In the 1960’s the then French Finance Minister Valerie Giscard D’Estaing bemoaned the “exorbitant privilege” that the use of the US Dollar afforded the Americans- never mind that the French themselves tied their former African colonies to an even more unequal arrangement with the CFA Franc (the Communauté Financière d’Afrique); they were upset at the position of dominance that the global prevalence of the US Dollar gave in matters of influence over trade, political alignment and seigniorage. But 2022 might mark the beginning of the end for that regime that has been in place since the Bretton Woods Accord and the Marshall Plan post World War 2.
The imminent demise of the dollar has been predicted many times over and for many decades now. Yet the US Dollar still comprises one side of 88% of all foreign currency trades, followed by the Euro at 30%, the Japanese Yen at 17%, the British Pound at 13% and- supposedly the next big contender, the Chinese Yuan- at 7%. But what difference does having the most commonly used currency make? What are the advantages and what do they mean in real terms?
The biggest gripe that most countries have over the US Dollar being THE currency of exchange is the seigniorage that it affords the United States of America. Whilst this term usually refers to the profit that a government makes between the cost of production of currency (notes and coins) and their face value it also extends to the international cost advantages. Primarily- having all debt issued in your home currency significantly reduces borrowing costs for a few reasons: there is no fear of default since you can print as much of your own currency to repay that debt (hence gilt-edged bonds or G-secs are seen as default proof) which means lower coupon rates. So, the US enjoys lower borrowing costs than anyone in the world issuing in USD. And, because of its liquidity, most global debt is issued in US Dollars.
If an Asian country or African or Latin American country wants to issue bonds, it’s usually in US Dollars. Thus, they face high borrowing costs since there is a risk of them not being able to repay the Dollars because they have to buy it in the markets. The volatility and growing strength of the US Dollar and steeply climbing rates the last two years put a number of sovereign nations at risk of default in their overseas dollar denominated debt. Sri Lanka defaulted on its dollar debt and Vietnam came close. The cost of servicing debt suffered a double whammy with both principal and coupon obligations surging. This is driving these indebted nations into recession. This is one of the main reasons why US Dollar denominated bond sales have fallen to 37% of the global total this year when it usually was above 50% for the last decade.
Apart from just the debt repayments it is the lack of control over inflation arising out of dollar denominated international commodities- food and fuel being the ones that most countries are having to deal with. Higher food and oil import costs have driven up poverty rates, worsened foreign exchange reserves which then create the downward cycle of higher borrowing costs and austerity programmes which hit the poor the hardest.
Probably the principal factor that will drive the move away from the dollar is the open weaponization of the US-centric system of payments. The US has never been shy of protecting its primacy in the world payment system: everyone is aware of the extent to which the US has gone to ensure that no alternatives are successful- including regime change a la Muammar Gaddafi who proposed a pan-African currency. But the recent impounding of USD 300 billion of Russian FX reserves held with the Federal Reserve may have convinced the world that the United States is beginning to abuse its role as a fiduciary agent. Venezuela, Afghanistan, Iran and Libya have all been the victim of the United States mixing up politics with financial ethics. Using FX reserves hostage is a form of extortion which sets the United States as always being ‘in the right’- even when they are acting with complete impunity and outside the sanction of the international community; take the war against Iraq in 2003 for example. The action against Russia earlier this year may be the action that finally convinced many nations of the need to diversify their reserves portfolio away from the US Dollar.
12 countries in Asia alone are experimenting with ‘de-dollarisation’. Technology, the third factor in this, facilitates the creation of payment networks which bypasses the SWIFT network and Russia, China and India have begun settlements on their own platforms which run parallel to SWIFT but are not dependent on institutions in Europe or America to facilitate the movement. Similarly, Malaysia, Singapore, Thailand and Indonesia have set up systems for transacting with each other, as have Taiwan and Japan; India is similarly setting up a payment system with the UAE whilst moving to a Rupee-Rouble arrangement with Russia. These payment systems may be made possible because of new technology but it has been driven mainly by Russia’s experience at the hands of the United States since they avoid any interaction with US/ European controlled systems completely.
It can be argued, of course, that part of this turning away from the dollar is due to the rise in US rates and the surge in the value of the Dollar- making it less attractive of a currency to borrow in from both a risk and cost perspective; that is, the inverse causality of the argument made earlier. It might be that once the Federal Reserve starts dropping rates the demand for Dollar denominated bonds may again pick up. But global financial market conditions are moving away from one of easy liquidity and low rates- meaning that rate spreads may widen even as rates go lower thus negating the impact. But the move to ‘de-dollarize’: the increased build-up of gold reserves by Central Banks; the move towards non-Dollar denominated debt; the development of regional currency payment arrangements- all point to peak Dollar having been seen and a move towards a post-USD world well and truly begun.