Global reset – Monetary decoupling (Part 5: The end of USD supremacy – Will it be different this time?)

Global reset – Monetary decoupling (Part 5: The end of USD supremacy – Will it be different this time?)

Phuah Eng Chye (14 August 2021)

Currency dominance is one of the factors reinforcing global power. In the previous century, the US ascendency to global power was paralleled by the rise of the greenback displacing sterling. In this century, the debate is on the ability of the yuan to challenge USD supremacy; given the likelihood China could overtake US as the world’s largest economy by the end of this decade.

Predictions on the demise of USD supremacy are not new. Since the 1960s, events such as US becoming a net debtor country; the break with gold convertibility; the emergence of the euro; and the 2008 global financial crisis led to conjectures that the end of USD supremacy was near. Each time, the USD bounced back stronger. Not only that, international agreements such as the 1985 Plaza Accord was actually aimed at forcing a USD devaluation to reduce US trade deficits. These incidences underline one the international standing of the USD.

Why USD reigned supreme for so long

In analysing currency supremacy, a distinction should be made between currency value and currency usage. Currencies regularly experience bouts of weakness and strength. Value is thus not a critical factor in determining currency supremacy. USD supremacy derives from its indispensability in international usage. The Working Group of the Committee on the Global Financial System describes the USD as “the foremost funding currency is reinforced by its use as a vehicle currency for foreign exchange transactions, invoicing currency for global trade and reserve currency for reserve managers”. Wenxin Du and Jesse Schreger notes “while the United States accounts for about 15% of world trade and 25% of global GDP, the U.S. dollar accounts for about 50% of cross-border loans and international debt securities, 90% of all foreign exchange (FX) transactions, 60% of official FX reserve holdings, and 50% of trade invoicing”.

USD supremacy has been durable for several reasons. First, there is a lack of viable alternatives to the USD. Only the USD ecosystem could provide (and create) a sufficient supply of assets to satisfy international demand. Michael Hudson points out “in 1972, a year after the United States went off gold…American diplomacy was in an even stronger position now that its deficit was not having to be paid with gold. What were other countries to do? How were foreign central banks going to hold their international reserves? There was only one currency that they could hold, and that was the U.S. dollar. So the fear by Wall Street and the U.S. Government that the dollar would be devalued as a result of its military spending didn’t materialize, because foreign central banks were in a quandary: If they did not recycle the dollars that they received from the America’s balance of payments deficit, their currencies would rise and that would hurt their export interests. From the American point of view, central banks recycled dollars into Treasury bond holdings, because foreign central banks at that time could only invest in official government securities; they were not creating sovereign wealth funds. America’s balance-of-payments deficits thus financed its domestic budget deficits”.

Second, USD supremacy reflects overwhelming global demand for the greenback. The traditional source of demand arises from the global recycling of US consumption and deficits[1]. Foreign central banks, investors and corporations seek USD assets to park their export earning surpluses. The new source comes from the economic growth driven by information, financialisation and globalisation which has generated huge global demand for USD credit and liquidity. Firms from emerging economies, particularly from China, tapped USD public and debt markets to finance their growth. Global USD liquidity played a key role in financing the technology revolution, the revival of American enterprise and the growth of emerging economies.

Overall, the status of the USD as the primary global reserve currency is a function of its many strengths such as its economic, military and technology leadership; the liquidity, sophistication and credibility of USD-denominated markets; its willingness to create an ample supply of safe assets to satisfy international demand; and its leadership role in global financial stability and governance. The US influence over critical global institutions the International Monetary Fund (IMF) and World Bank and networks such as the Society for Worldwide Interbank Financial Telecommunication (SWIFT)[2] and the Clearing House Interbank Payments System (Chips)[3] helps it to defend its currency supremacy.

Why it is different this time

For the first time, the US is suddenly faced by a formidable rival in China with all-round strengths in the economic, financial, military, technology and information spheres. China and the yuan still have too many shortcomings to pose an immediate and direct threat to USD supremacy but it poses a long-term challenge. In this context, USD dominance will be gradually eroded by several developments that will reduce international USD usage in payments, funding and investing.

