A calm before the storm in the dollar-based global financial system?

As we enter the third year of the Russia-Ukraine war and sanctions warfare, the divergence in expert opinion about the future of the dollar has not only not narrowed, but has become wider than ever. Opinion-forming Western banks and financial analysts believe that the dollar’s decline is a “myth” or at least “vastly exaggerated”, and they are backed up by the facts. But are they looking at the right data? If there’s nothing to see, why is presidential candidate Donald Trump threatening to punish countries that are about to abandon the dollar, and why are the International Monetary Fund (IMF) and the European Central Bank (ECB) warning of historic changes? Another group of experts is predicting the imminent collapse of the dollar, highlighting the increasingly consistent dollar substitution by BRICS and the gold purchases by central banks. But despite all the hype, these are moving forward very slowly and with difficulty. In fact, to understand the future of the dollar, we need to look not at the countries that are opposed to the US, but at the decisions taken by Washington: the fate of the dollar will be determined by the out-of-control US overspending and debt spiral, as well as the transformation of world trade that is taking place before our eyes.

If we look at the periodic data of the Western financial institutional system (SWIFT, IMF, BIS), we do not see any significant change in the use of the dollar, i.e:

The dollar was used in 47 per cent of global financial transactions in April 2024, up slightly from 10 years ago when the dollar’s share was 43 per cent.
The share of dollar assets in foreign exchange reserves was 58 per cent, a sizeable but not very significant decline from 66 per cent ten years ago.
The yuan’s share in financial transactions has been steadily rising, but is still below 5 per cent (4.5 per cent; 1.4 per cent in 2014). It is mainly displacing the euro and the pound sterling rather than the dollar. The euro’s share has fallen from 32 per cent 10 years ago to 23 per cent, reflecting the collapse of European-Russian trade due to the sanctions.
In 88 per cent of foreign exchange deals, the dollar is on one side of the deal. Globally, 37 per cent of corporate bonds and 58 per cent of world government debt are issued in dollars, according to BIS data. None of these has changed significantly from 10 years ago.

The figure can be referenced here: https://public.flourish.studio/visualisation/18843622/

This rather obvious statistic leads mainly Western banks and experts to reject the “dedollarisation”: the renowned US commodity market commentator Jeffrey Christian, for example, has called the dollar’s loss of ground a “myth” and a “bad joke”, while the JPMorgan bank has described it as “vastly exaggerated”.

Is that all the negative consequences of using “the dollar as a weapon”? After all, reputable economists and organisations have long warned that turning the dollar into a geopolitical weapon undermines confidence in the dollar-based financial system, leading to a severe crisis over time. Indeed, the dollar weapon is now being deployed en masse by the United States: financial and trade sanctions, once used against international terrorist organisations and to cripple Iran which was working on its nuclear bomb programme, are now being used everywhere, from the thousands of crippling sanctions imposed on Russia to influencing anti-LGBQT laws in Uganda and to the intimidation of Chinese banks that work with Russian firms. Where are the consequences?

However, the above Western institutional statistics should be treated with great caution.

