For many years, I have contended that the US dollar will remain the main reserve currency in the world economy. Today, this is still accurate. No other currency, real or virtual, can replace the dollar as the cornerstone of the world's monetary system.
Despite still being the “reserve currency” of the world, the dollar continues to face a variety of non-economic difficulties that are restricting its power on the global stage. This is a product of the increasingly fragmented global economic system. Geopolitics and national security are overtaking economics as the main determinants of how states and nations interact.
Nations will eventually be compelled to choose between two radically divergent courses of action: either boost collaboration to strengthen multilateralism and its rule-based framework, or embrace economic decoupling as an essential implication of increased risk mitigation by individual states.
As the biggest economy in the world, the depth and breadth of its financial markets, and the predictability brought on by institutional maturity and respect for the rule of law, the US has long maintained the dollar's status as a reserve currency.
The US now has more power to use its own currency to purchase goods and services from other nations while having access to a larger pool of low-cost financing, which is essentially what former French president Valéry Giscard d'Estaing referred to as a “exorbitant privilege” in the 1960s. By using the dollar as a means of commerce and a store of value, other nations have seen considerable increases in efficiency.
It is a clause in an unwritten agreement under which America receives benefits in return for careful system maintenance. However, during the preceding 15 years, both the US-caused global financial crisis of 2008 and the unexpected introduction of trade tariffs in 2017 have raised concerns about the contract's latter provision.
The “cleanest dirty shirt syndrome” contends that despite the dollar's hegemony being shaken by these events, it was not fundamentally destroyed. Even though the dollar is not a perfect reserve currency, it is nevertheless seen to be the cleanest currency for this purpose.
This position has become substantially tougher as a result of the US Federal Reserve's poor handling of the cycle of interest rate rises over the last two years and the growing significance of resilience in economic and company strategy. The global payment and trade infrastructures are now making greater attempts to build pipelines around the dollar than to entirely replace it.
China has retained its position as the industry leader by pushing up efforts to create new regional and global institutions, boosting the use of its own currency in bilateral payment and loan arrangements, and revitalising the Belt and Road Initiative. However, it is not exclusive to China.
Rugged sanctions on Russia have raised global interest in transactions that don't use the currency. Furthermore, a growing number of nations are starting to think that they can someday reduce their dependence on US dollars. They are looking at how Russia has reoriented its commerce and abandoned the dollar in both export and import operations, although in awkward and costly ways.
Given these developments, the US and its allies effectively have two options. They may work together to reorganise multilateralism in a manner that wins the favour of what Goldman Sachs' Jared Cohen refers to as the “geopolitical swing states” (Geopolitical Swing nations). This would include modernising the governance, representation, and operations of the IMF and World Bank.
They may also choose to accept the short-term costs and risks associated with the decoupling necessary to appropriately de-risk. The G7's suggestion to “de-risk, not decouple” may appear enticing, but it is more likely to result in an unstable middle ground than a viable new equilibrium.
Economically speaking, there is little doubt that a more open multilateralism underpinned by a robust rule-based system provides advantages over the alternatives. But it is becoming evident that economics is no longer the main force behind trade and international finance. A major shift has taken place in the relationship between economics and the linked elements of geopolitics, politics, and national security.
Without a fresh, considerable effort, the secularly weakened multilateral system cannot successfully address this inversion, which supports the derisking and decoupling of cross-border supply chains and payments.