The hard “de-risking” choice facing economies

Featured Sponsor

Store	Link	Sample Product
UK Artful Impressions	Premiere Etsy Store

For decades I have argued that the US dollar will maintain its position as the predominant currency in the world economy. This remains the case today. There is no other currency – physical or virtual – that can replace the dollar at the center of the international monetary system.

However, the dollar’s global influence is facing several non-economic challenges, despite its continued status as the world’s “reserve currency”. This is a consequence of an increasingly fragmented international economic system. National security and geopolitics are supplanting economics in shaping national and international interactions.

Slowly and surely, countries will now be forced to choose between two startlingly divergent paths: work together more to strengthen multilateralism and its rules-based framework, or embrace economic decoupling as the inevitable accompaniment to greater risk mitigation by individuals States.

The role of dollar as a reserve currency it has long been underpinned by three attributes of the United States: its status as the world’s largest economy, the depth and breadth of its financial markets, and the predictability that comes with institutional maturity and respect for the rule of law.

By adopting the dollar as a medium of exchange and as a store of value, other countries have achieved significant efficiencies while offering the United States a chance to enjoy what former French President Valéry Giscard d’Estaing famously described over the years ’60s as an “exorbitant privilege” — essentially, greater power to exchange one’s currency for goods and services from other countries by having access to a larger pool of cheap finance.

It’s part of an implicit contract: America benefits in exchange for running the system responsibly. Yet this latter aspect of the contract has been challenged for the past 15 years by the 2008 global financial crisis that originated in the United States and the sudden imposition of trade tariffs in 2017.

While these events have shaken the dollar’s dominance, they have not substantially weakened it due to what can be described as “cleaner dirty shirt syndrome”: the dollar may not be a pristine reserve currency, but it is nonetheless regarded as more clean of any other currency for this role.

Over the past two years, this situation has become considerably more complicated due to the US Federal Reserve’s mismanagement of the interest rate hike cycle and the growing emphasis on resilience in economic and trade strategies. Rather than seek to replace the dollar outright, there is now increased efforts to build pipes around it in the world’s trade and payment infrastructure.

China has maintained its lead in this, stepping up efforts to create new regional and global institutions, expanding the use of its currency in bilateral payments and loan agreements, and revamping its Belt and Road Initiative. But it’s not just China.

The harsh sanctions imposed on Russia have helped spur the country’s increased interest in dollar-flanking deals. Additionally, more nations are starting to perceive it as feasible to reduce their dependence on the US currency over time. They are watching as Russia has refocused its trade and replaced the dollar in both its export and import transactions, albeit in cumbersome and costly ways.

Faced with these developments, the United States and its allies have essentially two options. They can work collectively to revamp multilateralism in an inclusive way that guarantees the consensus of what Goldman Sachs’ Jared Cohen refers such as “geopolitical swing states”. This would include modernizing the governance, representation and operations of the IMF and the World Bank.

Or they may choose to accept the short-term costs and uncertainties associated with decoupling necessary to adequately mitigate risk. The notion of “risk reduction, not decoupling” put forward by the G7 last weekend may sound appealing, but it is likely to result in an unstable middle ground rather than a viable new equilibrium.

From an economic point of view, a more inclusive multilateralism supported by a robust rules-based system undoubtedly offers greater advantages than the alternatives. However, it is increasingly evident that the economy no longer holds the reins in guiding the process of international trade and finance. There has been a fundamental shift in the relationship between the economy on the one hand and the combined forces of national security, politics and geopolitics on the other.

It is a reversal that now encourages both the risk reduction and decoupling of cross-border supply chains and cross-border payments, and it is a reversal that the weakened secular multilateral system cannot effectively counter without a major new effort.