Western institutions, such as SWIFT, can report on the movements of funds through their own systems. So when non-dollar trade flows, for example in Asia, are moved outside the infrastructure of Western institutions, the weight of the dollar in their statistics increases proportionally, not decreases. This is how it is possible that although for the first time last year a fifth of world oil trade was no longer conducted in dollars, and Moscow’s trade that was 70 per cent dollar-based before the war is now largely in yuan and roubles, the effect of this does not show up as the dollar’s loss of ground in Western data.
Contrary to the popular narrative, the BRICS members are not seeking to replace the dollar. The favourite pastime of the Anglo-Saxon financial press is to prove time and again that the dollar has no real challenger in the competition between currencies; that is, the dollar’s dominant position as a trading and reserve currency cannot be replaced by any other currency. This is factually true, but irrelevant. Indeed, the BRICS members would not be able to do so; they are not technically capable of doing so at present – neither the yuan nor the rupee is freely convertible – and the institutional conditions are not in place either. But that is not the goal: BRICS’ ambition is to substitute the dollar in trade. In the current, often improvisatory, practice, this is done by applying several cumbersome solutions in parallel. For example, through yuan transfers in China’s banking payment system, CIPS; foreign exchange swaps between central banks; the inclusion of third-party currencies such as the Singapore dollar; and even by bringing back the ancient gold-based bilateral clearing settlement. All of these are mostly invisible to the Western institutional system, known on a self-reporting basis. It is telling, however, that the Chinese CIPS payment system, which has been in existence for barely a few years, now has a turnover of 15 to 20 per cent of the $400 billion a day turnover of the globally dominant Western SWIFT.
Finally, the imposition of sanctions against Russia almost coincided with an extraordinary surge in US oil and gas exports, which have jumped to historic record levels (before 2018, the US essentially exported no gas, whereas it is now one of the world’s leading exporters of LNG; it is now also the world’s largest producer and one of the largest exporters of oil). This in itself has further increased the use of the dollar in world markets, as buyers need to buy dollars to purchase oil and gas, which for the time being offsets the falling Eastern demand for the dollar.

The widely cited Western data thus show that the global trade remittances and reserves flowing through the Western financial infrastructure remain entirely dollar-based, and say nothing more and nothing less than that.

The figure can be referenced here: https://public.flourish.studio/visualisation/18843791/

Beyond the Western infrastructure, however, BRICS is working hard to institutionalise payment settlements which completely bypass the dollar-based financial system and which are now often experimental or crisis management-like:

BRICS members are increasingly trying to use their national currencies not only for trade between themselves but also with third countries. After agreements between Brazil and China, Saudi Arabia and China etc. that are gradually increasing in scale, India and Nigeria, for example, have recently concluded such an agreement between themselves (the latter is the world’s 15th largest oil producer with 220 million inhabitants). In the case of China, the shift to its own currency in foreign trade has got to the stage that, while in 2010 83 per cent of Chinese payments across the border were in dollars and 1 per cent was in yuan, the yuan now accounts for 53 per cent.

China and India are also developing their internal (residential) digital payment systems with extraordinary dynamism, which, by their sheer size (almost 3 billion users), will have a major impact on the world financial system, especially if they can interact with each other and the outside world in some kind of framework. Today, Chinese e-commerce alone represents more than half of the world e-commerce market.
A precursor to this interconnectivity between systems is, for example, the Chinese-led mBridge project, which allows digital money transfers between central banks and banks. (In the US, Congress has explicitly banned the introduction of digital money.) Saudi Arabia has now joined the project, following Thailand and the United Arab Emirates. It is not difficult to predict that Beijing will gradually integrate its trading partners into at least one of the mBridge or CIPS platforms. This means that the yuan can eventually become a major trading currency without the usual and expected ‘reserve currency’ characteristics of the dollar, such as a ‘capital market with deep liquidity that is open to all’ or the dominant role of international commercial banks.
BRICS members are also trying to reduce their dependence on the dollar-based financial system by steadily increasing their gold reserves and, in the case of China, reducing their holdings of US Treasuries. Beijing has increased its gold reserves by 18 per cent in the past 17 months, while reducing its holdings of US Treasuries by 40 per cent to a 15-year low. India recently repatriated 100 tonnes of gold from the UK. Russia has tripled its gold reserves since the first sanctions in 2014. As one analyst aptly noted, in fact, “BRICS already has a common currency, and it’s called gold”. Gold cannot, of course, be used directly as a trading currency, but it could play a significant role in balancing a new clearing system and clearing money, as a reserve currency that all parties accept. And if fewer dollars are needed to trade with each other, the amount and importance of dollars in global reserve will be reduced.