  • Fraying of the petrodollar system

One pillar of strength has been its role as the de facto currency for the oil trade. But this no longer holds as the role of oil and the US in the global economy is diminishing. Lyn Alden points out “it’s challenging to maintain a system of all oil and most commodities being priced worldwide in US dollars if there is a bigger global trade partner and importer of oil and commodities than the United States…The global energy market, and more broadly international trade, is now too big to be priced primarily in the currency of a country that represents this small of a share of global GDP…as the US economy represents a smaller and smaller share of global GDP over time, it becomes increasingly unable to supply enough dollars for the world to price all energy in dollars. There’s no country or currency group big enough to do that alone anymore. Not the United States, not China, not the European Union, and not Japan”.

She notes “the petrodollar system encourages mercantilist nations to run trade surpluses with the United States and recycle those dollars into buying US Treasuries, but after a while of doing this, China started taking their dollar surpluses and investing in other foreign assets instead…they launched the Belt and Road initiative in 2013… whether the loans are successful or not, China gains access to commodity deals, trading partners, and hard assets around the world…So, the US runs big trade deficits with the rest of the world (and especially China), but now rather than funnelling those dollar trade surpluses back into financing US fiscal deficits, China uses its incoming dollars to finance hard asset projects around the world, and increase their global reach”. “As of this year, the US Federal Reserve now owns more Treasuries than all foreign central banks combined. That’s not exactly how the global reserve currency is supposed to work. It’s like a restaurant chef eating her own cooking more than her customers do. This is what other non-global-reserve countries look like. Within one year, the Fed went from owning half as much Treasuries as foreign central banks combined, to more than them combined”.

Lyn Alden explains “basically, the petrodollar system and the associated fiscal policy is fraying under its own inherent flaws over decades, which again gets back to the Triffin dilemma that to maintain a global reserve currency, you need to export an increasing amount of your valuable assets like gold reserves or your industrial base…As the system frays, it’s easy to point to external nations as the cause of this fraying. When they begin pricing things outside of the dollar-based system, or employing mercantilist currency policies, or building pipelines, or deciding to do something with their dollar surpluses other than reinvest them in US Treasuries, it can seem as though they are undermining an otherwise sound system. In reality, those external actions are a symptom of the more underlying flaws in the system: the fact that the United States is no longer big enough as a share of global GDP to supply enough dollars to fund global energy markets and global trade, the fact that the United States has to run persistent trade deficits to get dollars out into the system, and the fact that an all-fiat global currency system incentivizes mercantilist currency manipulation by many countries to generate trade surpluses against the US wherever possible”.

  • USD in international funding and investment

It is USD strength in international funding and investment that underpinned the longevity of USD supremacy. The Working Group of the Committee on the Global Financial System highlights “the US dollar dominates international finance as a funding and investment currency. Although the United States accounts for one quarter of global economic activity, around half of all cross-border bank loans and international debt securities are denominated in US dollars. Deep and liquid US dollar markets are attractive to non-US entities because they provide borrowers and lenders access to a large set of counterparties. The pre-eminence of the US dollar as the global reserve currency and in trade invoicing further motivates its international use. The widespread use of a dominant currency for funding gives rise to a complex and geographically dispersed network of relationships. This has important implications for the resilience of the global financial system. Specifically, the central role of the US dollar in international finance means that global economic and financial activity is highly dependent on the ability of US dollar funding to flow smoothly and efficiently between users. This broad international use of the US dollar generates significant benefits to the global financial system. These benefits arise from economies of scale and network effects, which reduce the costs of transferring capital and risks around the financial system. But it can also lead to vulnerabilities, as the resulting interconnectedness can transmit and amplify shocks that emanate from the United States or elsewhere in US dollar funding markets, across the globe”.

