Barry Eichengreen
The dominance of the U.S. dollar is being challenged from twodirections: the geopolitical and the technological. The so-called“weaponization” of the greenback through sanctions, along withdigital alternatives like stablecoins and China’s eCNY, seem tothreaten the dollar’s global role. But for now, these alternativesare more potential than reality.
A paradox lies at the heart of the global economy. Whereas transactions in today’s world are substantially international, money remains unapologetically national.
Globalization may be under strain, but it is still a fact of 21st-century economic life. For decades leading up to the global financial crisis of 2008-09, global trade increased faster than global gross domestic product. At that point, merchandise trade as a share of GDP leveled off, but trade in services continued to grow. Similarly, up to the eve of the GFC, cross-border capital flows and financial assets held abroad rose more rapidly than global GDP. The foreign asset/GDP ratio plateaued subsequently, but at high levels. Financial globalization in particular thus remains a fact of 21st-century economic life.
But notwithstanding the very considerable sway of international commercial and financial transactions, money remains the preserve of national governments. The closest thing we have to international money, the International Monetary Fund’s Special Drawing Rights, is little more than an accounting convention for use in valuing entries on the IMF’s balance sheet. The euro is exceptional in that it is the money of a collection of national governments. But it is a regional currency, not widely used outside Europe itself.
Hence, banks, firms and governments continue to use national monies when undertaking international transactions. They rely first and foremost on the United States dollar, which is the dominant international currency and is widely utilized and accepted outside the U.S.
Two challenges
Now, however, the dollar’s position as the de facto global currency is being challenged from two directions: the geopolitical and the technological. Tensions between the U.S. and China have pointed up the leverage the U.S. enjoys as a result of the dollar’s “exorbitant privilege.” This has prompted China and other countries, conscious of the possibility that they might find themselves in America’s strategic crosshairs, to attempt to reduce their dependence on the dollar. U.S. policymakers’ recourse to financial sanctions, which has been increasing over time, and specifically the decision to freeze the Bank of Russia’s foreign reserves in response to Vladimir Putin’s attack on Ukraine, highlight the risks of relying on the dollar and the U.S. banking system. Consequently, China and other BRICS countries are contemplating steps to curtail their use of the dollar.
Meanwhile, technological innovations, from cryptocurrencies to instant payment systems and central bank digital currencies (CBDCs), pose another set of potential challenges to the dollar. The qualifier “potential” is important here, since actual cross-border use of digital currencies is still in its infancy. In principle, however, these new units provide an alternative set of payments rails to the U.S. banking system, and an alternative means of settlement to the dollar. The fact that the Federal Reserve System is itself exploring, however cautiously, the possibility of issuing a digital dollar indicates that it is not entirely dismissive of this prospect.
A cautionary tale
Understanding what the future may hold requires understanding how we got here. In turn, this entails a look back at prior experience with international currencies. Throughout history, the dominant unit used in cross-border transactions has been the currency of the leading commercial and financial power. When Western Europe sank into its Dark Ages but the Byzantine Empire continued to thrive, the Empire’s 4.5-gram gold coin, the Solidus, was used in transactions everywhere from England to India, reflecting the extent of Byzantine trade. With the rise of Florence as a commercial and financial center in the 13th century, its florin, both in coin form and as bank money, was accepted throughout Europe and the Middle East. One can tell similar stories about the international dominance of the Dutch florin following the emergence of the Low Countries as commercial and financial leaders in the 16th century, the pound sterling during and after the British Industrial Revolution, and of course the U.S. and the dollar following World War II.
But this history also serves as a cautionary tale. Each of these earlier episodes of international monetary dominance was transitory. In each case, confidence was lost as a result of political dysfunction and military conflict, leading to fiscal imbalances and currency debasement. Byzantium fought expensive wars with everyone from the Abbasids to the Bulgarians, tripling its military budget between 775 and 1025 and forcing successive emperors to reduce the gold content of the solidus by as much as 90 percent. It is no surprise, then, that the unit lost favor in the second millennium AD.
The wool industry of Florence fell behind those of England and the Low Countries in the 16th century, as a small city-state lacking a vast hinterland and abundant natural resources couldn’t match the military might of larger polities. The Dutch bank florin lost its reserve currency status in 1781-92, when a fourth war with Britain led to a surge of military spending and caused the Dutch East India Company to lose its monopoly of East Indies trade — forcing the Bank of Amsterdam to embark on aggressive monetary expansion and causing the florin exchange rate to collapse. The British pound’s transformation into what economic historians call a “zombie international currency” coincided with World War II and the policy of force-feeding sterling securities to Britain’s allies and colonies, and with the subsequent decision to block these sterling balances — that is, to prevent them from being used. Sterling’s definitive loss of international currency status was then sealed by the Suez Crisis of 1956, when Britain was forced, by an Eisenhower administration opposed to the joint Franco-British-Israeli incursion, to choose between an embarrassing strategic climb-down and financial collapse.
Geopolitical tensions
The implications for the U.S. and the dollar are clear. At some point, chronic budget deficits — reflecting military and social spending pressures on the one hand and political dysfunction on the other — could lead the Federal Reserve to monetize a portion of the public debt. Inflation and depreciation could then tarnish the attraction of holding and using the greenback for international transactions. Geopolitical tensions with the U.S. might lead other countries to use this as an occasion to move away from the dollar rather than lending it their support, echoing the fate of the pound sterling in 1956.
