3/18/24, 2:00 PM The Dollar Still Dominates | Foreign Affairs

The Dollar Still Dominates

American Financial Power in the Age of Great-Power
Competition
BY CARLA NORRLÖF February 21, 2023
CARLA NORRLÖF is a Senior Fellow at the Atlantic Council and Professor of Political Science
at the University of Toronto.

The centrality of the U.S. dollar in world affairs is mainly determined by

economic factors, but geopolitical forces are threatening to weaken its top
spot in the currency hierarchy. U.S. sanctions in response to Russia’s
invasion of Ukraine have pushed some countries to further reduce their
reliance on the dollar. The geopolitical tug of war between allies and foes,
liberal and illiberal states carries high stakes. “Great powers have great
currencies,” quipped the Nobel laureate Robert Mundell. If the currency
system were to become multipolar, U.S. monetary perks would recede, as
would the United States’ global economic influence and its ability to use
dollars as an alternative to military force when policing international
order.

A more fragmented global economy in which security partnerships

determine economic relations is coming into view. But an end to the
dollar’s dominance is still unlikely. Countries participating in the
sanctions against Russia or benefiting from U.S. currency coercion aimed
at upholding the liberal international order’s core principle of

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nonaggression have no incentives to diversify away from the dollar. Even

countries opposing Western sanctions are likely to stick with the dollar to
preserve their own security and U.S. security guarantees in a hardening
geopolitical climate.

In today’s fraught international environment, countries are returning to

Cold War logic, questioning the sustainability of systemwide economic
interdependence over privileged economic ties with friends. With the
United States at the center of the largest security network in the world,
the dollar stands to benefit from this shift, even though it will
simultaneously be counterbalanced by the currencies of geopolitical rivals.
This bifurcated dynamic, in which U.S. supporters shore up dollar
dominance and Washington’s detractors reduce their dollar dependence,
nonetheless represents the most important threat to the dollar’s global
prominence since the arrival of the euro in 1999.

The dollar is the preferred currency of governments, accounting for

approximately 60 percent of central bank reserves in late 2022, compared
with the euro’s 20 percent, and the yen’s six percent. Individually, the
pound, the Chinese yuan, and the Canadian and Australian dollar
represent less than five percent of government reserves. The dollar is also
dominant, although less so, in private markets.

Yet pessimism about the dollar’s future abounds. Rana Foroohar of the
Financial Times has warned of a “post-dollar world”; her colleague Martin
Wolf worries that dollar dominance will give way to a bipolar
international monetary system, with the United States at one end and
China at the other. Gita Gopinath, the deputy managing director of the
International Monetary Fund (IMF), sees sanctions ushering in a
fragmented, multipolar currency order. Big banks are also skeptical about
the prospects of continued dollar dominance. Zoltan Pozsar of Credit
Suisse believes a multipolar, commodity-based currency order lies ahead.

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A year ago, Goldman Sachs’s Cristina Tessari and Zach Pandl cautioned
the dollar might follow the fate of the British pound and become a
second-tier currency.

If predictions about a coming multipolar currency order are correct, the

United States will undergo a meaningful decline in its power base and in
its ability to project power, with broader implications for international
stability and order. By rethinking how it imposes sanctions, however, the
West can help protect the dollar’s standing. The United States and its
allies can design sanctions in a way that will prevent the unipolar currency
order from further eroding. Namely, they must build broad sanctions
coalitions in which participation is strictly voluntary and those who do
not join are not forced to choose sides. Countries imposing sanctions
should recognize the consequences these punishing measures have on
third parties and, whenever possible, take steps to alleviate those
unintended effects. Sanctions should be reserved for the clear-cut cases in
which the international order is under threat, as in Ukraine, and should
not be used for parochial purposes, as when sanctions were reinstated
against Iran in 2018, even though it hadn’t broken the terms of the
nuclear deal, and when the Trump administration imposed overly harsh
sanctions on Cuba. Imposing sanctions to pursue narrow U.S. interests
raises legitimate fears among countries that they could be targeted next
and therefore motivates them to find alternatives to the dollar. But if the
United States and its allies resort to sanctions to preserve the central
elements of the liberal international order, the dollar should keep its place
as the currency of choice.

THE RENMINBI AND THE RUBLE

China and Russia are openly taking steps to raise the attractiveness of
alternative currencies for international economic and reserve purposes,
building multinational financial infrastructure to promote trade and
investment in renminbi and rubles. China’s Cross-Border Interbank
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Payment System acts as a clearing-house, similar to the U.S. Clearing

House Interbank Payments System. Comparing these platforms reveals
the gulf between them. The Chinese system, or CIPS, processes
approximately 15,000 transactions per day, amounting to the dollar
equivalent of $50 billion. Meanwhile, CHIPS, the U.S. version, processes
250,000 transactions per day, exceeding $1.5 trillion. CIPS makes it
possible to clear and settle cross-border exchange in renminbi. Once
China develops a financial messaging system, the cross-border settlement
of yuan-denominated transactions can occur independently of the global
SWIFT interbank messaging service dominated by the West. Russia, for
its part, created what it calls the System for Transfer of Financial
Messages after it invaded Ukraine in 2014. The express purpose of SPFS
is to allow users to bypass SWIFT. There were roughly 400 users before
the February 2022 invasion of Ukraine, but according to Russia’s central
bank, demand increased significantly afterward.

