How a Weaponized Dollar Could Backfire
United States foreign policy under President Donald Trump continues to run counter to America’s traditional post-war objectives. Should the US carelessly relinquish leadership of the global multilateral order, the dollar might eventually lose its own long-standing primacy.
Locking China Out of the Dollar System
By broadening the nexus between economic interest and national security, Trump is encouraging the decoupling of the world’s two largest economies and the emergence of a bipolar world order led by rival hegemons. Beyond fragmenting the trade and financial system that has underpinned the global economy for decades, the stage would be set for a devastating conflict.
LONDON – The recently announced “phase one” agreement between the United States and China has been touted as an important step toward a comprehensive deal that ends the trade war that has raged for over a year. But if you think that US President Donald Trump is ready to abandon his antagonistic China policy, think again. In fact, the Trump administration is already moving to launch another, closely related war with China, this time over financial flows.
In a highly integrated world economy, trade and finance are two sides of the same coin. Cross-border trade transactions depend on a well-functioning international payments system and a robust network of financial institutions that are willing and able to issue credit. This financial infrastructure has been built around the US dollar – the most liquid and exchangeable international currency.
The dollar’s position as the leading global reserve currency has long afforded the US what Valéry Giscard d’Estaing, then France’s finance minister, dubbed an “exorbitant privilege”: America can print money at negligible cost and use it to purchase goods and services globally. But, with the opening up of global capital markets, the US has also gained exorbitant leverage over the rest of the world.
Today, some 80% of global trade is invoiced and settled in dollars, and most international transactions are ultimately cleared through the US financial system. About 16 million payment orders transit daily through the Euro-American Society for Worldwide Interbank Financial Telecommunication (SWIFT) network. Thus, US restrictions on capital flows have more far-reaching effects than any trade tariff. And yet imposing them requires only invoking the 1977 International Emergency Economic Powers Act (IEEPA), which allows the US president to declare a national emergency and deploy a range of economic tools to respond to unusual or extraordinary threats.
The IEEPA has formed the legal basis for many US sanctions programs, with presidents using it largely to block transactions and freeze assets. For example, in the 1980s, President Ronald Reagan issued an executive order under the IEEPA blocking all payments to Panama after a coup brought Manuel Noriega to power. (Funds intended for Panama were diverted to an escrow account established at the Federal Reserve Bank of New York.)
Trump – who has proved more than willing to cry “emergency” when it suits him – has cited the IEEPA many times, including to justify tariffs on imports from Mexico and to assert his authority to demand that US companies “immediately start looking for an alternative to China.” Hoping to drive Venezuelan President Nicolás Maduro from office, he used the IEEPA to freeze the assets of state-owned oil company PDVSA.
Trump has also forbidden US investors from purchasing any debt owned by Venezuela’s government or trading in shares of any entity in which it holds a controlling stake. Meanwhile, Trump has given Juan Guaidó, the US-backed interim president, access to Venezuelan government assets held at the Fed since his predecessor, Barack Obama, froze them in 2015.
Contrary to popular belief, Trump has not imposed more sanctions than his forebears. But he has devised particularly creative ways – often taking advantage of America’s disproportionate financial leverage – to ensure that his administration’s measures impose maximum damage, regardless of the effects on third parties. Likewise, Russia faces not only standard asset freezes and transaction blocks, but also limits on access to the US banking system and exclusion from procurement contracts.
China, which is already struggling with declining exports, sluggish investment, weak consumption, and a growth slowdown, apparently is next. The Trump administration is reportedly considering restrictions on US portfolio flows into China, including a ban on US pension funds from investing in Chinese capital markets, delisting Chinese firms from US stock exchanges, and limiting their access to stock indexes managed by US firms. How such policies would be implemented remains unclear; it would be no easy feat. But lacking a well-defined strategy has never stopped Trump before, especially when it comes to using economic levers to advance geopolitical objectives.
This approach may work in the short term, but it is sure to catch up to the US. Trump’s repeated weaponization of the dollar undermines trust among holders of dollar-backed and US-verified assets. How many foreign companies will be willing to list on a US stock exchange knowing that they may be delisted at will? And how many non-US residents will keep their assets in US banks if any geopolitical skirmish can result in a freeze?