This reference to tensions brings us back to the efforts of China, Russia and the other BRICS members (Brazil, India and South Africa, along with other recently invited countries) to reduce their dependence on the dollar. One initiative along these lines is Beijing’s creation of the Cross-Border Interbank Payment System (CIPS), complete with an integrated messaging system, as an alternative to the dollar-based Clearing House Interbank Payments System (CHIPS) and the Brussels-based Society for Worldwide International Financial Telecommunications (SWIFT).
As China has become a hub for international trade and financial transactions, CIPS has enabled nearly 1,500 participating banks from 109 countries to clear payments using Chinese renminbi. Still, CIPS remains leagues behind the New York Clearing House. Whereas CIPS processed $14 trillion of payments in 2022, CHIPS processed upwards of $200 trillion. Complying with China’s restrictive financial regulations remains onerous. And now that the Chinese economy is growing more slowly, China’s own cross-border transactions, which account for the bulk of CIPS-intermediated transfers, are likely to grow more slowly as well.
Another option is for third countries, rather than relying on the dollar or the renminbi, to settle bilateral transactions in their respective currencies. But this assumes a coincidence of wants that is unlikely to exist in practice. The collapse last year of talks between Russia and India on settling their bilateral trade in rubles and rupees illustrates the point. Russian businesses have limited appetites for holding rupee bank deposits and Indian government securities; given the cash crunch at home, they prefer to sell their rupees on the foreign exchange market and repatriate the funds. But doing so puts pressure on India’s foreign exchange reserves, causing the Reserve Bank of India to discourage the practice.
In addition, there is no direct market in which the rupee and ruble can be traded for one another. To repatriate their funds, Russian firms must first sell their rupees for dollars and then use those dollars to buy rubles, which rather defeats the purpose.
Finally, India and Russia are not aligned politically. Whereas Russia relies first and foremost on China and the renminbi when engaged in international transactions, China and India are not on the best of terms. India has attempted to stay studiously neutral in Russia’s conflict with Ukraine. It worries that engaging in local currency settlement with Russian banks and firms may raise U.S. hackles, and therefore subject its banks and even its government to secondary sanctions.
Political obstacles
Eventually, new digital technologies may relax some of the logistical constraints. A growing number of countries have implemented instant-payment systems, and several — Singapore and India, for example, and Thailand and Malaysia — have linked these QR code-enabled payment systems to one another’s. But these systems are suitable only for relatively low-value retail and tourism-related transactions. More consequentially,[no comma here please] for the international monetary and financial system, central banks are now piloting central bank digital currencies and experimenting with their direct exchange for one another on multiple-CBDC platforms or bridges (so-called mBridges). This opens up the possibility of directly exchanging a multitude of national currencies, in digital form, rather than having to go through either the dollar and the U.S. banking system or the Chinese renminbi and CIPS.
We already have some evidence of central banks gradually diversifying their foreign reserve portfolios away from the U.S. dollar and toward the currencies of small, stable, well-managed economies such as Australia, Canada, Norway, Singapore, South Korea, Sweden and Switzerland. Individually, none of these countries is large enough for its currency to make a visible dent in the global reserve system. Collectively, however, they constitute a modest alternative to holding dollar reserves. If their currencies could also be exchanged directly and thereby serve as vehicles for cross-border payments, this alternative would become more attractive still.
Here again, however, the obstacles are political. Multiple countries seeking to establish and operate an mBridge would have to agree on its design and governance. They would have to agree on which countries and currencies are authorized to participate, which institutions will be licensed as authorized dealers in CBDCs, and more generally who sets and enforces the rules. The Bank for International Settlements’ Project mBridge has four founding members: the People’s Bank of China, the Hong Kong Monetary Authority, the Central Bank of the United Arab Emirates and the Bank of Thailand. In principle, one can imagine them agreeing on a common set of protocols. But the BIS project also has 25 observing members, ranging from the Bank of Korea and Central Bank of Turkey to the European Central Bank and the Federal Reserve Bank of New York. As the number of participants grows, so does the difficulty of agreement.
The dollar dominates cross-border transactions because its reach is global; it can be used almost everywhere for almost everything. A digital platform with Project mBridge’s 29 founding and observing members would similarly have global reach, and in theory could constitute a serious competitor to the dollar and the U.S. banking system. But it is hard to imagine the PBoC, the ECB and a heterogeneous collection of some two dozen other institutions agreeing on operational rules and ongoing supervision.
The future of the international monetary and financial system will turn on domestic political and economic events in the incumbent reserve-currency country (the United States), on the course of technological developments, and above all, on geopolitics. Hence, the paradox: geopolitical tensions render other countries uncomfortable with the dollar’s global dominance, but they also foreclose the obvious alternatives.
Barry Eichengreen
Barry Eichengreen is Professor of Economics at the University of California, Berkeley. He is a Research Associate of the National Bureau of Economic Research in Cambridge, Massachusetts, and a Research Fellow of the Centre for Economic Policy Research in London. His books include Hall of Mirrors: The Great Depression, The Great Recession, and the Uses-and Misuses-of History (2015), How Global Currencies Work: Past, Present, and Future, with Livia Chitu and Arnaud Mehl (2017), The Populist Temptation: Economic Grievance and Political Reaction in the Modern Era (2018), and most recently, with Asmaa El-Ganainy, Rui Esteves and Kris James Mitchener, In Defense of Public Debt (2021).