Complementing these systems is a series of bilateral treaties that intend to

facilitate trade and investment in non-Western currencies. China and
Russia signed a bilateral treaty in 2019 with the goal of promoting their
national currencies for trade settlement. India has created a Special Rupee
Vostro Account, which countries can credit to encourage settlement of
trade and investment with India in Indian rupees. India and Russia have
also tried to encourage trade denominated in their currencies by
reintroducing the rupee-ruble Cold War currency mechanism shortly
after the sanctions against Russia were imposed in 2022. Under this
scheme, settlement would occur directly between Russian banks holding
rupees in India and Indian banks holding rubles in Russia.

After the 2008 financial crisis, China began funneling renminbi to other
countries by extending bilateral swap lines, allowing foreign central banks
to acquire Chinese yuan in exchange for their own currency. Making
renminbi available to foreign governments is a prerequisite for its use by
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governments and private actors, and the ability to act as the lender of last
resort in times of crisis is an important aspect of reserve currency status.
China’s largest line, amounting to $24 billion, is with Russia. More
recently, China has collaborated with the Bank for International
Settlements to create a renminbi liquidity arrangement to support
contributing central banks during emergencies. The central banks of
Chile, Hong Kong, Indonesia, Malaysia, and Singapore have pledged $2
billion each to the reserve pool held in Basel, Switzerland, where the BIS
is headquartered. China’s reserve and liquidity provision remains small,
compared with the supply of the U.S. Federal Reserve, but it is sure to
grow. In 2016, the International Monetary Fund updated the reserve
basket of currencies that defines its so-called Special Drawing Rights
(SDRs), the reserve asset in which the IMF denominates its loans to
governments, to include the Chinese yuan.

China is also promoting the use of renminbi by creating digital payment

alternatives, such as the e-CNY, a digital currency the country’s central
bank began to offer in 2016 and introduced as a payment option for
anyone attending the 2022 Olympics in Beijing. When fully
implemented, the e-CNY will function independently of other payment
and financial messaging systems. By promising cheaper, faster, and safer
transactions, a Chinese digital currency can speed up the
internationalization of the renminbi. All these developments will make
the renminbi more widely accessible and liquid and, therefore, will
promote its use for trade and investment.

Joint efforts to decimate the dollar are also being discussed by Brazil,
Russia, India, China, and South Africa, known as the BRICS. Together,
these countries have explored issuing a joint reserve currency with the
explicit purpose of bypassing the dollar and other major Western
currencies. The common currency would be based on a basket of BRICS
currencies and would serve as an alternative to the IMF’s reserve basket of
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currencies, although little progress has been made since its June 2022
announcement. China, India, and Russia, however, agreed to expand trade
and promote their national currencies in international payments at a
September summit of the Shanghai Cooperation Organization.

Dollars remain the currency of choice for governments, firms, and

financial institutions to conduct trade and investment, but cross-border
exchange in alternative currencies is progressing. Oil is one of the world’s
leading export products. Using dollars to pay for oil is therefore seen as an
important element in maintaining the dollar’s role as the default currency
for international payments. China, Russia, and countries in the Middle
East and South Asia are trying to move away from oil settlement in
dollars. China and Russia are promoting their national currencies in oil
trade. China and Saudi Arabia are drawing up plans to invoice oil in
renminbi. Russia and India are exploring the use of the dirham, the
currency of the United Arab Emirates (UAE), to settle oil deals among
them. Russia and Iran are considering the use of a gold-backed stablecoin
for international payments.

If oil producers insist on settling oil transactions in Chinese renminbi,

Russian rubles, Indian rupees, the UAE’s dirham, or non-dollar-backed
stablecoins, the dollar’s role will decline. The use of renminbi to trade oil
among countries not involving China also stands to raise the significance
of the renminbi as an international currency. Third-party use of the
dirham will likewise raise its international role, although it is unlikely to
become a major international currency. The rupee is a more likely
contender as an international currency, but so far it is used only in bilateral
trade. The ruble is also used in bilateral trade and highly unlikely to join
the currency major league. Even if these currencies are primarily used for
bilateral trade, the dollar will be used relatively less frequently,
undermining its status.

CHOOSING SIDES IN AN ECONOMIC SHOWDOWN

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As China and Russia are making moves to promote the use of their
currencies, the United States is pressuring countries to join the sanctions
regime against Russia, with consequences for the dollar’s primacy. U.S.
dollar dominance depends on the disproportionate use of dollars relative
to other currencies by governments and private actors. Governments use
and hold dollar reserves in order to intervene in foreign exchange markets
and to defend the prices of their currencies, particularly during times of
crisis. Governments with difficulty instilling confidence in their own
currencies “peg” the value of those currencies to the dollar to stabilize their
exchange rates. Private actors, including individuals, businesses, and
financial institutions, also use dollars to conduct trade and investment.