As mistrust of the US mounts, the drive for international monetary reform, which China has been advocating for the last decade, will gain momentum. This could mean expanding the international role of other currencies, such as the euro or, if China has its way, the renminbi. It could also lead to the creation of an alternate monetary system, centered on the needs of developing countries, especially oil and commodities exporters.
By broadening the nexus between economic interest and national security, Trump is encouraging the decoupling of the world’s two largest economies and the emergence of a bipolar world order led by rival hegemons. Beyond fragmenting the trade and financial system that has underpinned the global economy for decades, the stage would be set for a devastating conflict.
The Hardening of Soft Power
For decades, the distinction between hard and soft power offered a framework for dividing the world between governments seeking mutually beneficial cooperation and those bent on zero-sum gains. But now that the traditional tools of soft power are increasingly being used as a means of coercion, the old rules no longer apply.
PARIS – International-relations theorists generally distinguish between soft and hard power. Soft power refers to the exercise of political influence through flexible, non-binding instruments such as economic assistance; the dissemination of environmental, health, and civil-security standards; and exports of cultural goods. Soft-power leaders are generally reluctant to coerce others and prefer to wield influence by example. The European Union is the leading exponent of this approach.
Hard power, by contrast, refers to military and economic instruments of coercion. Rather than leading by example, countries that depend on the hard power at their disposal wield it to try to bend others to their will. Following Machiavelli, they would rather be feared than loved. Here, Russia is a quintessential example. And between Europe and Russia, the United States has long represented a unique combination of both forms of power.
But nowadays, the distinction between hard and soft is becoming less relevant, because soft power itself is being weaponized. In what some commentators now refer to as “sharp power,” traditional soft-power tools – trade, legal standards, technology – are increasingly being used to coerce. If one were to identify three primary causes for this change, it would be the rise of China, the ensuing Sino-American rivalry, and the new powers of digital technology.
So far, the most sensitive domain in which soft power has been weaponized is trade. Since President Donald Trump came to power, the US has ratcheted up import tariffs and invoked “national security” to justify its circumvention of the rules-based multilateral trading system. Although the US can no longer control the multilateral system singlehandedly, it still can harm its competitors (and its allies) on a bilateral basis.
The consequences of this weaponization of trade have been profound. By the end of 2019, the US will have an average import tariff rate of 6.5%, up from just 1.5 % three years ago, putting it close to Brazil in terms of import barriers. The Trump administration has now imposed levies on 90% of imports from China, yet its strategic objectives for the trade war remain unclear.
To be sure, the Trump administration wants to force China to reduce its bilateral trade surplus with the US, and many in the US want China to move toward a market economy. But the irony is that the trade war has forced both countries to embrace managed trade, which gives the Chinese state an even firmer grip on the economy.
A new era of managed trade implies significant risks for Europe. China may have to import less from Europe in order to import more from the US, or it may dump onto European markets exports that it can no longer ship to the US. Either way, international trade is increasingly becoming a zero-sum game.
The weaponization of soft power is also gaining ground in the legal domain, through the extraterritorial application of national laws. Both the US and the European Union rely on extraterritoriality, but the differences in how each wields this power is revealing. European extraterritoriality has never been used for strictly political purposes and is essentially limited to three areas: market standards, competition policy, and the protection of personal data.
The US, however, regularly uses the dollar to sanction any economic activity that it regards as a threat to its foreign-policy interests, even in the short term. The French bank BNP Paribas, for example, has been fined $9 billion by the US Department of Justice for violating US embargoes against Cuba, Sudan, and Iran. And under the 2018 Clarifying Lawful Overseas Use of Data (CLOUD) Act, US law-enforcement authorities can now access data held by American companies even when it is not stored in the US.
Once again, European companies have borne the costs of these measures. And because European firms are so heavily integrated with the US economy, Europe has struggled to maintain an autonomous foreign policy toward Iran. Unless the euro can be made into an international currency to rival the dollar, the European economy will remain highly vulnerable to US extraterritoriality.