It is therefore understandable why, despite the statistics, there is growing concern among Western politicians and institutional leaders: as Donald Trump has said, “I would not allow countries to break away from the dollar standard because (…) it would be like losing a revolutionary war” and “it would be a blow to our country”. His advisers would develop punitive measures for such cases. ECB President Christine Lagarde caused a minor storm last year with her statement that “the international role of the dollar should not be taken for granted”. IMF deputy managing director Gita Gopinath has said that “countries are now reassessing their trading partners on the basis of economic and national security considerations” and that this will lead to a significant setback in global economic integration, including the dominance of the dollar. In more mundane terms, how much influence will Western central banks, finance ministries and international organisations have if a part of the world economy simply does not use Western financial infrastructure in the future? (And when it does, it is typically the West importing from the East.)

But this is not for the short term. The BRICS members’ dollar substitution will be a very slow and volatile process that could take decades.

The reasons for this are rather prosaic:

The geopolitical interests of the BRICS countries are often very different and conflicting. India is actually trying to balance between the US and China, but Brazil and Saudi Arabia also need a good working relationship with Washington. Beijing and Washington’s relationship is also volatile, with many common interests beyond geopolitical antagonism. This in itself slows down the institutionalisation of transitional settlement solutions.
Member countries (with the obvious exception of Russia) are very comfortable using the existing Western financial infrastructure; just think about how easy it is to make business transfers in dollars or euros between any two points in the world today. Trading internationally in a domestic currency, which is not liquid and often not even convertible, and especially on a national economic scale, is a much more difficult, “uncharted” path. The technical problems of clearing are further complicated by the fact that often the countries and companies trading with each other are unable to deal with each other’s foreign currency in such large quantities if the two countries’ foreign trade is unbalanced. What, for example, can Russian companies do with the extraordinary amount of Indian rupees they receive in exchange for oil in India, estimated by Moscow to be the equivalent of 40 billion dollars (!) a year? This is a subject of constant dispute and conflict, and Russian sellers definitely need complicated, lengthy and transnational assistance to convert the revenue into rubles. But what happens if, in the meantime, India devalues the rupee or freezes the withdrawal of the rupees thus accumulated for whatever – economic or political – reason? The risk is very high. Negotiating and implementing safe procedures and systems takes a very long time. Even if, over time, some of these problems will resolve themselves. For example, in the Brazil-China relationship, Beijing’s large-scale investment in the automotive sector and infrastructure development will, over time, reduce the current serious imbalance in Brazil-China trade: in 2023, Brazilian exports to China, worth USD 100 billion, were twice (!) the value of imports.

BRICS is therefore a threat to the dollar-based financial system in the long term at most, and even then it is more a kind of alternative road network, a “beltway around the motorway”, than a “replacement”, and will hardly cause a “collapse”. In fact, the source of the growing risks to the dollar system is not coming from BRICS, but from US economic policy itself.

“People like me have grown up thinking that if someone sends you cheap goods, it’s polite to thank them in a letter. I would never do that again,” said US Secretary of the Treasury and former Federal Reserve Chair Janet Yellen when she de facto announced a new chapter in the trade war with China in April. The speech was historic in every respect, and in Europe it did not get the attention it should have got, given its consequences.

“Chinese overproduction, with its artificially low-priced products, threatens the global economy and the survival of US and other foreign companies,” the argument continued, shortly after which Washington imposed another round of high protective tariffs on Chinese products, especially electric cars.

What is of interest to us here is not whether the argument is correct or rational. (The use of state resources to aid the development of Chinese industry was already well known in 2001, when China entered the WTO: what has changed is the high-tech competence of Chinese industry compared to that of the US. The West now has reason to be concerned.) The decisive moment for the world economy is that with this speech, Janet Yellen has done away with the Western economic thinking of the past centuries: from Ricardo’s comparative advantage, where both the importer and the exporter always benefits due to specialisation, to the WTO’s justification as a supranational trade organisation. (Universities can start rewriting the textbooks.) In essence, the United States from now on sees world trade as a zero-sum game, or at least not as a fair and friendly environment, and its first priority will be to restore and strengthen American industry and competitiveness. This shift in strategy – which, of course, has already appeared in its early form in the Trump administration and Joe Biden’s IRA programme – will have serious consequences for the dollar too.

