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zornes23253 April 17, 2023 Comment

Driven by perceived U.S. sanctions overreach, numerous countries now seek to circumvent the dollar-dominated financial system. Emerging technologies are paving the way.

By identifying key players, quantifying relative influence, and assessing the competitive landscape, FP Analytics breaks down complex foreign policy issues by mapping out spheres of influence and the risks and opportunities these topics present. Learn More

, we examine the forces shaping the global financial landscape and driving the adoption of new financial instruments by major institutions such as central banks, investment banks, and large tech companies as well as individual investors. Part I analyzes the status of the dollar as the world’s reserve currency, details the emerging challenges to the dollar, and walks through China, Russia, and the European Union’s efforts to transform the existing financial system. We also discuss the launch of China’s digital currency and its broad international and domestic implications. A digital renminbi allows the Chinese Communist Party (CCP) to tighten its domestic control and to export its influence internationally, boosting China’s long-term efforts to undermine the dollar and potentially weakening the impact of U.S. sanctions. The launch of China’s digital currency and other central bank digital currencies (CBDCs) around the world, combined with explicit efforts to de-dollarize by Russia and China, all pose threats to the current status quo. New technologies, economic power shifts and geopolitical tensions are driving fundamental shifts in the international financial system. While the international strength of the dollar still grants the U.S. unique privileges, new challenges are rapidly emerging with the potential to completely upend the international financial system as we know it.

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The development of new financial technologies and their adoption by nation states and private actors is unleashing transformative effects on the international financial system. Simultaneously, perceived U.S. sanctions overreach under the Trump administration is driving China, Russia, and the EU to seek alternatives to the dollar-dominated financial infrastructure in use today. The incentive to end dollar-reliance, circumvent U.S. sanctions, and boost domestic currencies has led to the development of alternative financial messaging systems, the launching of national digital currencies, and collaborative efforts to de-dollarize foreign reserve holdings. While today the dollar remains the dominant international currency, there is contentious debate among economists and policy experts on the extent to which that its status is under threat.

The centrality of the dollar in the international financial system grants the U.S. an outsized ability to exert leverage in geopolitical negotiations—a privilege that it used to cut off Iran’s banking system in 2018 and exclude Venezuela and North Korea from participating in most of the global economy. As geopolitics collide with technological innovation, powerful international forces such as China and the EU are taking steps to reinvent the international financial architecture that underpins the dollar’s global influence. Part I of FP Analytics’ three-part

U.S. influence over the international financial system has wide-ranging impacts, including playing a central role in the U.S.’s capability to contain China, Russia, and other countries; its ability to curb nuclear programs in Iran and North Korea; and its broader global influence. Since the 1990s, sanctions have served as a critical tool for U.S. international relations and undermining the U.S.’s ability to enforce sanctions through the current financial system could significantly shift global power dynamics, particularly among great powers.

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Since the early 2000s, central banks have been diversifying their holdings, and the percentage of reserves held in dollars has decreased modestly over the past five years, from 65 percent to 59 percent. The dollar still dominates international trade and finance, but technological improvements and waning U.S. influence are generating new challenges to the dollars’ status. The dollar’s increasingly precarious position has made U.S. policymakers begin to take the threat of losing influence seriously, but few concrete policy measures have been initiated to maintain dollar centrality. Meanwhile, China, Russia, and the EU have all begun building alternative financial infrastructure and to circumvent U.S. control.

In April 2020, China became the first major economy to launch a central bank digital currency, introducing a digital version of the renminbi. To date, the digital renminbi is only available domestically, and in limited supplies. Nevertheless, its launch has widespread implications both within China and internationally. The digital renminbi could lay a foundation for state oversight in the way that other Chinese technologies—such as facial recognition and smart cities—previously have, while simultaneously weakening the U.S.’s ability to enforce global sanctions. China will now serve as a test case for other countries’ adoption of central bank digital currencies, and if successful, the digital renminbi could accelerate renminbi internationalization, strengthen China’s existing alternative financial infrastructure, and give the country a first-mover advantage in developing the underlying technology and standards. Critically, in the long-term, it could provide an alternative source for financing international trade and business for China and other nations facing U.S. sanctions.

