The Ukraine War is clearly a game changer. It upended many assumptions on who is strong militarily and who is weak in the media war. The war will be remembered as the end of the peace dividend era, when the world enjoyed decades of global peace and stability without major wars. China could not have risen without the peace dividend. Russia and Ukraine are now facing a necrotizing war that eats into their social and economic fabric. No one will win until both sides negotiate a pathway to peace.
Geopolitical strategist George Friedman claimed that the biggest lesson from the current war has nothing to do with Russia or Ukraine, but “the United States has demonstrated that perhaps the most powerful weapon in the world is the weaponized dollar.” “The American war strategy is partly derived from not wanting to engage Russian troops in combat, both because of an aversion to losing any more wars and because the center of gravity of the enemy today is not military but financial.” The physical war is fought by Russia and Ukraine, whereas NATO is engaging in proxy war, using financial sanctions and supplying arms to Ukraine to fight to the last Ukrainian. Such is the cruelty of power politics.
As the dollar accounts for 40% of global trade invoicing, as well as 60% of official reserves, there is no question that it has more clout than the Euro, Yen or the RMB. The fact that the EU and Japan joined the sanctions meant that Russia finds it hard to evade sanctions or escaping a liquidity crunch, not just in foreign exchange, but also domestically. As Friedman shrewdly observed, “The combination of banning Russian energy imports to the U.S. and managing the dollar as a weapon – in concert with a large alliance – poses an unanticipated military crisis for Russia.”
Why has the US dollar such preeminent advantages?
The standard argument is that the USD has superior advantages as a unit of account for global credit and invoicing, means of payment and store of value, accruing to the issuer “exorbitant privileges” by being able to issue currency at will. For many years, this has been true, as when the dollar depreciated over time against other currencies, the world has boomed with extra liquidity, ease of payment and higher return on holding US bonds, equity and real estate. However, whenever the dollar appreciated as US interest rates rose, global liquidity tighten, and non-US borrowers holding USD debt will pay more, running the risk of debt default and asset bubble deflations. The 1997-98 Asian financial crisis can be understood as dollar appreciation in a dollar zone without a dollar lender of last resort. Only when the Fed lowered interest rates and expanded dollar liquidity did the Asian economies recover.
Thus, the rest of the world were both obliged and willing to hold the currency. In former US Treasury Secretary John Connally’s dictum, “my dollar, your problem”. The problems multiplied after the War on Terror, when the US started applying sanctions against revisionist countries such as Iran. Over time, sanctions expanded in scope and intensity on countries, companies and individuals. The only problem with sanctions is that despite inflicting economic pain, proud countries never seem in a hurry to come to the negotiating table.
Recently, several scholars have brought fresh insights into why the dollar benefits not just the US but also its users who create an eco-system that entrenches its superiority. Harvard Professor Yakov Feygin and Dominik Leusder examined the class politics of the dollar system, and concluded that it actually has an ecosystem supported by global private and political elites. After all, “in many countries, the dollar system allows corrupt elites to safely transport their ill-gotten earnings to global banking centers located in jurisdictions with opaque ownership laws.” Until recently, London and New York had no problems taking money from Russian oligarchs.
The rich in both developed and developing markets prefer to trade in dollars and hold assets in dollars. The global corporations, pension funds and asset managers hold dollar assets because they can have both store of value as well as quick liquidity from dollar swaps. Political scientist Herman Mark Schwartz therefore conceived the dollar as the state money of a quasi-imperial global system, in which different economic regions are tied together by a shared reserve currency. In that sense, Sterling, Euro and Yen, having tied themselves to similar quantitative easing and sanctions, are like vassal currencies within an imperial system. Reserve currencies that neither have the military clout nor the depth of stock markets that yield superior returns cannot seek to be a dominant currency.
Are there alternatives to the dollar system? The OECD, in its latest assessment on the Ukraine War, has warned that attempts to develop alternatives could “potentially reduce the dominant role of the dollar in financial markets and cross-border payments.”
My view is that RMB is still long ways away from offering an alternative to the dollar. But the Bank for International Settlements Innovation Centre has just published preliminary results of Project Dunbar, a collaborative effort between the central banks of Australia, Malaysia, Singapore and South Africa to see how a common platform for multiple central bank digital currencies (multi-CBDCs) could enable cheaper, faster and safer cross-border payments. The project is technically feasible, but many regulatory and policy barriers remain. One possible issue is how Deep State national security issues play in such platforms.
As the Roman Empire understood perfectly, money is at the root of all success in warfare – you fight for money, and you need money to fight. But the Roman empire fell when its currency was continually debased. The denarius was strong as long as Roman did not lose wars. The minute that was challenged, everyone went back to gold.
The more things change, the more they stay the same.