The Illustrious dollar, undisputedly undertaking global dominance since the second world war, so ubiquitous it's been assumed for generations to be unshakeable: The predominant global reserve currency. Picture being able to amass massive deficits every year; spend more on your military and government programs; relish cheaper interest rates on debt; and yet never worry about your currency collapsing since it prevalent world wide. Now imagine being able to punish your enemies by cutting off access to this currency, making it illegal to transfer any money through U.S. banks. The U.S. need not imagine this exorbitant privilege, to borrow a term from a former French leader: It's been the reality since the Second World War, when the U.S. dollar became the dominant international currency.¹ Around the world it's popular with people, companies and governments, in everything from cross-border sales to the central bank holdings other countries use to stabilise their economies. "It's a pretty great deal," said David Laidler, professor emeritus at Western University and University of Chicago- trained monetary economist. "It's international money, is what it is.”² Being the almighty currency it has set the precedent to be, do the dollars uses have their limits? Can the weaponisation of the dollar actually harm the US?
We have to consider a lot of things to be able to assess if the methods of economic warfare are actually venial; When? If in a period of economic downfall, recession and low confidence the US chooses to weaponise the dollar, the US or other Countries likely to experience negative consequences, a perfect example of this is in now post pandemic with Brexit and a war in Ukraine developing, US are bound to get some parties experiencing negative side effects, such as we are already seeing in Europe. How? The extent at which the US or other countries are sanctioning, what exactly Is it they are limiting. Who? Who are they trying to cut access from and switch off, in this more globalised and interconnected world, they are dependant on; raw materials, exporting, imports, outsourcing... . Why? If the reason is simple it might be a shorter duration and less intense. Factoring all of this in I’m going to focus particularly in the Ukraine situation, where weaponising the dollar means mobilising the western countries against Russia for the national sovereignty of Ukraine. The US has tested the dollars effectiveness as a weapon, with Defending Ukraine Sovereignty Act (DUSA) and western Sanctions, Russia is weakening and hurting. The swift response there has been by the west to use their financial system will definitely help them come out unscathed, the stronger the west seems, the better the outcome for them. The rouble has hit record low in Moscow, remaining volatile and losing over 30% of its value³. With this comes Russia’s economic warfare strategy, having never expected such an amalgamated sanctions hit, it’s driving its oil prices up and demanding payment for it’s resources in Roubles causing significant and artificial spikes in its currency. Russia hopes to exploit the main weakness of this economic blitzkrieg, weak politicians, without 100% effort they can only achieve so much, politicians that “back up” the sanctions but allow deals are the ones keeping the Russian economy on track. It isn’t a dire problem but definitely an issue, even if the west will ultimately “win” the economic war with Russia, feeble governments (such as Italy and France) can do side-deals which are only prolonging Putins kleptocracy. In this specific case the problem of implementing a weaponised dollar is the reliance of the west on Russia, especially Europe. The challenge for the west is to facilitate a change from Russian oil and gas, making it as fast and with as little friction as plausible, at the speed LRP facilities are being built it will be long, energy costs will rise, recession across Europe is almost guaranteed. Is Europe willing to take the hit? A critical zone is the Gulf – where the capacity to increase supply exists. Despite the Americans quickly shipping new Patriot missiles to Riyadh, thus far Saudi and the Emirates have proved unwilling to turn on the spigots – pretending neutrality. That may be a mistake. All wars – even economic ones – have winners and losers. It would be foolish to be associated with a clear loser – which will be Russia. Ensuring Russia’s oil and gas can swiftly be replaced with alternative sources is a critical part of the Western War Strategy⁴. Clearly the dollar is a strong weapon but it comes with several possible collateral damages such as recessionary threat. Interest rates are already very low, and employment is very high, both of which suggest any short-sharp inflation spike could be absorbed. However the cost of living shock is already taking effect - taxes, cost of food, energy bills and rising insurance can zero discretionary spending. High estimates suggest £2000 per head tax and inflation hit this year, 15% of post-tax earnings on average wages, taking into account this is a society where people are already crippled with personal debt and not many people are regular savers. The economic impact on consumers – who quickly burnt through any pandemic savings – will be enormous. While wages are rising in the public sector, private companies can’t afford higher salaries as their costs go through the roof. Stagflation is likely to occur, possible economic pain - consumer credit crisis, inflation and even a burst in housing bubbles across the west⁵. The food and energy shocks combined with end-Covid china supply chain shock have not helped out the situation.
