Dethroning The Dollar Requires Much More than Digitalization

Whilst it would be tempting to presume that a digital, frictionless state-issued cryptocurrency has the potential to unseat the dollar, a global currency requires much more than ease of use.

AsSeaman Du Jun polished the deck of the spanking new Chinese Type-055 Air Defense Destroyer, sitting in the docks at Shanghai’s naval construction yard, he could not help but look out in awe at the massive fleet build-up surrounding his state-of-the-art missile destroyer.

At the massive JN Shipyard in Shanghai, advanced destroyers, cruisers and what looked to be the beginnings of a massive aircraft carrier were in various states of construction — a fleet so massive that Admiral Cheng Ho (of the Ming Dynasty) and his Imperial Treasure Fleet would no doubt have been envious.

As impressive as the sight of China’s bluewater navy being built before Du Jun’s very eyes was, globally, a far more powerful force for coercion can be exercised without a single shot being fired in anger — America’s use and weaponization of the dollar.

Dollars To Donuts

In the aftermath of the Second World War, with the almost complete destruction of Europe and Japan’s industrial stock, the dollar cemented its role as the world’s dominant currency, giving the United States extraordinary influence over other countries’ economic destinies.

Yet although successive U.S. administrations have used the dollar in saber-rattling from time to time, it has been the Trump administration that has routinely used the power of the dollar to its fullest extent, wielding it as a weapon of financial warfare.

The results of such regular and unabated weaponization of the dollar have been both awe-inspiring and shocking, not least because the power of a weapon often lies in its brandishing, but typically restrained application.

The Trump administration’s willingness to demonstrate the dollar’s dominance with regularity has in turn prompted countries to seek to break free of American financial hegemony.

Dollar Damnation

In 2018 alone, America’s Treasury Department put legal measures in place that prevented Rusal, a strategically important Russian aluminium firm, from freely accessing the dollar-based financial system, to devastating effect.

Overnight, Rusal was unable to deal with many counterparties and clearing houses refused to settle its debt securities, collapsing the price of Rusal bonds overnight.

The crippling moves against Rusal were eventually lifted, but the scars will take decades to heal, if ever.

Then in January this year, U.S. Treasury Secretary Steven Mnuchin announced that the U.S. Treasury Department would cut off billions of dollars of support to the Iranian regime and the State Department said that it would cut Iraq’s access to its government account at the Federal Reserve Bank of New York, restricting Iraq’s use of its oil revenues, causing a cash crunch and flattening its economy.

But Iraq and Russia are hardly unique in feeling the sting of American dollars.

Today, the U.S. Treasury Department has over 30 active financial and trade sanctions programs, not counting the numerous actions it has against individuals.

And the United States is uniquely well positioned to use financial welfare in the service of its foreign policy.

Foreign Policy Brought To You By The Dollar

Globally, the dollar is used as a unit of account, a store of value and a medium of exchange — the very three qualities that some Bitcoin maximalists aspire the cryptocurrency to.

No less than half of all cross-border trade invoices are denominated in dollars — five times America’s share of world goods imports and three times its share of exports.

Say what you may about American financial hegemony, but internationally, the dollar is still the preferred currency of central banks and capital markets.

And despite a 10% drop as a share of central banks’ foreign reserves over the past decade, the dollar still accounts for close to two-thirds of global securities issuances and foreign exchange reserves.

Whether the world likes it or not, it dances to the beat of the dollar.

When the U.S. shifts interest rates or risk appetites alter on Wall Street, global markets respond predictably, in unbroken correlations that have held together for decades.

And the world’s financial plumbing relies on the U.S. as well, because more international transactions are ultimately cleared in dollars through New York by American correspondent banks than on anywhere else in the world.

Dollar Denominated Messaging

The U.S. also holds sway over the main cross-border messaging system used by banks, SWIFT, despite the organization being headquartered in Brussels, Belgium.

Meanwhile CHIPS, a clearing house that processes US$1.5 trillion worth of payments daily, is another part of the U.S.-centric global financial ecosystem.

And Washington uses America’s coveted position as the hub of global finance, to both monitor all manner of financial activity and influence it where it deems necessary.

Denied access to America’s financial infrastructure, an organization, like a branch pruned from its tree, becomes gradually isolated, financially crippled and eventually withers away.

For better or worse, individuals and institutions across the globe are subject to American financial jurisdiction and vulnerable to punishment.

But unbridled American belligerence in weaponizing the dollar is not without consequences.

Critics of the Trump administration’s use of the dollar to extend the reach of American law and policy, include both America’s adversaries and allies.

Russian President Vladimir Putin speaks of the dollar as a “political weapon”, while allies such as the United Kingdom and France regularly express concern that the Trump administration risks undermining America’s role as guarantor of orderliness in global commerce.

Trump’s willingness to wield the dollar as a weapon has led to a new age of international monetary experimentation, from cryptocurrencies to de-dollarization, trade workarounds using local currencies, to swaps and new bank-to-bank payment mechanisms — nothing is off the table.

Last June, Chinese President Xi Jinping and Russian President Vladimir Putin announced that they would expand settlement of bilateral trade in their own currencies.

On the sidelines of a recent summit, leaders from Iran, Malaysia, Turkey and Qatar proposed using a combination of cryptocurrencies, national currencies, gold and even barter for trade.

Dying To De-Dollarize

When viewed in isolation, such moves could be dismissed as bluster, but examined in their entirety, represents an urgency to de-dollarize as has never been witnessed before.

Of the countries seeking to de-dollarize, Russia has been the most pro-active.

Since 2013, the Russian central bank has cut the dollar share of foreign exchange reserves from over 40% to 24%.

And since 2018, Russian holdings of American treasury bills has fallen by over 90% from US$100 billion to less than US$10 billion.

