Since World War II and, more exactly, the United Nations Monetary and Financial Conference held in Bretton Woods, New Hampshire, the US dollar has been the pivotal currency of the international monetary and financial system. By being the sole originator of the global reserve currency, the US henceforth has had an "exorbitant privilege". The termination of the Bretton Woods system meant that the link between the dollar and gold ceased to be, prompting every currency of every country around the globe into fiat status. As a result, one would think that because US dollars were no longer perceived to be as good as gold, all other countries would stop using the greenback for international trade. Inasmuch as the Eurodollar system had been developing for roughly twenty years, financial centers worldwide kept on settling transactions and producing financial instruments in US dollars. Additionally, in 1974, the United States struck a deal with Saudi Arabia to standardise oil prices in dollar terms. Through this deal, the petrodollar system was born, strengthening the US dollar as the world's reserve currency and, through this status, the United States continued to enjoy the "exorbitant privilege" of having persistent trade deficits and being a global economic hegemony. The petrodollar system also provides US financial markets with a source of liquidity and foreign capital inflows through petrodollar "recycling", which consists simply of the oil nations using their dollar-denominated revenues to acquire US assets, such as Treasuries and equities. Through bilateral agreements with Saudi Arabia, the US managed to influence members of the Organization of the Petroleum Exporting Countries (OPEC) to standardise the sale of oil in dollars. In return for invoicing oil in dollar denominations, Saudi Arabia and other Arab states secured US influence in the Israeli-Palestinian conflict along with American military assistance during an increasingly worrisome political climate, which saw the Soviet invasion of Afghanistan, the fall of the Iranian Shah, and the Iran-Iraq War. Out of this mutually beneficial agreement, the petrodollar system was born. However, there are several factors pushing the world to abandon the US dollar standard. To wit, the growing role and importance of China and other emerging markets (EM) in the world economy, the increasing dissatisfaction of Saudi Arabia and the OPEC towards the American oil industry, and even the other developed economies (DE), particularly the Euro Area (EA) and the UK, are getting disgruntled with the US regulating every aspect of international trade. More importantly, everybody has been, for quite some time, irritated with the reduced economic growth throughout the world and with the foreign policy conducted by the US. In a nutshell, what was once a beneficial scheme for every party, it is now a source of affliction and conflict. This is the first part of a two-part series about the challenges the US dollar has been facing, in addition to its prospects in the current context. On this first part, I am going to discuss the motivations driving some countries to conceive alternatives to and the ultimate abandonment of the dollar-centric monetary and financial regime. Firstly, being the world’s largest economy by PPP for a few years now - and may soon become the world’s largest economy even in exchange rate terms -, China has been cranking up the fight against the dollar dominance, attacking the most vital points and building up relationships with other countries. In pursuing its mission to dump the dollar, China has introduced the Belt and Road Initiative (BRI), it has been accumulating large reserves of gold, it has expanded the activities of the Shanghai Gold Exchange (SGE), it has fostered the cooperation among the BRICS nations (Brazil, Russia, India, China and South Africa) and has clinched bilateral agreements with Russia, Iran and Venezuela to obtain oil in yuan payments. At last, during the kung-flu pandemic, the Chinese government has been providing aid to various countries, including in the West. Beginning with the bilateral agreements, China since 2007 has lent Venezuela more than $50 billion. Moreover, Venezuela began accumulating funds in China thanks to payments in yuan for oil exports, causing last year the government to discuss using yuan to pay contractors. Similarly, since 2018, China and Iran started to settle their transactions, including oil, in yuan. Likewise, in 2017, China has established a payment versus payment (PVP) system for Chinese yuan and Russian ruble transactions in a move to reduce risks and improve the efficiency of its foreign exchange transactions. Russia and Central Asia are considered top-priority oil and gas sources for China, the world’s top energy consumer. In addition, China plans to introduce PVP systems for yuan transactions with other currencies based on the BRI, and complying with the process of renminbi internationalisation, following its ambition of bringing about a New Silk Road to expand links between Asia, Africa, Europe. In this initiative, China negotiates "win-win" deals with other countries, where Chinese companies build infrastructure in strategical places, like ports and train stations, to increment international trade. (...) the United States turns itself into a financial empire. The United States has brought the entire world into its financial system. Seeing that it is a centrally planned programme, it comes to no surprise the BRI is turning out to be a tremendous mess. Due to being a huge debt trap for those strategic countries, the BRI is failing to accomplish its mission of fomenting good relationships with the other parties. Nevertheless, China has been invested in other projects. The BRICS group established in 2014, at the 6th