A third area of soft-power weaponization has been technology, particularly with respect to 5G. Unlike 3G and 4G broadband systems, 5G deployment has far-reaching security and geopolitical implications, because it promises not only to improve mobile telephony, but also to accelerate the development of the Internet of Things and the digitalization of entire economies. Thus, any malicious intervention in the 5G architecture could cause considerable economic, social, or even physical damage.
Owing to China’s growing capacity to conduct cyber warfare, the head of the German intelligence service has expressed deep reservations about opening the German 5G network to the Chinese company Huawei. Although it is currently the world’s leading provider of 5G hardware, Huawei is subject to Chinese law, and thus ultimately answerable to the Communist Party of China and Chinese intelligence and security services.
Whatever one thinks of the Trump administration, the US is not wrong to highlight the potential danger posed by Huawei and Chinese technology providers generally. US allegations against Chinese companies such as Huawei and ZTE should open Europeans’ eyes to the threat of weaponized network technologies.
Looking ahead, it would not be unreasonable for the US to offer its support to European companies such as Ericsson or Nokia, which serve as counterweights to Huawei in Europe and elsewhere. For its part, the EU’s strict competition rules prevent it from extending overt assistance to these companies on its territory. And because the EU is not a state, it has no interest in providing state aid or otherwise playing the card of soft-power weaponization.
Yet European leaders should be careful not to ignore realities on the ground. Missing the opportunity to get ahead of a worrying new global dynamic would not be in the interest of the world’s last major soft-power actor.
Is the Global Dollar in Jeopardy?
The US Federal Reserve is right to be concerned, if not worried, about the greenback's dominance of international trade and finance. Fortunately for consumers, growing potential competitive pressure – call it the Libra effect – creates an incentive to make the existing system work better.
WASHINGTON, DC – Since the end of World War II, the United States dollar has been at the heart of international finance and trade. Over the decades, and despite the many ups and downs of the global economy, the dollar retained its role as the world’s favorite reserve asset. When times are tough or uncertainty reigns, investors flock to dollar-denominated assets, particularly US Treasury debt – ironically, even when there is a financial crisis in the US. As a result, the Federal Reserve – which sets US dollar interest rates – has enormous sway over economic conditions around the world.
For all the associated innovation evident since the launch of the decentralized blockchain-based currency Bitcoin in 2009, the arrival of modern cryptocurrencies has had essentially zero impact on the global taste for dollars. Promoters of these new forms of money still have their hopes, of course, that they can challenge the existing financial system, but the impact on global portfolios has proved minimal. The most powerful central banks (the Fed, the European Central Bank, and a few others) are still running the global money show.
Suddenly, however, there is a new, potentially serious player in town: Facebook’s Libra initiative. Facebook and a currently shifting coalition of firms are planning to launch their own private form of money that would, in some sense, be secured by holdings of major currencies.
Without question, Libra could become a widely used form of payment – partly because Facebook has over two billion monthly active users, but also because the existing financial system is full of inefficiencies. If private money could make it cheaper, easier, and safer to make payments, then consumers would be happy to use it. Few people care what is under the hood of the monetary engine; most just want crash-proof transactions.
The unfortunate truth is that our current payment system is expensive to run, including for sending money overseas in the form of remittances sent by workers back to their home countries. If Libra could allow people to send money as easily (and as cheaply!) as they post updates to Facebook, the currency would get a lot of likes.
We have repeatedly experienced how quickly a disruptive new digital technology can transform the economic landscape. Think of how fast taxis came under pressure from Uber and Lyft.
Bitcoin and its fellow crypto-travelers were designed to supersede financial intermediaries, such as banks. And, in theory, it would be possible to organize much of finance without the kind of banks and other intermediaries that currently exist. But as a matter of inconvenient reality, the crypto-market infrastructure that has developed can hardly be described as consumer-friendly. It’s too easy to lose your money or to have it stolen in myriad ways.
