Russia’s invasion of Ukraine and the economic warfare that followed have reopened the question of whether the dollar’s trade dominance is drawing to an end. What would it take for global commerce to take place outside the US financial system, upending the status quo that has governed it for much of the last century?
That moment has been anticipated for decades, with the euro and the yuan put forward as potential successors to the dollar. The traditional argument has been that as these rival economies grow larger than the US, their financial gravity will lead them to gradually usurp the role of the American financial system. By and large, that hasn’t happened since the euro went into use in 1999 and China joined the world trade system in 2001.
Each of those currencies has its drawbacks, according to Federal Reserve economists: The euro still sits uncomfortably on top of a confederation of independent states, not a single fiscally-integrated government, with unpredictable results, as Brexit showed. China, meanwhile, does not allow its currency to trade freely or be managed by independent institutions, which makes it less attractive than the US dollar.
Now, though, the massive sanctions imposed on Russia have some commentators wondering if the US and its allies have created incentives to switch to a different currency.
How major exporters could push against the dollar
It goes something like this, according to Zoltan Pozsar, a bond market strategist at Credit Suisse. In a world of increasing supply chain and trade challenges, where commodity prices rise against the background of elevated inflation, major exporters will be able to demand payment in their own domestic currencies. “It used to be as simple as ‘our currency, your problem.’ Now it’s ‘our commodity, your problem,'” Pozsar wrote in March.
For example, he notes that Russia is attempting to get payment in rubles for its exports, and that Saudi Arabia is rumored to be considering allowing China pay for oil in yuan. As countries focus on obtaining stockpiles of key commodities, demand for dollars and dollar debt will fall, and offshore yuan will start to dominate global commerce.
It’s a compelling picture—but certainly in the near-term, an unlikely one. For one, Russia isn’t having great luck getting rubles for its petroleum products, and as a country that depends on imports for many non-commodity goods, it may not succeed. It has also not succeeded in leveraging another key commodity, gold, to avoid sanctions. Similarly, it’s not clear that Saudi Arabia has actually let China pay for oil in yuan.
And a global monetary system based on commodities would be volatile, likely more than most investors would like. As analyst Joseph Politano writes, “there’s a reason why no major country uses the gold standard anymore.”
Then again, nobody eats gold or fuels their factories with it. Pozsar’s thesis is that scarcity of oil and wheat will change that dynamic. Yet the actual future prices of wheat and fertilizer changed in ways that “were big but not historic,” according to one agricultural economist. Crude oil prices haven’t risen to the record levels predicted by some analysts after Russia’s invasion, and it currently costs less than it did in 2014. The world may prove more resilient than expected, especially if countries are spurred by these events to seek energy independence through renewables.
What about the politics?
Economic arguments for the strength of the dollar system sometimes turn on the same idealism that argues for the shared benefits of free trade. Real life political impulses are often economically harmful, as Donald Trump’s trade policy and Brexit show, and that kind of autarkic nationalism lends itself well to the potential fall of the dollar. But in recent weeks, we’ve seen that the dollar system is still backed by significant soft power.
The idea that the US is abusing its dominance of global finance arises whenever it applies anti-money laundering penalties or sanctions against foreign states like Venezuela and Iran. The US, particularly when it acts capriciously, gives other states reasons to move away from its currency. But throughout these experiences, we’ve seen little evidence the dollar is losing ground.
Consider recent research led by economist Barry Eichengreen, perhaps the authority on reserve currencies. He finds that the share of US dollar reserves has fallen from 70% to 59% in the last two decades. But historian Adam Tooze points out that the currencies showing gains are all from states close to the US, like Canada, Australia, and South Korea, and moreover, those with central banks that benefit from the US Federal Reserve’s international swap lines.
Similarly, if you believe geopolitics is driving currency trends, Russia has not exactly covered itself in glory in Ukraine. The more it is bogged down in a costly and unpopular war, the less economic leverage it will have. While China hasn’t abandoned Russia, it also hasn’t attempted to broadly undermine sanctions, one sign of where the winds are blowing.
Institutions matter here. Even if China were to take the steps necessary to make the yuan broadly attractive to investors, like opening its capital account, it would still be led by an autocratic government with opaque processes. The uncertainty around the future of a troubled company like Evergrande would not do well when applied to a currency regime. In recent years, China’s liberalization has slowed. That’s why many see the euro as a more threatening rival to the dollar—but the EU, with some exceptions, generally joins efforts to sanction nations that violate international law.
Dollar dominance won’t last forever
The extraordinary dominance of the dollar as a trading currency in the second half of the 21st century is likely to fade over time. The question is what currency will be the dollar’s replacement, or perhaps more realistically, which of multiple trading currencies will work side-by-side. Investors have expectations from a reserve currency: Stability, security, value, and liquidity. Until another currency can offer all four, it’s hard to see the dollar being supplanted.
US policymakers, though, shouldn’t rest on their laurels. Decisions like the Trump administration’s unilateral reimposition of sanctions on Iran or the Biden administration’s seizure of Afghanistan’s foreign reserves undermine confidence in the US financial system. Abandoning trade relationships, whether through counter-productive tariffs or leaving trade blocs like the Trans-Pacific Partnership, also diminishes the potential of the dollar as a global currency. Elevated inflation, though clearly a global phenomenon, does the same.
Russia’s invasion of Ukraine has offered numerous warnings, about the danger of autocratic states, and the risk of depending on them for key energy resources at a time when decarbonization should be an international goal. But rather than demonstrating the weakness of the US-led financial system, the sanctions against Russia showed it is surprisingly strong—and could be kept that way.