The Working Group notes “US dollar funding remains below its peak a decade ago relative to the size of the global economy, despite having grown in nominal terms. By contrast, the US dollar’s share in international borrowing has reversed its pre-GFC downward trend to again reach levels seen in 2000. It is clearly the dominant international funding currency”. “Non-US entities hold $6.8 trillion, or 43%, of US Treasuries outstanding (as of August 2019), and $1.2 trillion, or 17%, of US agency securities outstanding (as of June 2019)”. “In 2019, non-US investors held around $3.8 trillion, or about a quarter, of outstanding US long term corporate debt…US IG corporate bonds account for about half of all IG corporate debt securities outstanding”.

The Working Group explains “non-US entities may want to borrow US dollars for a variety of reasons: Size, liquidity and investor base: US dollar markets are attractive because they are large and liquid and provide access to a broad and deep investor base, all of which can help reduce transaction costs. Borrowers, especially in emerging market economies (EMEs) with high domestic inflation and weaker domestic institutions, might have to issue debt in a foreign currency, and the US dollar in particular, to attract lenders. In addition, non-US borrowers in other AEs might find borrowing in US dollars advantageous because it helps diversify their funding sources”. In addition, borrowing or lending in US dollars will hedge exposures; “thereby generating a cost advantage for borrowing in US dollars”. “For US investors, lending to non-US borrowers can be attractive for at least two reasons. First, they may obtain higher returns because non-US borrowers may be willing to pay higher rates given more limited access relative to US borrowers. A second reason is portfolio diversification. In 2019, US banks had between $1.5 trillion and $1.9 trillion in US dollar denominated international claims, mostly in the form of loans. In addition, US NBFIs hold more than $2 trillion of US dollar-denominated debt securities issued by non-US entities. Mutual funds have the largest holdings”.

The Working Group notes “the growing share of the US dollar in international borrowing has been accompanied by major changes in the structure of the US dollar funding landscape. After the GFC, geographical weights have shifted and bank intermediation has ceded space to market-based finance and non-banks. Banks have become more resilient; they have lower bilateral credit exposures and access to liquidity swap lines that provide a prudent liquidity backstop. Typically, nonbanks are less leveraged than banks, but have access to fewer sources of US dollar funding (including through central bank facilities). As such, they are more likely to act as amplifiers of market volatility if subjected to stresses”.

  • Rise and fall of the Eurodollar

The rise and fall of the Eurodollar[4] may be the canary in the mine reflecting impending changes to USD role in international funding and investment. “After World War II, the quantity of U.S. dollars outside the United States increased significantly, as a result of both the Marshall Plan and imports into the U.S., which had become the largest consumer market after World War II. As a result, large amounts of U.S. dollars were in the custody of foreign banks outside the United States”[5]. The initial Eurodollar bookings were thought to be made by Soviet Union and Communist China who feared their deposits in North American banks would be frozen. Hence, they moved the USD deposits to Soviet-owned banks with a British charter to prevent confiscation.

At that time, the US financial system was highly regulated; e.g. Regulation Q set the ceiling on interest rates for time deposits. “In the mid-1950s, Eurodollar trading and its development into a dominant world currency began when the Soviet Union wanted better interest rates on their Eurodollars and convinced an Italian banking cartel to give them more interest than could have been earned if the dollars were deposited in the U.S”[6]. The Eurodollar business expanded because Eurodollars operated outside US supervision, offered higher deposit rates and were a cheaper source of funds because they were free of reserve requirements and deposit costs. London emerged as the financial center for the intermediation of these offshore deposits.

Neels Heyneke and Mehul Daya notes “the Eurodollar market exploded after 1990, triggered by an amendment to Regulation D which meant that net Eurodollar deposits had a zero reserve requirement. The Eurodollar market also became an important source of funding for US banks, having grown in this role from half of (in the 1980s) to nearly equivalent the size of the Federal funds market currently”. “The system evolved from a payment system to a source of funding – especially for the shadow banking system and the carry-trade”. “In the new age of financial innovation, the growth in the Eurodollar market exploded. At the peak in late 2008 US branches of foreign banks were raising $600 bn in US wholesale money markets and transferred these dollars to fund the shadow banking system and other carry-trade transactions”. Not surprisingly, the shadow banking system was the epicenter of the 2008 global financial crisis.

