Washington: I have argued for many years that the US dollar will continue to rule as the dominant currency in the global economy. This is still true today. The dollar serves as the foundation of the global monetary system, and no other currency, real or virtual, can take its place.
Despite continuing to be the "reserve currency" of the world, the dollar is still experiencing a number of non-economic challenges that are limiting its global influence. This results from a global economic system that is becoming more disjointed. Economics is losing ground to geopolitics and national security in determining how nations and nations interact.
Slowly but surely, nations will be forced to choose between two starkly opposed paths: either increase cooperation to strengthen multilateralism and its rule-based framework, or accept economic decoupling as a necessary corollary to greater risk mitigation by individual states.
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Three characteristics of the US have long supported the role of the dollar as a reserve currency: its position as the largest economy in the world; the depth and breadth of its financial markets; and the predictability resulting from institutional maturity and respect for the rule of law.
The US is now able to enjoy what former French president Valéry Giscard d'Estaing famously referred to in the 1960s as a "exorbitant privilege" — essentially, more power to exchange its own currency for goods and services from other countries while having access to a larger pool of low-cost financing. Other countries have achieved significant efficiency gains by adopting the dollar as a medium of exchange and as a store of value.
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It is a provision of an unspoken agreement under which America gains advantages in exchange for prudent system management. However, the 2008 global financial crisis, which had its roots in the US, and the sudden imposition of trade tariffs in 2017 have both raised issues with the contract's latter clause over the course of the previous 15 years.
The "cleanest dirty shirt syndrome" holds that even though these events shook the dollar's dominance, it was not fundamentally destroyed. The dollar may not be a spotless reserve currency, but it is still regarded as cleaner than any other currency for this role.
Due to the US Federal Reserve's poor management of the cycle of interest rate hikes over the past two years and the increasing importance of resilience in economic and business strategies, this situation has become noticeably trickier. There are currently more efforts being made to create pipes around the dollar in the global trading and payment infrastructures than to completely replace it.
By stepping up efforts to establish new regional and international institutions, expanding the use of its own currency in bilateral payment and lending agreements, and reviving the Belt and Road Initiative, China has maintained its leadership position in this area. Yet it is not limited to China.
Russia has been subjected to harsh sanctions, which has increased international interest in deals without the dollar. Additionally, more countries are beginning to believe that they can eventually lessen their reliance on US dollars. They are examining how, albeit in clumsy and expensive ways, Russia has reoriented its trade and replaced the dollar in both export and import transactions.
The US and its allies essentially have two choices in light of these developments. They can cooperate to restructure multilateralism in a way that secures support from what Goldman Sachs' Jared Cohen refers to as the "geopolitical swing states" (Geopolitical Swing States). Modernising the IMF and World Bank's governance, representation, and operations would fall under this category.
Alternately, they can decide to live with the short-term expenses and risks related to the decoupling required to properly de-risk. Although the idea of "de-risking, not decoupling" put forth by the G7 last weekend may seem appealing, it is more likely to lead to an unstable middle ground than a workable new equilibrium.
A more inclusive multilateralism supported by a strong rule-based system unquestionably offers greater benefits than the alternatives from an economic standpoint. But it is becoming more and more clear that trade and international finance are no longer primarily driven by economics. The dynamic between economics and the intertwined forces of geopolitics, politics, and national security has undergone a fundamental change.
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This inversion encourages the derisking and decoupling of cross-border supply chains and payments, and the secularly weakened multilateral system cannot effectively counter it without a new significant effort