Another possibly even bigger problem for the US is that the weaponisation of finance can threaten the future of the dollar standard. This weaponisation could definitely become a catalyst that could push for a new currency hegemony, or perhaps not one but several, a multi-currency global reserve system. The pandemic had already raised concerns about the dollar-centric global monetary order, although emergence of a China-Russia economic and strategic partnership isn’t a far fetched idea, it is still hard to believe the yuan, a digital currency or any other currency will be able to get a government to do what is necessary to become a reserve currency, there is still no clear contender to replace the dollar as the dominant currency in global trade and finance⁶. Although even if this is true it could still definitely lead to central banks diversifying with more gold⁷ or other alternatives. 40 nations own a combined total of 193 million ounces of gold. That gold can be monetised and sold off-market or ramped up in order to further de-dollarize in an effort to reduce reliance on the US dollar and thus the Western banking system. In some reported published a few weeks ago by Nicky Shiels, head of metals strategy at MKS PAMP group Sheils said, "If those countries deemed Russian friends were to alter their gold reserves and bring them in line with the current threshold of 17%, collectively they would need to buy an additional ~290mn oz of Gold," she added an updated note Thursday. "That's a whopping 2.6x the size of all ETF holdings. Specifically, China would need to buy ~260mn oz, given the size of its reserves, Ind bia +33mn oz and Bangladesh would need to buy 3.9mn oz.”, While the U.S. dollar is not expected to lose its reserve status anytime soon, Shiels noted that superpowers weren't built in a day. At the same time, Shiels said that gold also faces some headwinds as nations and consumers deal with rising inflation. "Typically, food crises and the associated surging inflation is bullish gold, from an investment standpoint, but only to a point. If it severely impacts discretionary income from poorer gold consuming nations, not only is consumer demand crimped, but gold holdings/savings could potentially be unlocked,”,"Depending on whether the West is successful or not, the more they are used or, the longer sanctions are imposed, the more other countries will try to avoid relying on Western finance.”⁸
Analysts are also predicting U.S. sanctions against Russia should hasten a move by some countries to reduce their reliance on the U.S. dollar, which could also soften demand for Treasuries just as the Federal Reserve, the largest holder of U.S. debt, looks to cut its bond holdings⁹. It’s reserve status boosts demand for U.S. assets overall, this includes treasury bonds, it also makes it easier for the government to issue more debt than it would do. If treasuries are less appealing to investors as the supply increases could also lead to higher yields. The Fed is expected to begin letting Treasuries mature without replacement off its $8.9 trillion balance sheet in the coming months, in addition to aggressively hiking interest rates as it tackles soaring inflation. Benchmark 10-year yields hit 2.56% a few weeks ago, the highest since May 2019¹⁰. Russia has been gradually reducing its dollar holdings since the imposition of Western sanctions following Moscow’s annexation of Crimea in 2014. In 2021 it said it would ditch all U.S. dollar assets in its National Wealth Fund and increase holdings in euros, Chinese yuan and gold. Russia’s Treasury holdings fell to negligible levels in mid-2018, and are down from around $150 billion a decade ago, according to Treasury International Capital (TIC) data. Other countries have also been reducing their bond holdings. China held $1.1 trillion in Treasures in January, making it the second largest foreign owner after Japan, down from around $1.3 trillion in 2013. China has been buying a smaller share of U.S. debt held by the public, which has increased to $23 trillion from around $12 trillion over this time period. Saudi Arabia held $119 billion in Treasuries as of January 2022, down from $185 billion in February 2020. Even if these countries reduce bond purchases of Treasuries it is very unlikely they will dump the bonds by launching large sales of the bonds, there are only so many safe alternatives in terms of safety and liquidity.
Overall the combination of near-universal dollar convertibility, liquidity in dollar reserve assets, and financial system infrastructure designed for dollars, transacting in dollars is much cheaper than other reserve assets¹¹. The huge volumes at which the dollar is traded create economies of scale for transacting in dollars that no other currency can match. It feels inevitable that the dollar would be turned into a weapon, with its power of sovereignty, in such a structured and deeply financed world. Global debt – or, equally accurate, global interest bearing assets – topped $300 trillion in 2021 according to the Institute for International Finance. In that sense, the ease at which the US can restrict access to financial markets is unparalleled in all of history. The question we now have is, when is it worth weaponising and is it truly a double edge sword? A more maximalist approach of economic warfare is as powerful as full on warfare at times, the effect to the living standards of the adversary are immense. It is clear that in the short-term there are definitely consequences but longterm it is harder to determine, no economist would have predicted the collapse of the British pound as the global reserve currency. The weaponisation of the dollar definitely has harmful short term side effects, with recessionary threats and stagflation looming in but in the long run it is hard to see what the real outcome will be, how damaging it is apart of the possible loss in power as a global reserve. It really all depends of the factors, dependency and interconnectedness you have with the country you are weaponising the dollar against.
1 https://www.cbc.ca/news/world/us-reserve-currency-1.6382567 2 THE DOLLAR POLICY OPTIONS FOR SMALL COUNTRIES JULIUS SEN
3 https://www.reuters.com/markets/europe/russian-rouble-slips-past-100-vs-dollar-banks-hunt-fx-2022-03-02/ 4 BBs Economic Forum 2022 5 Morning Porridge
6 Atlantic Council 7 MKS’ Shiels 8 Shiels 9 Reuters 10 Karen Brettell
11 George Pearkes