Neels Heyneke and Mehul Daya estimated the Eurodollar market peaked at 0.87 times the size of the total US banking system in 2008. “However, post the 2008/09 financial crisis, with the introduction of new banking regulations and the Fed’s facility to pay IOER (interest on excess reserves), a flood of Eurodollars has been flowing back into the US – leaving the global financial system with a shortage of dollar liquidity”. “With this, the Fed has become both the supplier of dollars and a user of them. The Fed is trying its best to alleviate the pressure on the dollar shortage, while also trying to regain control of the dollar which it lost post the start of the banking deregulation”.

  • Loss of anonymity, sanctions and America First

USD supremacy came about because friends and foes alike made USD their currency of choice. But this advantage is dissipating. First, the anonymity protecting users from enforcement agencies and regulators are being vaporised by compliance rules such as Anti-Money Laundering (AMLA) and Know-Your-Customer (KYC) and digital audit trails. This is deterring users who would like to hide their transactions and wealth.

Second, the neutrality of the USD has been abandoned as the US has weaponized its control over the USD-centric international payments network. Karen Yeung notes this began with President Bill Clinton in 1993 and expanded under subsequent administrations. The US creates laws such as the International Emergency Economic Powers Act, Trading with the Enemy Act and Patriot Act to enable actions to be taken against firms or financial intermediaries for violations regardless of domicile and jurisdiction. The US can wield considerable influence over critical payments networks such as SWIFT[7] and Chips[8]. The US can punish foreign governments, firms and individuals by freezing bank accounts, seizing assets, and block their access to international commerce and finance; create refinancing and investing difficulties; and squeeze the pricing and liquidity of affected assets.  The US can force SWIFT to sever links with banks that did not comply with its sanctions. Sanctioned banks would be unable to send, receive or track banking instructions on their international transfers. Governments, firms and individuals suspected of breaching the sanctions can find themselves subjected to US investigations and penalties.

Karen Yeung notes the US has been adding Chinese companies to blacklists that “lay the groundwork for financial sanctions against these Chinese entities, forcing investors to weigh the choice of making money from China’s corporate bond market against the prospect of bond issuers being penalised by the US and suffering reputational damage…US authorities have also banned American investors from holding stakes in Chinese companies with links to the military, and threatened to delist Chinese companies from US exchanges if they do not comply with accounting rules…stirred further concern Chinese financial institutions could be targeted by American sanctions, including moves to curb China’s access to the dollar-denominated international payment system”.

In addition, hawks are pushing for more aggressive actions. Xiong Lan notes some US politicians attempted “to initiate the Compensation for Americans Act aimed at imposing sanctions on CPC officials and freezing Chinese assets in the US. Although the bill was blocked…the specific measures proposed…include freezing the necessary Chinese assets in the US in order to reach a bilateral compensation agreement with China, removing China’s eligibility for World Bank development loans, removing China’s developing country status in international bodies, and prohibiting the use of federal retirement savings for investing in China”. A worst-case scenario would involve “prohibiting Chinese state-owned banks from using the USD”. However, the US-based “Peterson Institute for International Economics (PIIE)” reminded on the need “to exercise caution on new financial restrictions against China” and to “avoid designating G-SIBs [global systematically important banks][9] and other high-profile entities without a full analysis and clear understanding of the potential consequences for US interests and international financial markets”.

China has responded in several ways. First, it is accelerating efforts to reduce reliance on USD and increase international use of yuan. China has expanded bilateral currency and payment arrangements and is exploring alternative currency arrangements with the growing list of sanctioned-affected countries such as Russia, Iran, Cuba, Turkey and Venezuela. China has also called for the Special Drawing Rights (SDRs) or a new global currency to replace the USD as the main reserve currency.