By providing an extensive mapping of the mechanisms underlying U.S. control of the financial system and the emerging challenges to this system, Part I provides a critical resource for governments, private companies, and individuals looking to understand and successfully navigate the financial system’s rapidly developing transformation. It lays the foundation for the comprehensive three-part analysis of the forces driving the ongoing revolution in the financial system explored throughout the

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The dollar has served as the world’s key reserve currency since the post-WWII international monetary order was established at the Bretton Woods Conference in 1944. The Bretton Woods system of fixed-but-adjustable exchange rates has since collapsed, but the central importance of the U.S. dollar in the international monetary system has endured. The widespread use of dollars as the predominant currency in international trade and payments grants the U.S. extensive control over the international exchange of goods and services and makes its ability to enforce sanctions particularly effective. Today, the U.S. is the only country that can effectively lock other countries out of the global financial system—something that is a source of resentment among other economic powers. Since most foreign exchange transactions (88 percent) are conducted in dollars, and these international transactions are transferred through the U.S. banking system, the U.S. has the power to cut off access to the dollarized economy. The U.S. uses this economic power as leverage in geopolitical negotiations and to levy economic sanctions against countries. For example, the U.S. has used its influence to exert pressure on the Belgium-based Society for Worldwide Interbank Financial Telecommunications (SWIFT) system, which is responsible for sending interbank messages containing the secure payment and transfer information necessary to settle international transactions. During negotiations over Iran’s nuclear program in 2018, the U.S. unilaterally pressured SWIFT into denying Iranian banks access to its messaging system, thus crippling Iran’s ability to conduct international trade. In 2017, the U.S. threatened to cut off China’s access to the dollar system entirely if it did not uphold sanctions against North Korea. These actions, among others, are now inspiring challenges to the current system from China, Russia, the EU, and other countries seeking to circumvent U.S. control.

The dollar’s status as the world’s reserve currency grants the U.S. an “exorbitant privilege”—the U.S. can purchase commodities without foreign exchange risk, borrow cheaply in its own currency, and impose economic sanctions. The dollar’s centrality in the international financial system gives the U.S. a unique ability to use the international financial system as a geopolitical tool. There are several key chokepoints the U.S. authorities target to facilitate (or interdict) the flow of dollars through the global economy and allow the U.S. to exercise its leverage over global trade, invoicing, and foreign exchange. Over 80 percent of global trade involves U.S. dollars, and transactions denominated in U.S. dollars must pass through domestic intermediaries before being settled. That grants the U.S. Office of Foreign Assets Control (OFAC) the ability to assert jurisdiction over any U.S. dollar transaction and surgically trace dollar transactions back to a foreign bank account, company, or individual, and block the transaction. For example, in the ongoing 5G dispute between the U.S. and China, the U.S. could use this financial leverage to further disrupt China’s ability to secure the necessary inputs to develop its domestic semiconductor industry. Beyond preventing U.S. domestic companies from exporting materials to China, the U.S. can intervene in transactions along the semiconductor supply chain that use U.S. dollars. If Taiwan Semiconductor Manufacturing Company (China’s largest semiconductor supplier) purchases raw materials from a copper mine in Zambia, and the payment is settled in dollars, the transaction must go through intermediary financial institutions in the U.S. Since the U.S. can intervene in the transaction, the companies are forced to abide by U.S. regulations. This power has contributed to making U.S. sanctions on China’s semiconductor suppliers so effective, and this capability has been a major driver for China to seek alternatives to the current system.

“The fact is we are moving towards an environment of increasing diversification by actors, by mediums, and by currencies. And in large part, this is because of the new technology we have, that gave rise to currencies like Bitcoin.”