Currencies Die with a Whimper Not a Bang: The US Dollar Won’t Crumble Overnight
For years I’ve written about efforts underway by Russia, China, and other US adversaries to implement alternatives to the US dollar payment system.
Today, the dollar represents 60% of global reserves, 80% of global payments, and almost 100% of global energy purchases.
That kind of dollar dominance has aggravated friends and foes alike since the 1960s.
Lately, the annoyance is even worse because the US has weaponised the US dollar to pursue geopolitical goals over and above financial goals.
The list of countries suffering under US financial sanctions is long and getting longer. Among the most prominent targets are Russia (due to Crimea and Ukraine), China (due to the trade wars), Iran (due to its uranium enrichment program and support for terrorism), North Korea (due to its ballistic missile program), and many others including Syria and Venezuela.
What all of these sanctions targets have in common is that the US restricts access to US dollar payments channels…
Russia begins to dodge the US dollar
In the case of Iran, the sanctions go even further to include the denial of access to SWIFT, the international payments system, which includes euros, yen, sterling, and other reserve currencies in its facilities.
While most of the targeted countries have been working on alternatives (including a possible gold-backed cryptocurrency to be jointly launched by China and Russia), actual implementation has been slow in coming.
That may all be about to change.
Russia and Iran have announced a new payments channel that avoids both SWIFT and the US payments system.
The new system involves secure financial message traffic between the two participants, with possible expansion to include Turkey and others in the near future.
This still begs the question as to which currency will be used, since Iran is mostly denied access to dollars.
But payments could include the Russian ruble, or gold that could be converted to US dollars through the Russian banking system and held for the account of Iran in veiled custodial accounts.
This is a modest step, but it is a beginning with far more pointed attacks on dollar hegemony yet to come.
Escaping US intervention
I only recently explained to subscribers how the new secure payments channel between Russia and Iran works.
This channel does not use US dollars and allows Russia to sell weapons to Iran and for Iran to hide reserves in Russia, free of US sanctions and US interdiction.
Now, Russia has unveiled an even more ambitious payments system.
This new system will provide services similar to SWIFT (the Society for Worldwide Interbank Financial Telecommunication), which is the leading bank message traffic facility in the world today for funds transfers.
In recent years, SWIFT has become politicised. Iran was banned from using SWIFT from 2012 to 2016. Certain Iranian banks were banned from SWIFT again in 2018.
Russia has never been banned from SWIFT, but the mere possibility gives Russia a large incentive to create an alternative payments system not subject to US control. With this announcement, Russia is getting closer to that goal.
The new Russian system may quickly be expanded to include China, India, Iran, Turkey, and eventually other nations.
What all of these countries have in common is that they have been subject directly or indirectly to US financial sanctions and risk account freezes and confiscations.
It is difficult to escape these sanctions while using large established networks like SWIFT.
Building an alternative from the ground up using local currencies such as the ruble or yuan, or new cryptocurrencies, is the best way to work around US sanctions. Russia is the leader in developing these new technologies and systems.
It may not be long before the participants in the Russian system trade oil, weapons, infrastructure, agricultural produce, and electronics among themselves without using dollars at all.
In time, the US dollar may be just another local currency like the Mexican pesos or Turkish lira.
King Dollar reigns…for now
The demise of the US dollar isn’t going to happen overnight. Changes to dominant currencies take years to evolve. Russia is taking steps to minimise using the SWIFT payment system.
Until then, we can expect more strength from the US dollar.
Today it is near an all-time high based on certain indices.
(The all-time high using the Fed’s broad trade-weighted index was in 1985, and prompted then Secretary of the Treasury James Baker to convene the meeting that resulted in the Plaza Accord to weaken the US dollar.)
Conventional wisdom is that a strong dollar hurts US exports and export-related jobs.
A strong US dollar also imports deflation (you get more for your dollar) at a time when the Fed wants inflation.
There’s some truth in both of these observations and they form the bases for forecasts of a weaker dollar.
Trump wants a weaker US dollar, US farmers want a weaker US dollar, and big US exporters like Boeing want a weaker US dollar….
Stronger US dollar props up Europe
Wall Street analysts have been predicting a weaker US dollar for over a year (and they’ve been wrong in their forecasts). So what’s the problem?
The problem is that a weaker dollar means a stronger euro.
The two currencies can’t both depreciate against each other at the same time. It’s a mathematical impossibility.
(Both can depreciate against gold at the same time, but that’s another story.)
The US may need an economic boost (the Atlanta Fed forecasts third-quarter growth at an annualised rate of 1.7%, even weaker than the weak average growth of the past 10 years), but Europe needs it more.
In effect, the US is bearing the costs of a stronger dollar in order to prop up Europe.
The Hill news site recently offered an excellent overview of the situation (although I disagree with the writer’s forecast for a weaker dollar):
‘A strong currency has been official U.S. policy for three decades. The benefits of being the de facto global currency are well known. Trump’s Treasury secretary reaffirmed the strong dollar policy.
‘But Trump is transaction-oriented, not beholden to taboos he believes do not serve his interests. He has been consistent in his criticism of how undervalued he considers the euro to be and was quick to target China as a currency manipulator on the recent drop in the renminbi.
‘The Fed’s policy prescription is plain: Cut rates enough to steepen the yield curve. Borrowing conditions might not move much but the effect on the dollar could be significant. It is an epic historical anomaly that almost all the world’s major countries’ sovereign debt trades with a yield below the US over-night risk free rate — a rate profile clearly helping to prop up the US dollar.’1
The US may want a weaker dollar, but we won’t pursue that policy because Europe needs a weak euro to avoid an economic collapse (Germany and the UK are headed for recessions and growth in Italy is zero).
The only way the US will pursue a weak US dollar policy is if the US is in a recession.
That’s a circumstance in which Europe might need help, but the US needs it more.
There is no recession on the horizon right now.
Therefore, you should expect King Dollar to continue its reign despite the weak US dollar forecasts.
All the best,