It’s always easier to discuss the future of the US dollar system when the dollar is going down rather than up. After all, that means you can concentrate on the broad geopolitical, economic and historical sweep rather than dealing with the killer argument of “number go up, hur hur”.
But just because it’s easier doesn’t mean that it’s a good idea to start calling the beginning of the end for the greenback (even if it will soon have a history published in hardback, traditionally a sign of impending doom for corporations).
As the BIS pointed out in a recent working paper, people have repeatedly predicted the end of dollar dominance — not least with the launch of the Euro and the tradeable yuan — but it actually ended the first quarter of the twenty-first century with a slightly higher share of global securities investment than it began.
But is it different this time? Are people really going to structurally use the dollar less as a currency for payments, reserves and borrowing? One framework for thinking about this might be the perennial question — is the juice worth the squeeze?
In a paper I’ve written with Henry Farrell as part of the joint British Academy/Carnegie Endowment project on Global Instability (there’s posh for you), we set up the juice/squeeze calculation like this:
‘Dollar centrality’ is a political-economic concept that refers to the extreme attractiveness of the US dollar as a currency for transactions and investment. The ‘global payment system’ is the specialised telecommunications network that connects financial institutions all over the world and allows payments to be made by electronic book entries rather than cash.
The part of the global payment system that deals with payments denominated in US dollars is the ‘dollar payment system’ or, for shorthand, ‘dollar system,’ which involves not only the hegemonic role of the US dollar but also the communications network that is bundled with the dollar.
The conveniences of dollar centrality for facilitating financial transactions are inseparable from the dollar payment system and its rules as set by the US government. International actors might prefer not to follow these rules, but it would be very painful to lose the enormous benefits of dollar centrality.
In other words, the juice is having access to a single liquid money, backed by a military hegemon that’s willing to act as a global “consumer of last resort”. The squeeze is that if you’re in the US dollar economy, you’re implicitly accepting US jurisdiction.
The dollar system squeeze
For legal purposes, the US asserts that every dollar transaction anywhere in the world can affect the dollar clearing, and therefore every dollar transaction, for legal purposes, might as well have happened in New York. This is a pretty massive over-reach in terms of extraterritoriality, but if you want to be part of the dollar economy, you’re stuck with it.
For a long time, the juice was very much worth the squeeze, because the US didn’t really do much with this implicit power. Then 9/11 happened, and the US authorities realised that the dollar system could be used both as a means of gathering information about its enemies, and an instrument of economic coercion. Foreign banks began to learn about the Treasury’s Office of Foreign Assets Control (OFAC, which is both an acronym and the noise you make when you discover you’ve been fined $9bn for sanctions infringements).
As Henry and Abe Newman put it in their book “Underground Empire”, the US in effect “weaponised” the global dollar. But the kind of weapon they turned it into wasn’t some sort of highly classified and carefully guarded cruise missile. It was more like one of those guns you can buy at an American convenience store on Saturday night if someone at the bar has annoyed you.
The trouble was, the Treasury had put the dollar sanctions weapon in place to guard vital US interests in the “War on Terror”, but it hadn’t put in place any control mechanism to ensure that the weapon would only be used for those vital interests.
If everything legally happens in New York, then anyone who can bring a case in New York can use the power of the global dollar. And inevitably, over time, various US agencies — and even private litigants — did in fact overuse the power. When you think about the FIFA scandal, for example, it’s not obvious why bribery allegations involving the Honduran members of a Swiss governing body over a tournament held in Russia were the business of the US Department of Justice.
So the squeeze got tighter over time; the EU started measures that might be characterised as somewhere between “smiling nervously and moving towards the door” and “saying ‘nice doggie’ while looking for a rock”.
Among those measures were the famous anti-coercion instrument. But the anti-coercion instrument has always lacked a degree of credibility as something which might be brandished against the US, simply because you can’t really use an anti-squeeze measure if you still need the juice.