The figure can be referenced here: https://public.flourish.studio/visualisation/18844582/

For if the US, which has a chronically extremely negative trade balance ($773 billion in 2023), starts importing less because it produces more and more of its own goods, and at the same time squeezes out some of its imports with tariffs, then the world’s exporters will have fewer and fewer dollars and dollar-related investments. The exporting countries that used to systematically accumulate hundreds of billions of dollars a year will have much less incentive to build up large dollar reserves and finance the increasingly risky US public debt. And this is where the fear of US sanctions and the dollar weapon comes in too. So not only is trade between the BRICS countries that are not involved with the dollar steadily increasing – in total, China’s trade volume with the Global South now exceeds that with the developed countries –, but the US itself is trying to limit the amount of goods and trade that flows in. As Zoltán Pozsár, a former expert at the US Department of the Treasury, aptly put it: every supply chain is also a chain of payments, but in reverse. In other words, if the path of trade changes, so does the path of money flow: if trade (imports) to the US decreases but US exports do not increase by the same amount (i.e. the world economy splits into blocks), the amount of dollars required by foreigners will also decrease.

This realignment could not come at a worse time for the American federal budget, as the US is very close to the eruption of a crisis triggered by spiralling debt:

The US national debt is now close to $35 trillion, and its growth has accelerated to the point where it is rising by $1 trillion every 100 days. Think about the scale of this: although the world’s purchases of US government bonds are still rising, with the exception of China and Russia, their total accumulated stock is still only $8 trillion!
The Fed’s interest rate hikes to curb inflation have made debt repayments so expensive that they now reach $900 billion a year. In other words, interest expenditure now exceeds the annual defence budget of $840 billion! And there is no crisis at the moment: what would happen if the United States was forced to go to war somewhere, or if there was another pandemic, and spending increased even more?
The pressure on the public debt can be illustrated by the fact that according to the Congressional Budget Office, in 2023 the US state had a total revenue of $4.4 trillion but spent $6.1 trillion! This brings the budget deficit to the level of public health care spending (Medicare and Medicaid).

The figure can be referenced here:https://public.flourish.studio/visualisation/18844644/

It is important to note that all this does not mean a predestined, inevitable financial-economic disaster, as is often portrayed. There are two possible ways of dealing with the debt spiral that threatens to trigger a crisis:

Drastically cutting US defence and welfare spending, or cutting them moderately but in combination with tax increases. This is obvious for many countries around the world but would mean austerity that is unprecedented in US history. For this reason, it currently seems politically unacceptable. (Not to mention the deep recession that would be triggered, which would also have a temporary debt-raising effect through lower tax revenues.) Instead, the Republican and Democratic party programmes include, typically, further debt-inducing items, such as the extremely costly green transition and the cancellation of part of the student debt in the case of the Democrats, and making previous tax cuts permanent in the case of Donald Trump. In addition, both parties plan to launch several new major industry support programmes.
Since the first solution is politically unacceptable, the seemingly easier solution of the Fed printing money seems much more likely. Washington is increasingly turning to this instrument: instead of taking painful measures, it was used to deal with the consequences of the 2008 financial crisis as well as the 2019 Covid pandemic. So far, these monetary programmes have worked every time because the old US financial and economic truism was true: “the dollar: our money, but your problem”; that is, because the US is uniquely indebted in the world’s reserve currency (which is the dollar), it cannot go bankrupt, as it can print fresh dollars at any time and use them to buy its own debt. For any other country, this would cause an inflation and currency crisis in short order.

However, as we have seen above, even if the US cannot go bankrupt, the printing of dollars would occur in a radically different environment this time than before. A world economy in transition, trading partly in blocs, and requiring fewer dollars in the first place is unlikely to tolerate the loss of value of its dollar savings as it did on previous occasions. Seeing the riskiness of the dollar and US bonds, as well as the inflationary dangers, the actors of the global economy may instead reduce their accumulation. To borrow and slightly modify Zoltán Pozsár’s phrase: “the dollar: our money, but your problem” could be replaced with unexpected rapidity by “our commodity and our trade, your problem”. In other words, it is ultimately the sellers of essential commodities and products who determine what the world’s reserve currency is.