Sanctions stop most of these activities dead in their tracks. Sanctions may
be limited to preventing certain government officials, private individuals,
or entities from accessing dollar-denominated assets or making dollar-
based transactions. Sanctions can also be more comprehensive, locking
banks and other key entities out of using dollars. Extreme forms of
economic coercion, such as freezing central bank reserves, deny a foreign
government the ability to use reserves to intervene in foreign exchange
markets and provide dollar funding to its economy.

Since last February, 44 countries—Australia, Canada, Japan, New

Zealand, South Korea, the United States, and nearly all of Europe—have
imposed sanctions on Russia for violating Ukraine’s territorial integrity
and waging war on its population and institutions. These countries stand
united in seeking to uphold an international environment free from
military coercion, terrorism, human rights abuses, and authoritarian coups.
Western sanctions include freezing Russia’s central bank reserves,
disconnecting major Russian banks from SWIFT, restricting foreign
currencies, and placing sanctions and asset freezes on more than 10,000
individuals, entities, vessels, and aircraft. Additional measures include
export controls on dual-use goods, an oil-price cap, a ban on gold imports
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from Russia, superyacht confiscations, travel bans, and the exodus of many
Western countries from Russia.

The sanctions against Russia are contributing to a realignment of global

currency holdings. The countries supporting sanctions on Russia have
strong geopolitical incentives to continue holding and using dollars for
international reserve and payment purposes since doing so reinforces the
constraining impact of the sanctions and helps ensure their future
effectiveness. Any economic incentives these governments previously had
to diversify away from traditional currencies, particularly the U.S. dollar,
by increasing the proportion of other currencies in their reserves and
international transactions must now be weighed against the geopolitical
incentives to hold dollars. As security concerns eclipse economic ones, the
United States and Europe are limiting their economic dependence on
foreign adversaries and pushing to relocate manufacturing and supply
chains to allied nations in what has come to be known as “friend shoring.”
Just as countries are beginning to source goods and inputs from friendly
nations, they are likely to adopt the currencies of friendly nations. The size
of the sanctioning coalition, the number of nonparticipating sanctions
supporters, and the number of countries under the U.S. security umbrella,
make large-scale currency diversification away from the dollar unlikely, as
shown by two recent studies.

Together, the coalition arrayed against Russia accounts for more than 90
percent of global currency reserves, approximately 80 percent of global
investment, and 60 percent of world trade and world economic output.
Overcoming that dominance would be difficult even if every country that
has declined to sanction Russia fell in line behind an organized anti-
dollar coalition.

Countries not participating in sanctions against Russia do not necessarily

disagree with the goals behind them: ending the war in Ukraine and

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deterring future territorial aggression. And many of those countries still

have incentives to strengthen the global dollar-centered system. Fully half
of the United States’ formal security allies are not participating in the
sanctions regime against Russia. Together, this group of countries, which
includes Argentina, Brazil, Chile, Pakistan, the Philippines, Thailand, and
Turkey, represents six percent of the world’s GDP, seven percent of global
trade, and two percent of global investment. Developing countries that
have not sanctioned Russia are feeling the brunt of the sanctions’
secondary effects: inflation, currency depreciation, and supply chain
shortages. Still, they are unlikely to respond to this fallout by siding with
Russia unless the West inflicts further pain on them—for example, by
diverting aid to Ukraine and cutting off foreign aid to them.

With geopolitical tensions rising, it is likely that an old security logic for
the use of the dollar will take hold. Historically, allies have offered
currency support in exchange for defense commitments. Most famously,
the United States stationed 200,000 troops in West Germany during the
Cold War. In return, President John F. Kennedy asked Berlin to procure
military equipment as a way of reducing the U.S. current account deficit,
supporting the dollar, decreasing the outflow of gold, and bolstering the
credibility of the fixed dollar-gold regime arising from U.S. military
spending. When security concerns receded after the Cold War, economic
calculations took over, with geopolitics taking a back seat in determining
dollar holdings and transactions. But with Russia’s invasion of Ukraine,
the security drivers of economic exchange have returned with a vengeance.

BUCK UP
Great-power competition poses serious risks to the dollar’s dominance in
the global economy. Geopolitically induced dollar support is, however,
working to stabilize and increase dollar holdings. The coalition behind the
sanctions against Russia is broad, wealthy, and militarily powerful, and its
objective of ending Russia’s barbarous war is widely shared, even by those
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not participating in the sanctions. And even though many countries look
on the sanctions against Russia with alarm, they have other geopolitical
reasons to support the dollar. For in a less secure world, countries privilege
survival and are more likely to support states capable of helping them
secure their territorial integrity, giving the United States an edge because
of its vast security network.

The dollar-centered financial system is becoming less widespread but

more entrenched where it persists. To safeguard the existing currency
hierarchy and limit the long-term trend toward currency multipolarity, the
United States must use economic statecraft in ways that promote the
public good of a liberal international order. The United States will not be
able to afford to alienate key allies or a large portion of the international
community and still preserve the unipolar dollar era.

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