The trade war is dominating all the headlines right now, and for good reason. But away from the headlines, other developments are taking place that will have a major impact on the economy — and your wallet.
I’m referring specifically to the future of the dollar as the world’s dominant reserve currency.
Today, the dollar represents 60% of global reserves, 80% of global payments and almost 100% of global energy purchases. That kind of dollar dominance has aggravated friends and foes alike since the 1960s.
I’ve written for years about efforts underway by Russia, China and other U.S. adversaries to implement alternatives to the U.S. dollar payment system.
But lately, the annoyance is even worse because the U.S. has weaponised the dollar to pursue geopolitical goals over and above financial goals.
The list of countries suffering under U.S. financial sanctions is long and getting longer.
Among the most prominent targets are Russia (due to Crimea and Ukraine), China (due to the trade wars), Iran (due to its uranium enrichment program and support for terrorism), North Korea (due to its ballistic missile program) and many others including Syria and Venezuela.
What all of these countries have in common is that they have been subject directly or indirectly to U.S. financial sanctions and risk account freezes, confiscations and restricted access to dollar payments channels.
In the case of Iran, the sanctions go even further to include the denial of access to SWIFT (the Society for Worldwide Interbank Financial Telecommunication), which includes euros, yen, sterling and other reserve currencies in its facilities.
SWIFT is the leading bank message traffic facility in the world today for funds transfers. It is difficult to escape U.S.-imposed sanctions while using large established networks like SWIFT.
And in recent years, SWIFT has become politicised.
Iran was banned from using SWIFT from 2012–16, for example. Certain Iranian banks were banned from SWIFT again in 2018.
Russia has never been banned from SWIFT, but the mere possibility gives Russia a large incentive to create an alternative payments system not subject to U.S. control.
While most of the targeted countries have been working on alternatives, including a possible gold-backed cryptocurrency to be jointly launched by China and Russia, actual implementation has been slow in coming.
But that may all be about to change.
Russia and Iran have announced a new payments channel that avoids both SWIFT and the U.S. payments system.
The new system involves secure financial message traffic between the two participants, with possible expansion to include Turkey and others in the near future.
Turkey’s an interesting case because of its recent military action against the Kurds in northern Syria.
Trump has threatened to “obliterate” Turkey’s economy if the attacks escalate into a full-scale invasion.
The U.S. placed sanctions on Turkey last year over a separate issue, so Turkey certainly has motivation to join alternative payments system.
Getting back to Russia and Iran, this still begs the question as to which currency will be used, since Iran is mostly denied access to dollars.
Payments could include the Russian ruble or gold that could be converted to dollars through the Russian banking system and held for the account of Iran in veiled custodial accounts.
It would allow Russia to sell weapons to Iran and for Iran to hide reserves in Russia, free of U.S. sanctions and U.S. interdiction.
That’s one step away from the dollar. But now Russia has unveiled an even more ambitious payments system.
This new system will provide services similar to SWIFT.
The new Russian system may quickly be expanded to include China, India, Iran and Turkey and eventually other nations.
Building an alternative from the ground up using local currencies such as the ruble or yuan or new cryptocurrencies is the best way to work around U.S. sanctions.
It may not be long before the participants in the Russian system trade oil, weapons, infrastructure, agricultural produce and electronics among themselves without using dollars at all.
These are modest steps, but they are a beginning with far more pointed attacks on dollar hegemony yet to come.
In time, the dollar may be just another local currency like Mexican pesos or Turkish lira. That time may not be far away.
Below, I show you how the dollar is under attack from multiple directions, including Europe and the IMF. How much longer will the dollar be king of the hill?
Dollar Under Attack From Multiple Directions
For years, currency analysts have looked for signs of an international monetary “reset” that would diminish the dollar’s role as the leading reserve currency and replace it with a substitute agreed upon at some Bretton Woods-style monetary conference.
That push has been accelerated by Washington’s use of the dollar as a weapon of financial warfare, including the application of sanctions. The U.S. uses the dollar strategically to reward friends and punish enemies.
The use of the dollar as a weapon is not limited to trade wars and currency wars, although the dollar is used tactically in those disputes. The dollar is much more powerful than that.
The dollar can be used for regime change by creating hyperinflation, bank runs and domestic dissent in countries targeted by the U.S. The U.S. can depose the governments of its adversaries, or at least blunt their policies without firing a shot.
But for every action, there is an equal and opposite reaction.
As the U.S. wields the dollar weapon more frequently, the rest of the world works harder to shun the dollar completely.
I’ve been warning for years about efforts of nations like Russia and China to escape what they call “dollar hegemony” and create a new financial system that does not depend on the dollar and helps them get out from under dollar-based economic sanctions.
These efforts are only increasing.
Russia has sold off almost all of its dollar-denominated U.S. Treasury securities and has reduced its dollar asset position to almost zero. It has been amassing massive quantities of gold, and has increased the gold portion of its official reserves to over 20%.