In contrast, Facebook represents a digital technology company that knows how to keep customers happy. Sure, people increasingly complain about its privacy policies or attitudes toward political speech, but they continue to use the service. There is a potentially potent combination lurking here: the rapid scale-up of digital technology, a focus on cheaper safe financial transactions, and a lack of concern for legacy systems.
Of course, Libra has some obvious disadvantages, including Facebook’s current reputation for not acting in the public interest. As a case study in public relations, it’s hard to imagine how the past year could have been worse for Libra’s prospects. And it is always possible for leading countries to block a private form of money by determining that it does not comply with regulations, such as anti-money laundering and Know Your Customer requirements.
But if Libra does not make progress, that just opens more space for some other, more careful corporate-backed entity. Or perhaps the challenge will come from a currency issued by a sovereign state, any of which is entitled to design and circulate its own form of money.
For some time now, there has been speculation that the Chinese renminbi could challenge or even one day displace the US dollar as the world’s main reserve currency. Perhaps, but it is not clear that we are moving closer to that day, because it is not clear that foreign investors will trust the Chinese political system with their rainy-day funds.
Still, the Fed is right to be concerned, if not worried. Growing potential competitive pressure – the Libra effect – creates an incentive to make the existing system work better, including through the new FedNow system, which will speed up payments.
In a recent speech, Fed Governor Lael Brainard argued that the Fed will innovate, to a moderate degree, and the dollar will be fine. She may be right. But for the first time in a long while, competition is coming to central banks. With a bit of luck, consumers may end up with a better deal.
The IMF Should Take Over Libra
Brilliant ideas that would be catastrophic in the hands of buccaneering privateers should be pressed into public service. That way, we can benefit from their ingenuity without falling prey to their designs.
ATHENS – The Libra Association is fragmenting. Visa, Mastercard, PayPal, Stripe, Mercado Pago, and eBay have abandoned the Facebook-led corporate alliance underpinning Libra, the asset-backed cryptocurrency meant to revolutionize international money. More corporations are likely to follow as pressure upon them mounts from worried governments determined to stop Libra dead in its tracks.
This is a good thing. Humanity would have suffered had Facebook been allowed to use Libra to privatize the international payments system. But the authorities that are now strangling Libra should look to the future and do with it something innovative, useful, and visionary: hand Libra, or its core concept, over to the International Monetary Fund so that it can be used to reduce global trade imbalances and rebalance financial flows. Indeed, a Libra-like cryptocurrency could help the IMF fulfill its original purpose.
When Facebook CEO Mark Zuckerberg announced Libra amid great fanfare, the idea sounded interesting and innocuous. Anyone with a mobile phone would be able to buy Libra tokens with domestic currency and by standard methods such as debit cards and online banking. Those tokens could then be used to make payments to other Libra users, whether to purchase goods and services or repay debts. To ensure full transparency, all transactions would be handled by blockchain technology. In sharp contrast to Bitcoin, however, Libra tokens would be fully backed by copper-bottomed assets.
To anchor Libra to tangible assets, the association backing it promised to use its revenues, along with the seed capital contributed by its member companies (at least $10 million each), to buy highly liquid, highly rated financial assets (such as US Treasuries). Given Facebook’s leading role, it was not hard to envisage a moment when half of the planet’s adult population, represented by 2.4 billion monthly active Facebook users, would suddenly have a new currency allowing them to transact with one another and bypass the rest of the financial system.
The authorities’ initial reaction was awkwardly negative. By highlighting the potential criminal uses of Libra, they only succeeded in confirming the libertarian suspicion that, faced with the threat of losing control over money, regulators, politicians, and central bankers prefer to smother liberating monetary innovations. This is a pity, because the greatest enabler of illicit activity is old-fashioned cash, and, more important, because Libra would pose a systemic threat to our political economies even if it were never used to finance terrorism or criminality.
Starting with Libra’s ill effects on individuals, recall the great effort most countries have invested in minimizing the volatility of the purchasing power of domestic money. As a result of those efforts, one hundred euros or dollars buy today more or less the same goods that they will buy next month. But the same could not be said of one hundred euros or dollars converted into Libra.