Second, China is developing new laws[10] to retaliate against foreign sanctions. Elizabeth Law reports “China has passed an anti-sanctions law, which it says will help it retaliate against punitive measures from Western governments…those involved in suppressing China or interfering in its internal affairs can be deported, have their assets frozen and be prevented from conducting business in the country…A new body will be set up to coordinate anti-foreign-sanctions work, and will coordinate with all other departments. The law, with just 16 articles, was passed by the National People’s Congress Standing Committee (NPCSC)…the European Union Chamber of Commerce in China…Such action is not conducive to attracting foreign investment or reassuring companies that increasingly feel that they will be used as sacrificial pawns in a game of political chess”.

Chen Qingqing and Li Qiaoyi notes “while the EU has a regulation to protect against the effects of the extraterritorial application of legislation adopted by a third country and the US owns a large number of legal ammunition in terms of long-arm jurisdiction, China lacks relevant laws in response to the external legal weapons”. The anti-sanctions law is a more comprehensive approach than the ad hoc orders issued by the Ministry of Commerce such as the unreliable entity list with “rules that could lead to severe penalties against foreign entities and individuals who undermine China’s national interests and Chinese companies’ legitimate rights” and an order “adopting necessary countermeasures against the unjustified extraterritorial application of foreign legislation”.

Chen Qingqing and Li Qiaoyi explains “the anti-foreign sanctions legislation marks an unprecedented move to put in place a wide-reaching yet sophisticated legal firewall to protect Chinese businesses and citizens…crystallize actionable countermeasures against the foreign governments and institutions that target Chinese businesses or individuals…legal effort to make up for losses that Chinese entities would suffer in case of foreign sanctions…more targeted legislative moves should be in the pipeline to get the country prepared for unexpected disputes and tensions”.

Jeff Pao notes “Hong Kong-based banks and financial institutions could soon be caught in a legal web of conflicting US and Chinese laws if Beijing moves as expected to impose its new anti-sanctions law on Hong Kong next month… banks would be punished by Beijing if they implemented the US sanctions in Hong Kong, or they would face secondary sanctions imposed by the US if they followed Beijing’s orders”. However, he observed there are “potential loopholes in the contradictory laws” as people or organisations could apply for exemptions from the anti-sanctions law.

Russia, which is subject to Western sanctions, has decided to reduce its use of USD. Dmitry Dolgin notes “over 2014-19, the share of dollar dropped by 15-20 percentage points in Russia’s trade and financial flows…Russia-China trade is the only area where de-dollarisation is more pronounced through a shift in oil contracts from US dollars to euros… Russian foreign debt continues to be actively de-dollarised, as maturing dollar liabilities are being replaced by euro and roubles…The area most challenging to de-dollarisation in Russia is private assets, as there has been no inclination to decrease dollar among banks, non-financial corporates and households”. “Russian households and corporates need to see a trustworthy alternative to the dollar before any material de-dollarisation of private sector trade and finance can be achieved”. Recently, Chinese Ambassador to Russia Zhang Hanhui[11] said the Chinese yuan’s share in China-Russia bilateral trade has risen from 3.1% in 2014 to 17.5% in 2020. Both countries also plan to expand bilateral trade aggressively. In the first half of 2021, bilateral trade reached $63.08 billion, up 28.2% year-on-year.

Sam Shead reports Russia’s $186 billion National Wealth Fund (NWF), which supports the nation’s pension and forms part of Russia’s gold and currency reserves, has “decided to reduce investments of the NWF in dollar assets…Once complete, the share of euro assets in the fund is expected to stand at 40%, the yuan at 30% and gold at 20%. Meanwhile, the Japanese yen and British pound will likely make up 5% each”. According to Ambassador Zhang Hanhui, the Renminbi already accounted for 30.4% of NWF and 12.8% of Russia’s reserve assets.

Xiong Lan reports in March 2021, “China and Iran signed a 25-year cooperation agreement…will enable China to purchase Iranian oil with the RMB. Using the RMB to price and settle payments for oil will have a direct impact on the monopoly of the USD in oil trading. Once the US commences a wider range and stronger financial sanctions against China, RMB internationalisation will definitely accelerate”.