Russia has about 2,000 tonnes of gold, having more than tripled its gold reserves in the past 10 years. It has actually acquired enough gold to surpass China on the list of major holders of gold as official reserves.
This combination of fewer Treasuries and more gold puts Russia on a path to full insulation from U.S. financial sanctions. Russia can settle its balance of payments obligations with gold shipments or gold sales and avoid U.S. asset freezes by not holding assets the U.S. can reach.
And Russia is providing other nations a model to achieve similar distance from U.S. efforts to use the dollar to enforce its foreign policy priorities.
Certainly any talk of a monetary reset must involve China.
Despite its present weakness, China is still the second-largest economy in the world and the fastest-growing major emerging market. Like Russia, China is amassing gold, and likely has far more gold than it officially lists. It has also been helping to suppress gold prices so that it can buy gold cheaply without driving up the price.
Europe has also shown signs that it wants to escape dollar hegemony. For example, German Foreign Minister Heiko Maas has called for a new EU-based payments system independent of the U.S. and SWIFT (Society for Worldwide Interbank Financial Telecommunication) that would not involve dollar payments.
As I said earlier, SWIFT in the nerve center of the global financial network. All major banks transfer all major currencies using the SWIFT message system. Cutting a nation off from SWIFT is like taking away its oxygen.
In the longer run, these are just more developments pushing the world at large away from dollars and toward alternatives of all kinds, including new payment systems and cryptocurrencies. The signs of a reset are everywhere, but at least for now the dollar is still king of the hill.
The dollar still represents about 60% of global reserve assets, 80% of global payments and almost 100% of global oil sales. With such a dominant position, the dollar will not be easy to replace.
Still, the trends are not good for the dollar. The international reserve position may be 60%, but as recently as 2000 it was over 70% and just a few years ago it was still at 63%. That trend is not your friend.
Meanwhile, Europe has remained a faithful partner to the U.S. and has gone along with sanctions against Iran, for example. That’s because European companies and countries that violate U.S. sanctions can be punished with denied access to U.S. dollar payment channels.
But now, Europe is also showing signs it wants to escape dollar hegemony. German Foreign Minister Heiko Maas has called for a new EU-based payments system independent of the U.S. and SWIFT that would not involve dollar payments.
In the short run, Europe will probably go along with the U.S. because it doesn’t want to lose business in the U.S. itself or be banned from the U.S. dollar payments system.
But in the longer run, this is just one more development pushing the world at large away from dollars and toward alternatives of all kinds, including new payment systems and cryptocurrencies.
It’s also one more sign that dollar dominance in global finance may end sooner than most expect.
Another challenger to the dollar is the IMF’s special drawing rights or SDRs. The SDR is a form of world money printed by the IMF. It was created in 1969 as the realization of an earlier idea for world money called the “bancor,” proposed by John Maynard Keynes at the Bretton Woods conference in 1944.
The bancor was never adopted, but the SDR has been going strong for 50 years. The IMF could function more like a central bank through more frequent issuance of SDRs and by encouraging the use of “private SDRs” by banks and borrowers.
At the current rate of progress, it may take decades for the SDR to pose a serious challenge to the dollar. But that process could be rapidly accelerated in a financial crisis where the world needed liquidity and the central banks were unable to provide it because they still have not normalised their balance sheets from the last crisis.
In that case, the replacement of the dollar could happen almost overnight. Individuals will not be allowed to own SDRs, but you can still protect you wealth by buying gold. That’s what Russia and China are doing. Both countries have more than tripled their gold reserves since 2009.
But attacks on the dollar are not limited to gold or SDRs themselves. The most imminent threat to the dollar actually comes from a combination of gold and digital currency.
The fact that Russia and China have been acquiring gold is old news. Still, there are practical problems with using gold as a form of currency, including storage and transportation costs. But Russia is solving these transactional hurdles by combining its gold position with distributed ledger, or blockchain technology.
Russia and China could develop a new cryptocurrency that would be transferred on a proprietary encrypted ledger with message traffic moving through an internet-type system not connected to the existing internet. Other countries could be allowed into this new system with permission from Russia or China.
The new cryptocurrency would be a so-called “stable coin,” where the value was fixed with reference either to a weight of gold or another standard unit such as the SDR. Goods and services would be priced in this new unit of account. Periodically, surpluses and deficits would be settled up in physical gold.
Such net settlements would require far less gold than gross settlements (where every transaction had to be paid for in real-time). This type of system (also called a “permissioned blockchain”) is not pie-in-the-sky, but is already under development and will be deployed soon. But you can count on the U.S. government being the last to know.
The development of a gold-backed digital currency is just one more sign that dollar dominance in global finance may end sooner than most expect. And we may be getting dangerously close to that point right now.