The Washington PostDemocracy Dies in Darkness

Sanctioning Russia and the future of the dollar

Welcome to the 2022 version of a 30-year-old argument

A 100 rubles bank note in front of a dollar bill. (Martin Meissner/AP)
5 min

I have been teaching global political economy for a quarter-century, and during that time span, there have been recurring debates about the future of the dollar as the world’s primary reserve currency. No doubt they have been recurring for 75 years — as long as the dollar has been the primary currency used in international economic transactions. The United States benefits from having the dollar used in this way. As Paul Krugman recently noted, the economic rewards are minor but tangible. As Henry Farrell and Abraham Newman noted a few years ago, the geopolitical benefits are intangible but significant.

Anything that could appreciably shift the dollar’s standing would have significant international implications. This means any time there are incipient signs that this might be happening, we get a new round of “oh no, the dollar!” And after 25 years, I recognize these debates have a particular rhythm to them:

  1. There is some observable erosion in a key metric of the dollar’s standing.
  2. Essays are written about this trend and whether it will persist into the future.
  3. Speculation is put forward about a triggering event that could further accelerate the decline of the dollar.
  4. Additional essays are written about this kerfuffle as a sign of waning U.S. hegemonic power.
  5. Alternatives to the dollar are evaluated.
  6. Time passes.
  7. The dollar is still standing.
  8. The cycle repeats after a few years.

So far, this cycle is playing out in predictable fashion. As Megan Greene noted in the Financial Times, “the dollar’s share of foreign exchange reserves has fallen from 71 percent in 2000 to 59 percent in the third quarter of 2021.”

This has prompted a lot of speculative essays. The one that generated the most hype came from Zoltan Pozsar, the global head of Credit Suisse’s short-term interest rate strategy. In a note published during the early weeks of Russia’s invasion of Ukraine, Pozsar argued that the war was an inflection point: “We are witnessing the birth of Bretton Woods III — a new world (monetary) order centered around commodity-based currencies in the East that will likely weaken the Eurodollar system and also contribute to inflationary forces in the West.”

That brings us to step five. This is where, as always, analysts run into the roadblock of what the alternative would look like. In Pozsar’s telling, China will underwrite the development of this new commodity-based currency system. The problem is that China has minimal interest in creating such a currency. As Greene notes, “China shows little interest in giving up the micromanagement of its economy by pegging its currency to commodities it cannot control.” Also, there is a reason that commodity-based currencies are a relic of the past: They are too volatile.

As both Adam Tooze and Quartz’s Tim Fernholz note, even the dollar’s declining share of foreign exchange reserves is a false trend. It’s not like the dollar’s decline is leading to a dramatic increase in holdings of the renminbi or ruble. According to Fernholz, “the currencies showing gains are all from states close to the US, like Canada, Australia, and South Korea, and moreover, those with central banks that benefit from the US Federal Reserve’s international swap lines.”

I have written about the dollar’s status at various points in my career: see here, here, here, here, here and here, for example. In all but one of these essays, I was confident the dollar was not going anywhere, mostly because the alternatives were way worse and U.S. allies were not keen to empower a revisionist power. Twelve years ago, in the longest piece I wrote on this topic, I concluded that “neither the opportunity nor the willingness to shift away from the dollar is particularly strong.” In the years since, the willingness of some countries might have grown, but the opportunity has, if anything, shrunk.

The one time I wavered was when the Trump administration unilaterally reimposed sanctions on Iran, forcing SWIFT to comply with U.S. edicts despite European opposition. I fretted that Europe would try to challenge the dollar in league with Russia and China. That is not happening in response to the sanctions against Russia’s central bank. All of the countries acquiring a greater share of official currency reserves are in lockstep with the United States on the financial sanctions imposed against Russia.

If anything, Michael P. Dooley, David Folkerts-Landau and Peter M. Garber argue in a recent National Bureau of Economic Research paper that the sanctions will actually strengthen the dollar’s status. Their premise is that geopolitically risky governments reassure foreign investors by holding assets that leave them vulnerable to the financial hegemon. This enables the hegemonic actor, as the provider of the reserve currency, to provide safe, liquid assets to the rest of the world while simultaneously introducing risk premiums for economically interdependent countries acting in a revisionist manner:

The dollar is the dominant reserve currency because the US is the only country with sufficient power to impose exactly such sanctions when a country like Russia misbehaves. The US earns the “exorbitant privilege” of having the global reserve currency by daring to impose penalties when justified by the behavior of the owners of reserves …
Seizure of reserves in a serious enough geopolitical confrontation is a natural process that must occur if the dollar is to preserve its role as the economic foundation and defender of global capital flows. It is not the enemy of such flows. Sequestering foreign exchange reserves is not an exogenous initiative by the US; it underpins the global social contract behind gross and net international capital flows.

Russia clearly wants to develop an alternative to the dollar — but it lacks the capability. Maybe China will take this moment to liberalize its capital account and challenge the dollar, but that seems highly unlikely. Which means we have reached the point in this debate for time to seriously pass.