To the extent that Libra would be backed by assets denominated in several currencies, a Libra token’s purchasing power in any given country would fluctuate a great deal more than the domestic currency. Libra would, in fact, resemble the IMF’s internal accounting unit, known as Special Drawing Rights (SDRs), which reflect a weighted average of the world’s leading currencies.
To see what this means, consider that in 2015, the exchange rate between the US dollar and the SDR fluctuated by up to 20%. Had a US consumer converted $100 into Libra back then, they would be subjected to the agony of watching the tokens’ domestic purchasing power move up and down like a yo-yo. As for residents of developing countries, whose currencies are prone to depreciation, Libra’s facilitation of money changing would accelerate the depreciation, boost domestic inflation, and make capital flight both likelier and more pronounced.
Since the 2008 financial crash, authorities have struggled to manage inflation, employment, and investment with the fiscal and monetary levers that, prior to the crisis, seemed to work reasonably well. Libra would further diminish our states’ capacity to smooth the business cycle. Fiscal policy’s efficacy would suffer as the tax base shrunk, with every payment shifting to a global payments system residing within Facebook. An even greater shock would await monetary policy.
For better or worse, our central banks manage the quantity and flow of money by withdrawing or adding paper assets to the stock held by private banks. When they want to stimulate economic activity, central banks buy from private banks commercial loans, mortgages, deposits, and other assets. The banks then have more cash to lend. And vice versa when the authorities want to cool down the economy. But the more successful Libra becomes, the more money people will transfer from their bank account to their Libra wallet and the less able central banks will be to stabilize the economy. In other words, the greater the flight to Libra, the deeper the volatility and crises afflicting people and states.
The sole beneficiary would be the Libra Association, which would collect tremendous interest income on the assets from around the world that it would accumulate using the large portion of global savings attracted to its payment platform. Soon, the Association would yield to the temptation to advance credit to individuals and corporations, graduating from a payments system to a gargantuan global bank that no government could ever bail out, regulate, or resolve.
That is why it is a good thing that Libra is unraveling, along with Zuckerberg’s dream of a private global payments monopoly. But we should not throw the technological baby out with the monopolistic bathwater. The trick is to entrust implementation of the idea to the IMF, on behalf of its member states, with a view to reinventing the international monetary system in a manner reflecting John Maynard Keynes’ rejected proposal at the 1944 Bretton Woods Conference for an International Clearing Union.
To bring about this new Bretton Woods, the IMF would issue a blockchain-based, Libra-like token – let’s call it the Kosmos – whose exchange rate with domestic currencies floats freely. People continue to use their domestic currency, but all cross-border trade and capital transfers are denominated in Kosmos and pass through their central bank’s account held at the IMF. Trade deficits and surpluses incur a trade-imbalance levy, while private financial institutions pay a fee in proportion to any surge of outward capital flows. These penalties accrue in a Kosmos-denominated IMF account that operates as a global sovereign wealth fund. Suddenly, all international transactions become frictionless and fully transparent, while small but significant penalties keep trade and capital imbalances in check and fund green investment and remedial North-South wealth redistribution.
Brilliant ideas that would be catastrophic in the hands of buccaneering privateers should be pressed into public service. That way, we can benefit from their ingenuity without falling prey to their designs.
CAMBRIDGE – The language of international monetary policy has turned militaristic. The phrase “currency war” has now been popular for a decade, and the United States government’s more recent “weaponization” of the dollar is generating controversy. But ironically, a martial approach could end up threatening the US currency’s global dominance.
This is a good time to gauge the relative strengths of the dollar and rival international currencies (meaning currencies that are used outside their home countries). In September, the Bank for International Settlements released its triennial survey of turnover in global foreign-exchange markets. The International Monetary Fund’s statistics on central-bank holdings of foreign-exchange reserves have become much more reliable since China began reporting its holdings. And the SWIFT payments system issues monthly data on the use of major currencies in international transactions.
