While the US accounts for about 20 percent of the world’s economic output, more than half of all global currency reserves and trade is in dollars. This is the result of the 1944 Bretton Woods agreement, the effect of which was enhanced when the link between the dollar and gold ended in the 1971 Nixon shock, allowing America to control the supply of the currency.
The dollar’s pivotal role allows the US easily to finance its trade and budget deficits. The nation is protected against balance-of-payments crises, because it imports and services borrowing in its own currency. American monetary policies, such as quantitative easing, can influence the value of the dollar to gain a competitive advantage.
But the real power of the dollar is its relationship with sanctions programs. Legislation such as the International Emergency Economic Powers Act, the Trading With the Enemy Act and the Patriot Act allow Washington to weaponize payment flows. The proposed Defending Elections From Threats by Establishing Redlines Act and the Defending American Security From Kremlin Aggression Act would extend that armory.
When combined with access it gained to data from Swift, the Society for Worldwide Interbank Financial Telecommunication’s global messaging system, the US exerts unprecedented control over global economic activity.
Sanctions target persons, entities, organizations, a regime or an entire country. Secondary curbs restrict foreign corporations, financial institutions and individuals from doing business with sanctioned entities. Any dollar payment flowing through a US bank or the American payments system provides the necessary nexus for the US to prosecute the offender or act against its American assets.
This gives the nation extraterritorial reach over non-Americans trading with or financing a sanctioned party. The mere threat of prosecution can destabilize finances, trade and currency markets, effectively disrupting the activities of non-Americans.
The risk is real. BNP Paribas SA paid $9 billion in fines and was suspended from dollar clearing for one year for violating sanctions against Iran, Cuba and Sudan. HSBC Holdings Plc, Standard Chartered Plc, Commerzbank AG and Clearstream Banking SA have paid large fines for similar breaches.
Secondary sanctions made it difficult for United Co. Rusal to refinance dollar borrowings when global businesses, banks and exchanges were forced to stop dealing with the Russian company. Its bonds and shares plunged, even though the company sells only 14 percent of its products in the US, does not use American banks, and is listed in Moscow and Hong Kong. ZTE Corp., a Chinese electronics company, was hit hard by the inability to buy essential components from suppliers because of sanctions for trading with North Korea and Iran. In these cases, the entity was not in violation of laws where it was domiciled or operated, and the proscribed acts took place outside the US.
Europe want an alternative reserve currency system. The problem is that immediate replacement of the dollar is difficult.
First, the euro, the yen, the yuan and the ruble are not realistic options. The euro’s long-term future and stability isn’t assured, while Japan’s economy remains trapped in two decades of torpor. The Chinese and Russian political and economic systems lack transparency, and the yuan isn’t fully convertible.
Second, the required change in infrastructure is daunting. Foreign-exchange markets where the dollar is the currency of reference would have to be fundamentally restructured. Deep and liquid money markets to support a reserve currency can’t be conjured up overnight.
Third, most candidates are reluctant to take on the role of a global reserve currency because of tensions between national and global economy policy.
This means that the US can continue to use the dollar to help further its trade, financial and geopolitical aims, largely outside the strictures of international laws and institutions and without the need for messy, unpredictable military campaigns. As John Connally Jr., Richard Nixon’s Treasury secretary, put it in 1971: The dollar is “our currency, but your problem.”