Hence, weaponisation of the US currency networks is destroying the benefits of anonymity and neutrality. This will increase defections from the USD-ecosystem to alternative ecosystems, most likely anchored by yuan or crypto-currencies. Though these sanctions are aimed at foes, it increases compliance costs and risks for all private sector intermediaries and firms. In addition, America First policies such as tariffs, labelling countries as currency manipulators, reducing Chinese access to technology and education, attempts to reshore production and Buy America will have negative effects on long-term international demand for USD. It is overlooked that it is the globalisation charge spearheaded by American firms, intermediaries and investors that cemented USD supremacy. If these policies lead to deglobalisation of their operations, the inadvertent consequence of America First will be USD Last.

There are more alternatives

The biggest threat to USD supremacy is that there are more alternatives today. First, most capital markets around the world conform to international regulatory standards. This has narrowed the advantage of US markets and increased the availability and accessibility of non-USD investible assets.

Second, while China’s yuan is not an equal but it is likely to play a role in reducing USD dominance. China is preparing for greater internationalisation of the yuan by strengthening its regulatory framework and liberalising its markets – lifting restrictions on investment quotas and easing foreign entry. The range of Yuan-denominated financial products, foreign participation and market liquidity is growing. Its domestic fund management industry and bond market has grown to be the among the largest in Asia.

Third, technological alternatives to bypass the USD ecosystem such as digital currencies, financial blockchains and cryptocurrencies have emerged. Sanctioned countries have been keen to experiment. Alessandro Arduino notes Venezuela, “in February 2018 tried issuing its own cryptocurrency to circumvent financial pressure from Washington and deal with hyperinflation. The Petro, which was backed by oil reserves, failed miserably – but Caracas’ experience opened up the possibility of a national cryptocurrency”. “That same year, Iran announced it would issue a national cryptocurrency to use blockchain technology to develop a new financial infrastructure that was not linked to or affected by US-led sanctions…the Central Bank of Iran presented a draft on the legal structure for issuing a cryptocurrency based on the open-source blockchain technology Hyperledger Fabric…it issued regulatory framework Version 0.0, which recognised global cryptocurrencies and licensed their trade, but prohibited their use for internal payments. Early this year, Iranian regulators allowed the sale of crypto-mining licences…The US government…reaction. In December 2018, the Blocking Iran Illicit Finance Act, which threatened Iran with additional sanctions if it developed a national cryptocurrency, was introduced…A subsequent bill called for increased sanctions against any entity or person supporting Iran in the development of its national cryptocurrency, or even facilitating its adoption”.

China is furthest ahead in the central bank digital currency (CBDC) race. James Pang notes the People’s Bank of China (PBOC) set up a legal research team in 2014 and completed a trial to transact and settle bank acceptance bills in 2016. In April 2020, China’s digital currency electronic payment (DCEP) rolled out pilot tests in Shenzhen, Suzhou, Xiong’an New Area, Chengdu, and plans to use it at the forthcoming Winter Olympics games. It is also collaborating with other countries and SWIFT to facilitate digital yuan cross-border transfers. Alessandro Arduino points out “a Chinese endorsement of some sort of national cryptocurrency payment is going to be a direct challenge to the US. The size of China’s internal market, along with the population’s widespread use of mobile payments and its prominence in global trade, could trigger widespread adoption of a crypto yuan”.

Roger Huang notes “China is in a technological battle to define standards with emerging technologies: this has been a primal focus of the Chinese state. The amount of state-enforced patents and control of 5G technologies by Huawei can be seen as an example that dovetails with an inherently mobile-friendly approach to currency exchange. Whoever defines the standard of a new technology gets outsize representation in its iterations and can shape where it goes. A successful transnational digital currency backed by government fiat and force is something private organizations and governments around the world are liable to look at as a model and perhaps as a standard on its own – letting China define digital value for the majority of people on the world, if it were to come to pass”.