The bottom line is that the US dollar remains in first place by a wide margin, followed by the euro, the yen, and the pound sterling. Some 47% of global payments currently are in dollars, compared to 31% in euros. Furthermore, 88% of foreign-exchange trading involves the dollar, almost three times the euro’s share (32%). And central banks hold 62% of their reserves in dollars, compared to just 20% in euros. The dollar also dominates on other measures of currency use in trade and finance.
As for China, the renminbi is still in eighth place in terms of foreign-exchange market turnover. But it rose in August to fifth place in SWIFT payments, and, after leapfrogging the Canadian and Australian dollars, ranks fifth in central banks’ foreign-exchange reserves.
Predictions early in this decade that the renminbi might challenge the dollar for the number one spot by 2020 clearly will not be borne out. True, China’s currency fulfills two of the three necessary conditions to be a leading international currency, namely economic size and the ability to keep its value. But it still has not met the third: deep, open, and liquid financial markets.
Although the dollar’s share of foreign-exchange reserves and trading has trended downward, particularly since the turn of the century, the decline has been slow and gradual. Moreover, the euro’s share of reserves has fallen more rapidly (since 2007) than that of the dollar. Despite years of US fiscal and current-account deficits, and the country’s rising debt-to-GDP ratio, the dollar remains ensconced as the number one global currency – presumably owing to the lack of a good alternative.
Descriptions of exchange-rate policies have become increasingly extreme. If we took the three militaristic terms in vogue at face value, we might infer that a country with sufficient financial power first weaponizes its own currency, and then launches a speculative attack against that of a rival. If that elicits retaliation, a currency war has broken out.
However, such an interpretation would be nonsense, because these three military terms are inconsistent with each other in a currency context. To see why, let’s consider them in reverse order: first currency wars, then attacks, and weaponization last.
When Brazilian government ministers popularized the phrase “currency war” in 2010-2011, they were accusing the US and other countries of pursuing competitive depreciation. G7 finance ministers and central-bank governors subsequently pledged in 2013 not to target exchange rates, which was understood to include officials either “talking down their currencies” or pursuing monetary stimulus in a deliberate or explicit effort to depreciate them.
The one major country to have violated this 2013 agreement is not China, but the US. President Donald Trump has repeatedly engaged in “verbal intervention” to talk down the dollar. More worryingly, he has crudely pressured the US Federal Reserve to lower interest rates with the explicit objective of depreciating the currency.
By contrast, international relations specialists typically associate the exercise of geopolitical power with a strong currency. This is why some highlight the danger that China could “attack” America by dumping its vast stockpile of US treasury securities, thereby driving down the dollar and driving up the US government’s borrowing costs. That would work to appreciate the renminbi and thus would be the opposite of competitive depreciation.
More broadly, when a country runs chronic budget and current-account deficits, it undermines its geopolitical power – as the United Kingdom showed in the course of the twentieth century. The US inherited the UK’s “exorbitant privilege”: it can finance its deficits easily because other countries want to hold the world’s leading international currency.
Finally, the “weaponization” of the dollar generally refers to the US government’s exploitation of the currency’s global dominance in order to extend the extraterritorial reach of US law and policy. The most salient example is the Trump administration’s enforcement of economic sanctions against Iran in an attempt to shut the country out of the international banking system, and in particular SWIFT.
Even before Iran agreed to halt its nuclear weapons program under the 2015 nuclear deal, Europeans occasionally grumbled about US extraterritoriality, suspecting that the US might be quicker to impose large penalties on European banks than on their American peers for violating sanctions. But, because Trump abrogated a treaty that Iran was not violating, enforcing US sanctions via SWIFT is a real abuse of the exorbitant privilege. Arguably, it can no longer be justified in the name of a global public good.
Faced with US sanctions, Russia shifted its reserves out of dollars in 2018 and is selling its oil in non-dollar currencies. Likewise, Europe or China may succeed in developing alternative payment mechanisms that would allow Iran to sell some of its oil. That might in turn undermine the dollar’s role in the long run.
More generally, US foreign policy under Trump continues to run counter to America’s traditional post-war objectives. The prospect might seem a distant one, but should the US carelessly relinquish leadership of the global multilateral order, the dollar might eventually lose its own long-standing primacy.