Russian debt has also taken an anti-dollar stance as well, with the bulk of new issuance in roubles or euros and Moscow is said to be exploring Chinese yuan-denominated bonds as well.

Yet for all the attention that the Russian government gets for spurning the dollar, Russian citizens have been more than making up for the dollar falling out of favor with the Kremlin.

Russian firms and households, stung by volatility in the rouble and a slowing domestic economy, have continued to hold dollars, US$80 billion more than they did in 2014.

And where dollars are not held, Russians are one of the world’s biggest holders of cryptocurrencies such as Bitcoin as well.

China’s attempt to dethrone the dollar however has been in fits and starts.

A first attempt by Beijing to bypass the dollar-based global financial system was bungled.

After the financial crisis, Beijing promoted the international use of the yuan and lobbied for it to become part of the International Monetary Fund’s “Special Drawing Rights” — in effect receiving the Fund’s seal of approval as a global reserve currency.

But the Chinese stock market panic of 2015, which saw Beijing impose clumsy overnight capital controls, spooked markets and the yuan’s share of global payments has remained at about 2% ever since.

Dollars To Cryptocurrencies

Yet where Beijing has failed, Shenzhen and Hangzhou have succeeded, with tech companies such as Alibaba and Tencent globalizing faster than China’s lumbering conventional banks.

Today, Alipay is accepted by merchants in 56 countries and in some places, the Alipay logo is as common as Visa’s.

And Beijing has not thrown in the towel yet either, with the People’s Bank of China, China’s central bank, working on its own digital currency, due for release sometime this year.

Some speculate that China wants to get a head start on the U.S., in building whatever international system emerges for managing payments in central bank-issued digital currencies.

China is already in discussions with Brazil, Russia, India and South Africa , to create a common cryptocurrency that would rival the dollar.

To that end, China already has some of the building blocks to separate itself from the dollar-based financial system, with its own domestic payments and settlements infrastructure called CIPS.

Launched in 2015, CIPS currently complements SWIFT, but simplifies cross-border payments in yuan, providing banks with plenty of nodes for settlements.

Reports suggest that China, India and several other countries are already exploring alternatives to SWIFT.

And either the Chinese digital yuan or a BRICS (Brazil, Russia, India, China, South Africa) cryptocurrency could potentially add viability to a SWIFT alternative, providing a near-frictionless cross-border settlement system, denominated in a currency other than the dollar and built on infrastructure free from American influence or intervention.

Yet while it should come as no surprise that America’s geopolitical rivals are actively working to supplant a dollar-denominated financial system, that America’s allies are considering the same should be disconcerting.

In her manifesto for 2019–2024, the new president of the European Commission, Ursula von der Leyen said,

“I want to strengthen the international role of the euro.”

Her predecessor, Jean-Claude Juncker did not mince words when he called the dollar’s dominance of European energy trade an “aberration” — considering that just 2% of European energy imports come from the United States.

The European Commission has already started work on an action plan that wold encourage European Union members to eliminate undue reference to the dollar in payments and trade invoicing.

And if Europe manages to reform the inner workings of the euro, including greater banking union, fiscal integration and genuine capital markets union, the potential of the euro to expand its financial reach will increase.

In this regard, European powers are likely to play a leading role in efforts to create a global digital currency — an idea floated last year by Bank of England Governor Mark Carney — creating a network of central bank-issued digital currencies that could serve as a global invoicing currency — a network that would exclude the dollar.

But intention, planning and digitalization do not a reserve currency make.

Digital Does Not Make Dollar

Like gold that is tested in fire, the true measure of a reserve currency lies in its ability to weather financial crises.

And for that, the dollar is head and shoulders above all other currencies — for now at least.

Since the Second World War, the dollar has benefited in times of turmoil, even if such turmoil may have been directly the result of the worst excesses of Wall Street.

During the financial crisis, the dollar paradoxically strengthened, despite the crisis being one of America’s own creation.

When global trade, savings, borrowings and reserves are largely in one currency, these strengths are mutually reinforcing.

To date, no other capital market comes close to America’s for depth and liquidity — key factors in choosing a currency for commerce.

Even when China’s biggest tech firm Alibaba chose to list its shares in a public offering, it did so in New York and not Shanghai or Shenzhen.

And when Beijing pressured its tech firms to list closer to home, Alibaba completed an additional listing in Hong Kong and in Hong Kong dollars, not yuan.

Yet financial hegemony depends on a complex balance of economic might, incumbency and legitimacy, all of which have come under pressure from the Trump administration.

In 2016, while still in office, Jack Lew, former U.S. Treasury Secretary told an audience gathered in Washington,

“It is a mistake to think that (sanctions) are low cost. And if they make the business environment too complicated, or unpredictable, or if they excessively interfere with the flow of funds worldwide, financial transactions may begin to move outside of the United States entirely — which could threaten the central role of the U.S. financial system globally, not to mention the effectiveness of our sanctions in the future.”

And that America does not have a monopoly on financial ingenuity is ironically demonstrated in the creation of Bitcoin and other cryptocurrencies.

If nothing else, cryptocurrencies have opened the discussion on what a global currency can be and what financial inclusion could look like.

Whereas before, countries were confined to the American-led global financial plumbing, blockchain technology and cryptocurrencies have triggered governments to consider and for the first time, actively pursue, alternatives to the dollar.

Whether or not a global reserve currency of the future will be decentralized and private, controlled by no one and everyone, like Bitcoin, or whether it will devolve into a multi-currency, multi-polar system such as the one envisioned by rivals of the United States, remains to be seen.

But as the Trump administration continues to use sanctions aggressively, efforts to circumvent them will no doubt accelerate and under such circumstances, all alternatives will be tabled, including the use of cryptocurrencies.