The World has entered 2020 with social unrests, political risks, terror attacks, trade wars and the corona virus. In fact, all those turbulences are natural because we have been witnessing an undeniable geopolitical phenomenon: The old-world order is outdated, the new one is being formed and as all transition periods do, the current one also brings turmoil together with it.
When the transition period is examined, at first it is possible to observe that the unipolar international system based on US hegemony is coming to an end. In international security arena, the US has started to lose its superiority due to the hypersonic missiles developed by Russia and China. In the world economy, center of gravity has already shifted to Asia-Pacific region. At present, the US hegemony continues only in the field of international finance, thanks to the position of the dollar’s global reserve currency. However, even the dollar, which is the last stronghold of American hegemony, is now challenged.
The US dollar has been the world’s reserve currency for 75 years. Fundamentals of modern international economic system were created in Bretton Woods, US during the last period of WW2. The victorious powers of the Western world came together at Bretton Woods conference to discuss the economic order to be established after the war. This conference then gave birth to institutions that would regulate the international economy such as the World Bank, IMF, GATT (later the World Trade Organization). Providing resources for post-war infrastructure investments, solving financial problems and facilitating trade were made possible through these organizations.
One of the hottest debates that took place at Bretton Woods conference was about the creation of a global currency which would be used for international transactions. As the representative of UK delegation, notorious economist J.M. Keynes proposed an international currency (Bancor) issued by global payment association. However, the proposal by the economist White, who attended the meeting on behalf of the U.S. Treasury Department, was completely different. Accordingly, the US currency should be pegged to gold and all national currencies of the globe should be pegged to US dollar under a fixed rate. The US would also guarantee to give gold in exchange for the dollar to every country that accepts the system. Participants supported the idea proposed by Mr. White although Mr. Keynes’ view was based on more solid foundations. As a matter of fact, the US was the biggest power, it must have been the hegemon of the post-war period: Hegemony to others, with the consent of others. Ultimately the US dollar, backed by gold, has become new global currency.
This mechanism continued until US President Nixon unilaterally announced its end in 1971. It was replaced by the petrodollar system and free float exchange regime were introduced for the currencies. For nearly 50 years, the petrodollar system has been ruling the world. It stems from the Middle Eastern oil crises of the 1970s, when as biggest oil exporter Saudi Arabia bound itself to selling oil only in US dollars. After that, wherever oil is produced in the world, international trade of it has been made through the US dollar. Given that Saudi oil has played the major role in preserving the status-quo of US dollar as global reserve currency, the US turned into the security provider for Saudi Arabia and other oil rich Gulf states. Although the system seemed to change, it was not actually changed. In other words, the dollar maintained its reserve currency position. Only in the past, the dollar was officially indexed to gold, while this time it is tacitly indexed to a strategic commodity.
Nevertheless, the US dollar’s global position is now facing a tough challenge. The main reason for this is the tectonic change in international balances of power. The US has already lost its leadership in the world economy when calculated with purchasing power parity. In addition, with the structural change in international trade (not in Washington’s favor) essentiality of dollar, as an instrument for international payments, is opened to discussion.
Reminding the realities of today’s world economy, Head of the Bank of England, Mr. Carney questions why the dollar is still global reserve currency. He proposes the creation of an international currency as Keynes did before, only this time a digital one, to be used in international economic relations instead. In fact, Carney does not rediscover America! He only speaks loudly the silent revolution that has taken place in the world in recent years and it is not a coincidence that the voice comes from Britain. Having most sophisticated and diversified capital markets, the UK is also home to significant non-dollar financial operations. For instance, outside of China, the first yuan bonds were unveiled in the UK and this underscores the London’s status as the world’s biggest yuan trading hub outside China.
On the other hand, currently, around 48 % of global settlements are still made in dollar, compared to 30 % in euro. The share of other currencies is relatively low. However, tendency to trade with national currencies and efforts to internationalize some currencies such as Chinese yuan deserves special attention since it would correspondingly reduce the utilization of the U.S. dollar. Important steps have been taken recently to de-dollarize international trade and finance.
On March 26, 2018, China activated the Shanghai International Energy Exchange and began pricing oil in its own currency. The Chinese also provide options to the third countries that want to sell oil to China whether to receive yuan or gold in return for exported oil. Moreover, in late 2019, Russian national oil company Rosneft (20% owned by BP) announced that it would use euro as base currency in its petroleum pricing instead of dollar. While the reign of the dollar has been preserved thanks to its linkage with oil since the 70s, now specifically that linkage is under attack.
Apart from energy trade, China has reached currency swap agreements with many countries and it also developed its own CIPS against US controlled international money transfer system SWIFT. EU follows the trend with its INSTEX system so does Russia with its own SPSF due to threat of sanctions. For now, these relatively new developments are in early stage but ongoing trend seems to be irreversible. What makes the issue more complicated is the fact that not only Russia and China, but also NATO allies of US such as the UK and other European countries are enthusiastic about the demise of dollar’s global role.
So what will replace the dollar as global currency? Here it is not clear yet. Multiple scenarios are on the table. For instance, SDR, which is only used by the IMF, could be transformed into an international reserve currency. It could be a digital one as well. However, reorganization of the current structure of the IMF is a prerequisite for this aim since the US, only country which enjoys veto power, is still decisive in this institution.
Another possibility is absence of global reserve money and formation of regional money mechanisms instead. Economic nationalism is on the rise that could result in spread of trade with national currencies or even assertive regionalism. China-supported Asian Investment and Infrastructure Bank is already an alternative to US-supported World Bank. More precisely the New Development Bank under BRICS could be a counter balancer against US controlled IMF unless there will be consensus on future of international economic order between the stakeholders.
Another scenario is the re-introduction of gold, the most ancient currency of humanity, as a basis for new global money. Proportional distribution of gold reserves among the big economies and huge gold purchases by some Central Banks recently are interpreted as a sign for this option. In comparison with thousands of tons of gold in the American and European Central Banks, the official gold reserves of Russia and China have exceeded 2,000 tons for the first time. However, it is speculated that China has stored even much larger amount than the official statistics. Experts working on China speculate about Beijing’s success to gather huge amounts of gold through Hong Kong. As a matter of fact, China’s capability to offer gold payment to the energy sellers in return for oil, confirms this claim.
Of course, time will show that which scenario will be realized. The dollar will not be replaced as the global currency suddenly but one does not need a guide neither when the village is in sight: The US dollar’s status as reserve currency is started to be challenged. The US dollar as last stronghold of American hegemony will lose its global position gradually during 2020s in a world order which is already under transition from uni-polarity to multi-polarity.