The Dollar is Dying

When the United States architected the new post-war order in 1945 it thrust the US dollar into the world’s reserve currency. It superseded the British pound which was the global reserve currency for most of the 19th and half of the 20th century before Britain bankrupted itself fighting the two world wars. Before that, it was the Dutch gilder that was the world reserve currency for the 17th and 18th centuries. After the war, all currencies were pegged to the US dollar, and the US dollar was in turn backed by all the gold they were sitting on for the payments they had received for financing the war. This meant that anyone could present their dollar bills to the US government in exchange for the equivalent value in gold.

There are numerous advantages to holding the world’s reserve currency. Foreigners want to hold your currency because it is used to settle international trade. It anchors the currency and makes it a store of value. Those green-backed currency notes become a valuable export, but as long as it is backed by gold, it is only as valuable as the underlying gold. This is where it starts to get interesting. Between 1945 and 1971 demand for dollars increased. The world economy was becoming more globalized. Countries affected by the world wars needed to be rebuilt and opportunities arose for the rest of the world to sell them the raw materials and expertise to do so. In 1945 global exports adjusted for inflation and at constant prices were 1.5x that of total exports shortly before World War 1. By 1971, that factor had skyrocketed to 7.5% - in other words, total exports had increased fivefold in 26 years. Given that more than two-thirds of global trade is transacted in US dollars, the US ran into trouble extracting enough gold from the ground to back the dollars they had to print. Nixon, in what became known as the Nixon Shock, announced that the dollar would move off the gold standard. This was the best and worst thing to happen to the dollar. It gave them a license to print gold. It costs 17 cents to print a $100 bill. You do the math - there is no better business in the world than producing something that costs $0.17 and then selling it for $100.

This cheap money printing exercise helped the US finance wars in Vietnam, the Gulf States, Iraq, and Afghanistan, not to mention an invasion of Panama and numerous other interventions. Not only did the US dollar as a reserve currency fund their foreign policy initiatives, but it also enabled the United States to borrow huge sums of money from the rest of the world. Who wouldn't lend money to a country that can literally print gold? In the past 100 years, US federal debt has ballooned from $400 billion to $30 trillion. People have trouble understanding big numbers, so let me break this down for you:

1 million seconds = 11.5 days

1 billion seconds = 31 years

1 trillion seconds = 317 centuries

So for total debt to grow from $400 billion to $30 trillion is a huge deal. The United States government is technically insolvent - it has more liabilities than assets, and its income is less than its spending. So how is it possible it keeps going? The US dollar is the world’s reserve currency and it is no longer backed by gold, which means the United States prints gold. You could argue this is their secret weapon, and they would do everything possible to protect it.

Let us now wind the clock back to February 2022 and the US invasion of Ukraine. Biden quickly followed with a string of import bans and sanctions, in addition to freezing the assets. These actions set off a bunch of unintended consequences that are going to weaken the dollar and accelerate its demise as the global reserve currency.

Consequence 1: Russia Can Barter its Way Around Sanctions

Russians don't make their money through the financial system, so blocking them off from the international financial system does not have the same impact as it would have on the average American. Russia's natural resources reserves are worth $75 trillion by Statista's estimate. This amount incorporates, among other things, coal, oil, natural gas, gold, timber, and rare earth metals. Russia holds the world's largest proven natural gas reserves at 1.32 quadrillion cubic feet, accounting for nearly 20% of the global total as of 2020. Russia also has the second-largest gold reserves at 6,800 tons or more than 12% of the global total as of 2021. Russia was the world's third-largest crude oil producer at 12% of the global supply in 2020. Russia's proven oil reserves were the world's sixth largest at an estimated 107.8 billion barrels. In industrial diamonds, the country accounted for a third of 2021 global production and 61% of the commodity's reserves. Russia is the world's richest commodity country, which means it is able to barter its way around sanctions. Sure, it will not be able to barter with the United States, but one needs to remember that the US accounts for only 15% of the global gross domestic product. In addition, the United States is not Russia’s biggest trading partner. In fact, it is only 9th on the list. It exports 11 times more to its largest trading partner - the European Union, and four times more to its second-largest partner, China. To put everything into perspective, Russia exported a total of $256 billion for the calendar year ended 2021 and a measly $17.5 billion to the United States. This makes the United States nothing more than a rounding error for Russian exports. Sure, countries in the European Union introduced sanctions against Russia, but in many cases, they were more symbolic than substantive. Russia’s gas pipelines into Europe are so entrenched that to cut them off would force a total collapse in the electricity grid.

Consequence 2: It Forced Russia Closer to its BRICS Partners

BRICS is an acronym for five leading emerging economies: Brazil, Russia, India, China, and South Africa. The first four were initially grouped as "BRIC" (or "the BRICs") in 2001 by Goldman Sachs economist Jim O'Neill, who coined the term to describe fast-growing economies that would collectively dominate the global economy by 2050. South Africa was added in 2010. The BRICS have a combined area of 39,746,220 km2 and an estimated total population of about 3.21 billion, or about 26.7% of the world's land surface and 41.5% of the global population. Brazil, Russia, India, and China are among the world's ten largest countries by population, area, and GDP, and the latter three are widely considered to be current or emerging superpowers. All five states are members of the G20, with a combined nominal GDP of US$26.6 trillion (about 26.2% of the gross world product), a total GDP (PPP) of around US$51.99 trillion (32.1% of global GDP PPP), and an estimated US$4.46 trillion in combined foreign reserves (as of 2018).

