Yu Xiang: Nonresident senior fellow at the Center for International Security and Strategy, Tsinghua University, China Forum expert, and a senior research fellow at China Construction Bank.
The international monetary system refers to the institutional arrangements and practices for pricing, currencies exchange, payments adjustment, etc. The world monetary system is not eternal but will evolve with environmental changes. At the end of World War II, the United States promoted the establishment of the Bretton Woods system, the core of which was the dollar as a means of valuation, trading, and value storage. In the decades between the 1971s and the 2008 financial crisis, the Bretton Woods system had experienced changes, the fixed link between the US dollar and gold was nullified, and the exchange rates of national currencies entered the nominally free-floating Jamaican system, however the US dollar, as the foundation of the international monetary system, didn't falter.
After the outbreak of the financial crisis in 2008, the changes in the international power pattern and the new technological revolution poses new challenges to the dollar’s hegemony, and the de-dollarization of the world economy is accelerating.
First, the multipolar global economic structure has evolved in-depth with the rapid rising of non-US countries’ GDP. The share of the US GDP in world GDP fell from 40% in 1960 to 24% in 2021. Asia's GDP accounted for 20% of the world's GDP forty or fifty years ago but rose to 47% in 2021. In the past 10 years, the contribution of China's economy to world economic growth has stabilized at about 30%. Even in the past two years of the global epidemic, China's two-year average economic growth rate has reached 5.1%, ranking first among the world's major economies and continuing to be the engine of world economic growth. This changed the United States' long-standing position as the locomotive of the world economy in the post-war decades. The economic foundation determines the international structure, which requires more sovereign currencies to facilitate international payment settlement, balance-of-payments adjustment, etc.
Second, the United States continues to overdraw US dollar credibility. Under the guidance of the so-called "America First" principle, President Trump fought a "trade war", a "tariff war" and played a "zero-sum game", which seriously overdrew the global leadership of the United States. After the Biden administration came to power, he did not adjust the Trump administration's economic and trade policies, which let the international credibility of the US dollar fall irreversibly. Furthermore, the Federal Reserve's "unlimited quantitative easing" policy after the COVID-19 pandemic flooded the liquidity of the US dollar. The Fed's balance sheet expanded from about $4 trillion in March 2020 to more than $9 trillion at present, which is 10 times the size of the Federal Reserve's balance sheet before the 2008 financial tsunami. The Federal Reserve is clearly exploiting its unique situation in the US dollar global framework to pass on the cost of the COVID-19 pandemic. Just as the former US Treasury Secretary John Connery in the 1970s said: The US dollar is our currency, but it’s your problem.[1] After the breakout of conflict between Russia and Ukraine, the United States and Europe joined hands to kick Russia out of the SWIFT payment system, compounding the concerns of different nations which rush to study alternative transactions and payment systems outside the US dollar.[2] More and more countries hope to find a more stable currency. This is exactly what we have seen. Turkey has started the process of reducing its holdings of dollar assets, Iran announced that the valuation pre-settlement of its oil transactions will no longer use the US dollar, Russia has begun to use the local currency in its natural resource trade, and major European countries have vigorously promoted the European version of the settlement system.
Third, there is a new development in the international division of production. After the 2008 financial crisis, the process of globalization slowed down, and the trend of localizing production strengthened. In the short term, driven by geopolitical and risk aversion motivation, the global industrial chain will be dispersed and contracted to multiple region blocks, and the regionalization and localization of the industrial chain will also become a trend. The new pattern of globalization in the future will be to carry out a professional division of production among the world's best enterprises at regional levels and form vertically integrated clusters, and the proportion of benefits obtained by the host countries will increase, which represents the so-called "fairness" of production layout, promote the increase of regional trade transactions, and is sure to accelerate the rise of regional local currency settlement.