Roger Huang explains a digital Yuan “lets China interoperate between different currency contexts where the USD may start to fade”. Increasing “adoption of Chinese tech standards and the ubiquity of mobile payments with the widescale adoption of solutions like M-Pesa, and the creeping growth of AliPay in Africa help heighten the perceived value of the RMB in international contexts…A digital currency that can interoperate between different African systems or other Belt and Road Initiative Partners as well as what may be their largest trading partner, China, backed by some government force, may be able to sweep the area as people question the value of holding US dollar debts amid collapsing domestic currencies”. He suggests these trends “reinforces that digitization of currency is inevitable – it is whether or not it is cryptocurrency that prevails that will determine whether that will be at the hands of nation-states battling with one another, or a set of independent peers cooperating with one another”.

Digital currencies are gaining momentum. Recently, Sam Shead notes “Moscow published a consultation paper on a digital rouble in October, and aims to have a prototype ready by the end of 2021. Pilots and trials could start next year”. In June 2021, El Salvador became the first nation to recognise Bitcoin as legal tender.

David P. Goldman warns “the role of reserve currencies that began with the pound sterling under the Pax Britannica will atrophy over time, and with it tens of trillions of dollars in zero-interest loans that the world now extends to the United States” and that “China’s digital yuan is one of the catalysts”. But, as he explains “there’s nothing conspiratorial or nefarious about the great transformation of trade and finance…Every business in the whole variegated, complex supply chain will make a digital transfer from its CBDC account”. At the moment, “exporters and importers keep bank balances in dollars and euro (mostly), because those are the currencies in which banks lend…With the advent of smart logistics, just-in-time inventory management and just-in-time payments…exporters won’t have to write contracts in foreign currency for payments due months ahead, and buy expensive hedges against currency market fluctuations. They will just receive payment in their own CBDC”.

As a consequence, “the combination of Big Tech transformation of global supply chains and fintech transformation of the global payments system will bypass the banking system”. David P. Goldman explains “the digital system will hollow out the deposit base of the banking system, most emphatically for international trade financing. Reserve currencies won’t disappear, but they will become vestigial…The $16 trillion of offshore dollar deposits at international banks…will shrink to a small fraction of its present volume, because the Big Tech/fintech revolution will make them redundant”.

Digitalisation will also reduce global demand for USD hard currency. JP Koning notes estimates between 40% to 72% of the $1.74 trillion paper dollars in circulation are held outside of U.S. borders. He explains the foreign demand for US hard currency is strong in dollarized or partially-dollarized economies. “Nations tend to dollarize because they have experienced high domestic inflation”. Due to the unreliable value of their domestic currencies, “individuals and businesses develop a habit of using dollars for making transactions or hoarding wealth…Because U.S. dollars are so liquid, they have become the preferred medium for illicit international business dealings”. The benefit is the Fed doesn’t “doesn’t have to pay any interest on them”. He estimates based on a risk-free rate of 2.2%, “the Fed is currently earning $22.9 billion each year from foreign currency owners (2.2% x $1.043 trillion)”. The use of US hard currency is likely to be eroded by digitalisation; it is difficult to envisage criminals lugging suitcases stuffed with cash in the future.

Overall, the emergence of digital networks and assets will disrupt the USD-centric messaging and payments infrastructure. Digital networks and assets will drastically cut settlement times and risks, lower costs by compressing cross-currency spreads and transaction fees, and create new conveniences and applications by facilitating algorithms. The reconfiguration of the intermediation and data landscape implies an increasing proportion of international transactions would occur outside the US-centric network. This would undermine US oversight over the global financial system.

Beginning of the end

Over the past 7 decades, it seems like the world couldn’t get enough USD. The US could consume and spend as much as it wanted because expanding US deficits and central bank balance sheets did not result in currency debasement but instead, satiated the bottomless demand for international liquidity. Will these favourable conditions for USD demand still hold? Can the Fed willy-nilly triple the size of its balance sheet (QE) and yet remain confident that there is sufficient global demand to absorb the enlarged supply of USD.

