A pivotal moment in the arc of the dollar’s global power happened in 1944 with the Bretton Woods agreement. It was a simple agreement whereby countries outside of the United States (US) could trade amongst themselves in dollars and the US promised to have the dollar redeemable with gold ($35 per ounce). Thus, countries outside of the US did not have to have gold stored in their reserves so that their domestic currencies be acceptable internationally but could have the dollar instead while the US would have gold stored up in its reserves.
There are two noteworthy influential institutions that came to life in the time of the Bretton Woods system and that is the International Monetary Fund (IMF) and the World Bank, which was known as the International Bank for Reconstruction and Development. These institutions provided dollar denominated loans to countries outside of the US, which meant that the loan repayments also had to be in dollars. This spurred the need for countries outside of the US to have dollars. Currently, the US does not owe a foreign currency debt and its debts are in US dollars, which the US can always print, (Siddiqui;2023).
The paper standard
The US threw the Bretton Woods system out the window by breaking its promise in 1971 to have the dollar convertible to gold, effectively taking the world from a gold standard to a paper standard (also known as the fiat standard). During this time the world was heavily dependent on the US and its currency. To cement its influence on the global scale the US brokered an agreement with King Faisal of Saudi Arabia in 1973 to have the sale of oil be in dollars in exchange for money, military, and political support. With oil now tradeable in dollars, we got what is called the petrodollar. Again, this further spurred the demand for dollars as each nation was and still is heavily dependent on energy.
The leadership and dominance of the dollar in global commerce has enabled two noteworthy attributes for the US. The first is that the US is a country that is more equal more than others when it comes to its relationship with its own currency. If another country were to print 40% of its historic total money supply (M3) in 18 months, it would be faced with a devaluation of its currency as well as hyperinflation. This is not the case for the US where it has the unique ability to export its currency and ultimately its inflation. The second attribute is to have an unprecedented amount of leverage, that is the power to influence the world to its will through sanctions, finance, or sometimes military force. Russia knows this all too well when $300 billion of its foreign exchange reserves were frozen by the US after the Ukraine war. This event has put many developing countries on high alert to the point whereby these countries are attempting to reduce the reliance of the dollar as a reserve currency, a medium of exchange and unit of account, this is known as de-dollarisation (Desai and Hudson, 2023).
What it would take to unseat the dollar from its throne
Against the backdrop that has been laid thus far I make the argument that the dollar is still to remain supreme for the foreseeable future. This is because no country or region is willing to do what needs to be done to usurp the dollar. At the very least the BRICS countries can weaken the dollar by expanding bilateral trade agreements amongst themselves, whereby settlements are made in their own currencies and not the dollar. There are four main conditions that need to be satisfied to become a dominant currency and they are as follows:
· A big economy with a sizeable domestic market. China and the Eurozone are the biggest competitors when it comes to the weight of their economies on an international scale. Albeit that they are both lagging behind the US.
· The size/depth/openness of financial markets. Compared to the US the Eurozone lacks depth to its financial markets and the Chinese financial markets lack openness. Simply put, the Eurozone has less liquidity and China has less transparency.
· Currency convertibility. The US dollar benefits from network effects, that is the winner takes all or in this case the winner takes most. This network effect implies that you can sell your dollars at anytime you choose and there is someone who is willing to buy them. In 2022 the dollar was involved in 88.5% of transactions in the foreign exchange market compared to 30.5% for the Euro and 7% for the Renminbi. Volume percentages for all individual currencies should add up to 200%, as each transaction involves two currencies.
· Stable Macroeconomic policy. The US, the Eurozone and China display characteristics that enable a stable macroeconomic environment. These characteristics primarily include price stability, economic growth, employment, financial and exchange rate stability.
Based on these conditions the Eurozone has the better chance to take a swing at the American dollar. Even with the euro being second to the dollar in terms of foreign exchange reserves at 20.48%, it is unlikely that the euro will unseat the dollar. This is mainly due to the Eurozone’s frequent political alignment with the US, as demonstrated by the Eurozone joining the US in implementing heavy sanctions against Russia, (Thiagarajan et al; 2023). For the Chinese renminbi to have a chance at taking the dollar’s hegemonic status it’d have to cease a lot of capital control and enable greater transparency. This outcome is even more unlikely especially for a communist country.
Trust vs control.
A game changer would be for the BRICS nations to introduce a currency that is backed by gold. This would enable trust for countries trading this newly formed currency, as BRICS develops its own bond market and alternative payment system, independent from SWIFT. A gold standard currency satisfies the store of value function because it fulfils the scarcity property of money. This incentivises central banks and other economic agents to have this currency as part of its reserves/savings. The issue with this gold standard is that the BRICS leaders would have to make the trade-off to relinquish some control for trust. For instance, the ability to generate loans by the BRICS bank would be limited because the BRICS currency is tied to how much gold it has. This inhibits the ability of the BRICS leaders to spend money where they deem necessary. A BRICS currency that is not backed by anything of intrinsic value would affirm the control its leaders have but it would present trust issues for everyone else.
BRICS bilateral trade agreements
As more nations join the BRICS movement, China has been increasing its bilateral trade agreements. For instance, China has deals with Argentina, Brazil, Iran, Russia, and Saudia Arabia to settle transactions in renminbi and the other countries’ respective currencies. BRICS countries such as Russia, China, Iran, India, and others are putting in place currency swaps for trade in their own currencies (Financial Times, 2023; Siddiqui, 2021b). These outcomes weaken the dollar’s dominance as a global reserve currency. However, Thiagarajan et al (2023) find this multipolar currency environment to be unsustainable because of higher financing costs, increased exposure to currency volatility via natural hedges and higher transaction costs.
As things stand in the fiat world, the dollar has no equal and there isn’t a close competitor. As Vusi Thembekwayo eloquently puts it money/capital has a seriously monogamous relationship with return and in the context of paper money the dollar offers the greatest return. The question then is not about the falling power of the dollar, but it is to ask how it is possible that other paper currencies are still alive? A currency with a gold standard has a fighting chance, however such a standard is not favoured by nation leaders as they cannot manipulate the money supply in the same way they can with a paper standard. In the quest for de-dollarisation by disgruntled nations, Former Secretary of the US Treasury Larry Summers asked the question: “Where are they going to move?”. This is to say that you cannot beat something with nothing. However, despite the inefficiency and the risk of the multipolar currency environment countries may choose to remain in it for as long as the US continues to weaponise its financial system to impose sanctions, climate agreements and LGBTQIA+ policies to socially conservative countries such as Uganda. Thus, if the political risk of being dependent on the dollar is greater than the cost of being part of a multipolar currency environment then nation leaders would rather suffer the cost. Ultimately it is the US that can compromise the power and dominance of its currency.