Fourth, digital technology will promote the development of the global industrial chain in an intelligent and decentralized direction. With the gradual maturity and commercialization of information technologies such as cloud computing, industrial Internet, and automation, the manufacturing industry will become smarter and more diversified in the future. When meeting the needs of risk dispersion, it will also shorten and flatten the industrial chain, further strengthen the cluster model of vertical integration of the above-mentioned industrial chains, and accelerate the structure of the global industrial chain.
The security and value neutrality of blockchain is significantly fortifying the reliability of digital currencies, providing new choices to nations when the standing of the US dollar is declining. The digital technology’s impact on the US dollar system is more fundamental. Paulson, former US Treasury Secretary, and chairman of the Paulson Foundation stated with great concern in his article "The Future of the U.S. Dollar" published in the famous American journal Foreign Affairs in May 2021. He said, “The United States should not worry about the end of the global hegemony of the U.S. dollar at present, but should also worry about the status of the U.S. dollar by new financial technologies such as digital currency.”[3]
Nonetheless, we should remain objective and rational about the progress and improvement of the world monetary system. Economic history tells us to reform and adjustment of the world monetary system won't be accomplished overnight.[4] It will be a long historical process, and there will be rehashed sometimes.
The "Nixon Shock" of August 1971 denoted the transition from the gold standard to the credit standing. The United States unilaterally abandoned the peg of the U.S. dollar to gold, because it can’t keep the promise that an ounce of gold is equal to 35 dollars. Then the Bretton Woods system to some extent dysfunctioned. With it, the dollar lost its status as the only effective global reserve currency under international law. Doubts about the status of the US dollar had been increasing, the euro emerged as a challenger in 1999, but the hegemony of the US dollar has not been changed. The reason lies in the anchoring effect of comprehensive national strength behind the sovereign currency. So based on strengthening the comprehensive national strength, letting other countries widely accept non-dollar sovereign currencies should be the core task of other sovereign currencies in the future.[5]
What’s more, on the path to be international reserve and settlement currencies, other countries will inevitably face obstacles from the United States. The US dollar is one of the cornerstones of the US global hegemony. Without the dollar, US hegemony will no longer be stable. The so-called Thucydides trap also exists between the US dollar and any potential challengers. The United States will try its best to maintain the hegemony of the US dollar with its existing policy tools. Therefore, caution must be exercised in the competition for more important international monetary roles.
In the above process, a transitional feature of the coming world currencies’ competition is that the US dollar continues to dominate the international economic system, but the proportion of local currency settlement among countries will increase. More regional settlement arrangements will be formed. Take the Belt and Road Initiative as an example. Before the outbreak of the Russian-Ukrainian conflict, the countries along the route were working to establish a more complete financial services system, such as, accelerating the networked layout of local nations’ financial institutions in countries along the route and building a non-dollar payment and settlement system parallel to SWIFT.[6] In addition to basic businesses such as international settlement and remittances, enterprises participating in the construction of the Belt and Road Initiative would also be provided with new businesses such as localized credit loans and inter-bank lending. When the time is ready, related services could be expanded to emerging businesses such as investment banking business, stock futures agencies, personal financial management, etc. Though the ongoing Russian-Ukrainian conflict might stagnate the deepening of economic and financial cooperation along this route, this stagnation will be temporary. To strengthen resilience to extraterritorial risks, the process of relevant countries settling in local currencies is expected to restart and accelerate soon.
[1] https://www.chathamhouse.org/2021/09/policymakers-can-learn-nixons-dollar-shock
[2] https://foreignpolicy.com/2022/03/08/swift-sanctions-ukraine-russia-nato-putin-war-global-finance/
[3] Henry Paulson, The future of the Dollar, Foreign Affairs, May 2020.
[4] https://www.economist.com/finance-and-economics/2022/04/02/will-dollar-dominance-give-way-to-a-multipolar-system-of-currencies
[5] Henry Paulson, The future of the Dollar, Foreign Affairs, May 2020.
[6] Aditi Kumar and Eric Rosenbach, Could China’s Digital Currency Unseat the Dollar? Foreign Affairs, June 2020.
(Originally published on Valdai Club on May 12, 2022.)