from Saudi Arabia alone.
But China’s President Xi realizes that GCC oil producers don’t want to accumulate big reserves of yuan, since it’s not a freely convertible currency. Thus, in a March visit to Saudi Arabia, Xi spoke of “a new paradigm of all-dimensional energy cooperation.” In particular, Xi stressed the importance of oil and gas imports to China, and that exporters could use the Shanghai Petroleum and National Gas Exchange “as a platform to carry out yuan settlement of oil and gas trade.”
And there’s an important sweetener. To encourage traders to use the Shanghai exchange, China made it possible to settle the crude futures contract in gold through the Shanghai Gold Exchange.
Even America’s friends are awakening to the dangers of dollar hegemony. In 2020, the EU introduced a global payments system designed to allow EU companies to do business with Iranian companies without exposing themselves to US sanctions. More recently, on March 28, the French oil giant Total Energies sold 65,000 tons of liquified natural gas on the Shanghai exchange in exchange for what amounts to a gold-backed yuan.
Other recent developments that are billed as undercutting the greenback include:
-
Beijing and Brazil have also dropped the dollar in bilateral trade. Brazil’s leftist President Lula da Silva has called for Latin America to develop a new currency for regional trade.
-
Pakistan and India are buying oil from Russia and paying in their own currencies.
-
Kenya is buying Persian Gulf oil with its own currency.
-
The Reserve bank of India has announced that banks in 18 countries will be able to use Indian rupees for trade and exchange.
Viewed individually, none of these initiatives are likely to dethrone the dollar from its exalted reserve currency perch. And some of them simply seem like common sense. For instance, why would India, the most populous country in the world, pay dollars to buy oil from Russia, the world’s second largest producer?
But what might trigger the end of the dollar’s reserve currency status?
Well, there are a few things.
The first is the emergence of a credible alternative to the dollar.
The euro is the most obvious contender, with central banks holding about 20% of their reserves in this currency. However, if any country pulls out of the Eurozone and reintroduces a weaker domestic currency, its value could fall sharply. This “redenomination risk” makes the euro a poor candidate for a reserve currency.
China is gunning for the yuan to replace the dollar, but in reality, it’s far from achieving that goal. The yuan will never become a reserve currency so long as the government maintains strict exchange controls. According to SWIFT, the yuan is used for less than 2% of global payments and 4% of global trade finance. And less than 3% of central bank reserves are held in yuan.
But the fact that China is willing to indirectly back the yuan with gold is a big deal. It’s not a gold standard, but the move is very bullish for gold.
In theory, the world could return to a gold standard, but doing so would likely lead to the worst economic crisis in history. If its price is set relatively low, it is likely to lead to a deflationary depression as individuals, businesses, and governments convert their savings from fiat currencies to the precious metal.
But if the price of gold is set high enough to reflect the fact that the dollar has lost 98% of its value since 1971, it would cause hyperinflation as every asset not directly backed by gold is repriced in terms of its new value. Can you imagine waking up one morning to discover that all goods and services are now 100 times more expensive than they were when you went to bed?
The second trigger point would be the emergence of classic capital controls in the United States, a phenomenon we explored nearly 14 years ago in a three-part series (Part 1, Part 2, Part 3).
But if that were to happen, we would expect to see chaos in the global financial markets as the shift occurs. Inflation would spike. The economy would fall to its knees.
That’s not something that would benefit those within the system. And it’s probably the best case for why the Uncle Sam is unlikely to bring in such controls.
Besides, there are easier and quieter ways of keeping money from going offshore. Regulation of the money leaving the country and being held offshore, for example.
Another potential trigger is hyperinflation. American consumers got a whiff of that economic catastrophe starting in 2021, when prices for pretty much everything began rising at “official” inflation rates approaching 10% annually.
Real inflation rates were much higher. Indeed, if inflation were measured today as it was in 1980, prices were rising at 18% per year in mid-2022. Since then, they’ve come down a bit, but are still increasing at (real) double-digit rates.
In the meantime, dollar dominance remains well-entrenched. And it won’t change unless there’s a credible alternative monetary system waiting to take its place … and enough people, businesses and other governments vote with their wallets by moving their money into another currency.
Yes, the dollar is doomed – eventually. On its way out, you’ll see even higher inflation, bail-ins, and capital controls. But until a viable contender emerges that serves the global economy better than the dollar, the greenback will reign supreme.