BRICS summit in Fortaleza, Brazil, the New Development Bank (NDB). This bank was created with the intention of bypassing the dollar so as to support public or private projects established nationally, which are "socially, environmentally, and economically" sustainable". Its main objectives are: promote infrastructure and sustainable development projects with a significant development impact in member countries; implement an extensive network of global partnerships with other multilateral development institutions and national development banks; and build a balanced project portfolio giving a proper respect to their geographic location, financing requirements and other factors. Therefore, the NDB could be an entity of the likes of the IMF and the World Bank, which reside under the greenback dominion. In short, Chinese foreign policy is basically grounded in buying influence. Be that as it may, China is ruled by a socialist, authoritarian government, which obviously deters investment and cooperation from foreign investors and entities. For not respecting human rights and private property, as well as being very opaque and secretive, people are apprehensive on making deals with any Chinese company or institution, either state-owned or "private". Secondly, owing to the fact that crude oil is by far the most traded commodity, in dollar amounts - having a global demand in 2019 of 100.1 million barrels per day, at $55 a barrel, the total global crude oil market amounted to $2,010 billion - and it is denominated in dollars exclusively, the US must guarantee crude oil is priced in dollars to maintain it the reserve currency of the world. One of the main factors standing in the way of the world’s final rejection of the dollar is the wavering trust that Saudi Arabia and OPEC have with the US, in assuring oil transactions remain denominated in dollars under the 1970’s petrodollar agreement. Notwithstanding, even the Saudi kingdom is hedging towards a new global system, and has publicly stated that their ties to the US was open for re-negotiation. The fundamental bargain, oil for guns, a reliable supply of Saudi oil in return for US military protection and weaponry for the kingdom, seems to be no longer standing.
Today's shale oil and gas industry is leading America to have less need for Saudi oil, resulting in the crippling of the original bargaining. Hence, Saudi Arabia and other Arab countries are losing their incentive to accept US dollars for their oil. Thirdly, even the Euro Area and the UK are on their path to ditch the dollar in international trade, more notoriously in oil. Apparently, it is not just the EM that are fed up with the dollar hegemony and the US government's bullying. The DE want to transact freely in their own terms, without worrying about being punished by the Americans. The move kicked off when Iran was under US-imposed sanctions, from 2012 to 2015, before the signing of the nuclear deal in June 2015, formally known as Joint Comprehensive Plan of Action (JCPOA), between Tehran and the P5+1 nations (China, France, UK, US, plus Germany). In order to bypass US-related financial institutions, Iran instituted new mechanisms. Accordingly, as it did with China and yuan, Iran replaced the dollar for euros when transacting with European countries. Finally, because the US government weaponises the dollar to punish those that challenge or stand in the way of America's imperialistic goals, everyone is keen on coming up with ways to circumvent the dollar without being left out from the financial system or the US armed forces' wrath coming down upon them. Abandoning the dollar, or just threatening to do so, is certain economic ruin. The US could bar any country from international trade. The most used transaction network is SWIFT with, as of 2018, around half of all high-value cross-border payments worldwide. As of 2015, SWIFT linked more than 11,000 financial institutions in more than 200 countries and territories, who were exchanging an average of over 32 million messages per day (compared to an average of 2.4 million daily messages in 1995). In spite of being founded in Brussels in 1973, the US can oversee every transaction made in US dollars and stop them from being settled. Consequently, other countries have been busy in developing alternative payment systems. Furthermore, whenever the US feels somebody is seriously disputing the status quo, America unleashes its might on the offender. The US' response is inversely proportional to the power, past relationship and level of freedom of the transgressor. When it is a relatively small, weak, historically discourteous or human rights abusing country, the US automatically sends troops or finances dissenting factions and rebels to substitute the present despotic rulers for bootlicking puppets. However, when it is a big, powerful, an important partner or politically free(ish) country, the US partakes in so-called currency and trade wars, as a means to disrupt the offenders' economies, like it has been doing with China, Russia, Iran and Venezuela, and it has even threatened to impose tariffs on goods from the European Union. In conclusion, bi- and multi-lateral pacts between various nations could become a major driver on the way towards decreasing the dependence on the US dollar in international trade and on US controlled payment systems. Despite the relative ease of shifting to other currencies in those kinds of trade, changing the current international financial system, the Eurodollar, is the real difficult part for being the heart of the matter. That is exactly what is going to be discussed on the second installment of this series.
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AuthorDaniel Gomes Luís Archives
March 2024
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