In my view, this time is different. Too many forces are working against USD demand. Customers are alienated by geopolitical tensions, decoupling policies and sanctions which are increasing costs (compliance risks) and undermining confidence in the USD as a safe store of value. Advances in technology are lowering the barriers to the emergence of competitive networks and assets that offer greater convenience and lower costs. The USD is not in immediate danger but there is likely to be gradual diversification away from the USD which over time would lead to the end of USD supremacy.


Alessandro Arduino (7 September 2020) “Cryptocurrency: the next battleground in the US-China rivalry”. SCMP.

Chen Qingqing, Li Qiaoyi (7 June 2021) “Anti-foreign sanctions draft law proposed to top legislature”. Global Times.

Dmitry Dolgin (8 December 2020) “ING: Russia de-dollarising”.

David P. Goldman (21 April 2021) “China’s digital yuan displaces the dollar”. Asia Times.

Elizabeth Law (11 June 2021) “China passes law to counter foreign sanctions”. The Straits Times.

Global Times (30 July 2021) “Yuan expands in China-Russia trade amid US financial sanctions”.

Jeff Pao (28 July 2021) “HK banks may soon need to choose between US and China”. Asia Times.

JP Koning (4 Jul 2019) “How much U.S. currency is held overseas?” Bullion Star.

Karen Yeung (25 August 2020) “Explainer: How the US uses the dollar payments system to impose sanctions on a global scale”. SCMP.

Karen Yeung (21 October 2020) “China’s US dollar debt market showing cracks from US sanctions and prospect of more”. SCMP.

Lyn Alden (6 December 2020) “The fraying of the US global currency reserve system”.

Mary E. Lovely, Jeffrey J. Schott (June 2021) “Can China blunt the impact of new US economic sanctions?” Petersen institute for International Economics (PIIE)

Michael Hudson (6 February 2021) “Changes in super imperialism”. Naked Capitalism.

Neels Heyneke, Mehul Daya (September 2016) “The rise and fall of the eurodollar system”. Nedbank.

Phuah Eng Chye (2015) Policy paradigms for the anorexic and financialised economy: Managing the transition to an information society.

Phuah Eng Chye (5 June 2021) “Global reset – Two whales in a pond”.

Phuah Eng Chye (19 June 2021) “Global reset – Monetary decoupling (Part 1: Sterilisation and QE)”.

Phuah Eng Chye (3 July 2021) “Global reset – Monetary decoupling (Part 2: Economics of large central bank balance sheets)”.

Phuah Eng Chye (17 July 2021) “Global reset – Monetary decoupling (Part 3: Consequences of diverging policies)”.

Phuah Eng Chye (31 July 2021) “Global reset – Monetary decoupling (Part 4: Lessons from Plaza Accord)”.

Roger Huang (25 May 2020) “China will use its digital currency to compete with the USD”. Forbes.

Sam Shead (3 June 2021) “Russia says it will remove dollar assets from its wealth fund”. CNBC.

Wenxin Du, Jesse Schreger (May 2021) “CIP deviations, the dollar, and frictions in international capital markets”. NBER.

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Xiong Lan (28 July 2021) “Escalating China-US confrontation will accelerate RMB internationalisation”. ThinkChina.

[1] This refers to the global savings glut hypothesis. See “Global reset – Monetary decoupling (Part 3: Consequences of diverging policies)”.

[2] The Belgium-based SWIFT is a global messaging service connecting 11,000 banks and companies.

[3] The New York-based Chips is the clearing house for large-value domestic and international USD payments.

[4] Eurodollars are time deposits denominated in U.S. dollars at banks outside the United States, and thus are not under the jurisdiction of the Federal Reserve. See



[7] The Belgium-based SWIFT is a messaging service connecting 11,000 banks and companies globally.

[8] The New York-based Chips is the clearing house for large-value domestic and international USD payments.

[9] Currently, out of the 30 G-SIBs, four are Chinese banks (Bank of China, Agricultural Bank of China, Industrial and Commercial Bank of China, and China Construction Bank). See Xiong Lan.

[10] Mary E. Lovely and Jeffrey J. Schott provides an assessment of whether these laws can blunt the impact of new US economic sanctions.

[11] See Global Times.