Kindleberger’s Trap strikes again?
However, Europe has also started to worry about the reliability of the supply of juice.
“Juice” in this sense, meaning specifically the Fed swap lines. As the BIS data shows, the global dollar was actually on something of a downswing before the Global Financial Crisis; its recovery in market share is a post-2008 phenomenon.
Although the BIS authors don’t directly make this connection, it’s reasonable to suppose that one important factor supporting the dollar market after 2008 was the Fed’s decision to maintain permanent swap lines with other big central banks.
This meant that there was a global guarantee of liquidity in US dollars, reducing the risk you might be taking by having dollar assets funded by non-dollar liabilities. (The swap line agreements were mutual, so there was also global guaranteed liquidity provision in euro, yen, swiss francs and sterling, but it’s the global hegemon’s juice that actually matters).
Being able to rely on those swap lines is a big part of the value of the dollar system to non-dollar participants. And although the USA hasn’t made any outright threats, things do seem to have developed geopolitically in a direction where you’ve got to regard it as a possibility, in a way in which you didn’t before.
This is a big deal as Charles Kindleberger first astutely noted. The ECB has even started publishing analytical survey articles from its research department on the subject. Which is not cute; central banks only do this when they’re very stressed.
If that wasn’t enough, as well as all of the obvious geopolitical issues, being part of the dollar zone now quite likely means having to accept that stablecoins are going to be increasingly embedded into your financial system, with two-way exposures to your local systemically important banks.
A large part of the rationale for the GENIUS Act was that global take-up of stablecoins would underpin the use case for the greenback — in essence, they provide a bit more “juice” for users, albeit the kind of juice that European policymakers might not be too keen to consume.
And so . . . enter the digital Euro.
ECB CBDC FTW
The digital Euro looked like a sort of orphan project for a very long time.
It was launched at the same time as a bunch of other “Central Bank Digital Currency “projects, all of which appeared to be aimed at creating sufficient Fear, Uncertainty and Doubt to completely scupper Facebook’s Libra crypto project, and most of which appeared to be quietly sidelined the moment it became clear that they had thoroughly done that job.
But the digital Euro kept on. And it’s become increasingly clear that the purpose of the thing isn’t really because anyone cares about the difference between debit cards and legal tender. Nor is it really about payment fees.
It’s all about strategic independence from the USA.
If you want to wean yourself off the dollar system, you need to replace not just the currency, but the extremely fast, extremely reliable, extremely secure, high-capacity telecoms network with which it comes bundled.
Yes, Europe has its own payment networks for high-value and interbank business, and in many cases, the European version is better than the US. (One of the main grounds for scepticism of the digital euro is that instant bank payments work so well).
What Europe lacks is any equivalent to the big two global but US-owned, retail card payment networks, Mastercard and Visa. Requiring every European merchant that takes cards to be set up for digital Euro (because it’s going to have legal tender status) is their way to bootstrap exactly that.
So everyone might be underestimating the digital Euro. As a payment product, it’s debatable. But it needs to be seen as a way of buying optionality, to give some possibility of a future in which the EU isn’t quite so dependent on keeping access to a global dollar.
As a bunch of European economists argued in an open letter to the EU parliament last month, a digital euro is “not a nice-to-have, it is an essential safeguard of European sovereignty, stability, and resilience”.
This dependence on foreign (US) payment providers exposes European citizens, businesses and governments to geopolitical leverage, foreign commercial interests, and systemic risks beyond Europe’s control. Recent developments have made this more than a hypothetical risk. Without a meaningful digital euro, our dependence will deepen as US-backed private digital currencies are gaining ground. Europe will lose control over the most fundamental element in our economy: our money
Which means, of course, that at some point, the US might see widespread take-up of the digital Euro as a passive-aggressive action in itself, requiring some sort of retaliation. A system which was once a source of global stability is now, potentially destabilising itself.