So BRICS account for a substantial part of the global economy. Following the Russian invasion of Ukraine, the 193 members of the United Nations voted on special resolutions. Countries were given three options - in favor of punitive actions against Russia, abstained from voting, or against these actions. There were four resolutions in total. Brazil voted in favor of some and abstained from one making it mildly in favor. India and South Africa abstained from all four. China was against one and abstained from three. In aggregate, the BRICS abstained, which tells us they did not want to turn their backs on their Russian partner but also were not too keen on pissing off the United States. If you look at the map, it shows a clear division of loyalties. While Africa is divided, the East (with the exclusion of Australia and Japan) are generally supportive of Russia. In addition, the BRICS family could be growing. Just over two weeks after Russian state media announced that Iran and Argentina filed their official applications to join BRICS, Saudi Arabia, Turkey, and Egypt began the process of making the same move.

Consequence 3: Countries are Starting to Trade in Other Currencies

BRICS countries have been discussing the possibility of creating their own currency for some time now. The idea behind this is to reduce their reliance on the US dollar and create a more stable and equitable global financial system. The currency would be based on a basket of currencies, including the Chinese yuan, the Russian ruble, the Indian rupee, the Brazilian real, and the South African rand. This would provide greater stability to the currency and reduce the dependence on the US dollar. In addition, the BRICS currency would promote greater economic integration among member states, which would lead to increased trade, investment, and growth. This would benefit not only the BRICS countries but also other developing countries that would benefit from a more stable and diversified global financial system.

In the last year, there have been several major announcements of international trades being settled in currencies other than the dollar. Saudi Arabia is negotiating with China to accept the yuan instead of dollars for oil sales. Russia and India are doing the same, but settling in UAE dirhams. Brazil and Russia are focussing on using their own currencies in the settlement of bilateral trade transactions. Recently France and China agreed to a trade for liquified natural gas clearing in yuan.

The inclusion of Saudi Arabia in this group is significant. To understand this we need to chat briefly about petrodollars. Agreements in 1971 and 1973 stipulated that oil transactions were to be done in US dollars. Saudi Arabia, being one of the world's largest producers of oil, was instrumental in these agreements. In return for denominating oil sales in US dollars (in other words, the Saudis were to refuse all other currencies, except the U.S. dollar, as payment for their oil exports) the United States would offer military protection for Saudi Arabia's oil fields.

In 2023, there have been a few changes that suggest the petrodollar might not be as solid as once thought, and that the US might need to affirm its strength. Most notably, on March 29, Saudi Arabia announced that they have agreed to become a “dialogue partner” with the Shanghai Cooperation Organisation, the world’s largest regional political and defense organization in terms of geographic scope and population.

Lately, however, relations between the Saudis and the US have started to sour. Whereas US President Donald Trump had embraced Saudi Arabia, making it the first place he visited overseas after taking office in 2017, Biden took a different approach. During his campaign for the presidency, he vowed to make Saudi Arabia a global “pariah” over the murder of Khashoggi, who’d been a US citizen and Washington Post columnist. Biden didn’t actually go that far after taking office in 2021, but he did step back from the Saudis. He released a report blaming Prince Mohammed for Khashoggi’s killing. Unlike Trump, who met and spoke directly with Prince Mohammed, Biden shunned him. The White House said it was more appropriate for the president to deal with his counterpart, King Salman bin Abdulaziz, and relegated the crown prince, who is also the defense minister, to liaise with US Secretary of Defense Lloyd Austin. This was seen in the kingdom as insulting to the man who already effectively rules the country and will almost certainly become its next king. Any weakening of the petrodollar arrangement will certainly weaken the dollar as a global reserve currency.

Consequence 4: Many are Now Afraid of Holding US Dollars

When the United States effectively froze half the foreign currency reserves of Russia, shock waves were sent through the hallowed halls of every central bank in the world that was paying attention, as they asked, if this happened to Russia, it could happen to anyone. It is easy for the United States to hurt countries with sanctions. They sit at the heart of the global financial system. Eighty-seven percent of all global trade is in United States dollars. In addition, counties own trillions of dollars of United States treasury bonds. These are bonds issued by the US government. If you buy these bonds, you are effectively lending money to the US government. Japan has $1.2 trillion, China $970 billion, the United Kingdom $634 billion, and the list goes on. If you do something to piss the US off, they could just freeze those assets because they control them.

The administration of sanctions is done through OFAC - the Office for Foreign Asset Control. This organization has the power to impose sanctions on countries, companies, and individuals. It has the power to levy significant fines against entities that defy its directives, including freezing assets and barring parties from operating in the United States or doing business with United States entities and individuals. So as the world's largest economy and global regulator sets a precedent of freezing assets of governments that either oppose it or side with its enemies, central banks are starting to recognize the benefits of diversifying their foreign currency reserves away from the US dollar.

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