The recent military strikes authorized by former President Donald Trump against targets in Iran have sent ripples through global markets, accelerating a trend already underway: a gradual erosion of the U.S. Dollar’s dominance in international finance. While the immediate impact is instability in the Middle East, the longer-term consequence could be a reshaping of the global financial order, one less reliant on the greenback and more fragmented.
The strikes, described by some as “Operation Epic Fury,” represent a continuation of Trump’s assertive foreign policy, marked by a willingness to challenge established norms and prioritize American interests, even at the expense of international cooperation. This approach, coupled with previous actions like on-off tariff regimes and the intervention in Venezuela, has fueled a sense of uncertainty about the predictability of U.S. Policy, prompting nations to seek alternatives to the dollar-centric system.
The shift isn’t about a single currency replacing the dollar, but rather the emergence of a multipolar system, according to analysis from the Centre for Inclusive Trade Policy. The dollar remains the dominant currency for international trade, but its share of global central bank foreign exchange reserves has been steadily declining, falling from 71% in 2001 to 57% by the end of 2023, as reported by sources tracking global currency holdings.
This decline isn’t necessarily a rejection of the U.S. Economy, which remains strong, but a response to perceived risks associated with the increasing weaponization of the dollar. The U.S. Has increasingly employed economic sanctions – including asset freezes and exclusion from the SWIFT international payment system – as a tool of foreign policy. This has led to concerns about the reliability of accessing the dollar-based financial system, prompting countries to explore alternative mechanisms.
The Weaponization of Interdependence
Academics Henry Farrell and Abraham Newman have termed this phenomenon “weaponized interdependence,” highlighting how the U.S. Leverages its control over the global financial infrastructure. Canadian Prime Minister Mark Carney echoed this sentiment in a speech at the World Economic Forum in Davos, warning that great powers are increasingly using economic integration as a tool of coercion. Carney’s address emphasized the vulnerabilities created by interconnected supply chains and financial systems.
The desire to mitigate these risks is driving investment in alternative financial infrastructure. The European Central Bank (ECB) is bolstering its repurchase agreement (repo) arrangements, essentially offering a standing loan facility to other central banks in times of crisis. This move aims to prevent a repeat of the eurozone crisis and reinforce the euro’s viability as a safe haven currency.
“China and Europe are thinking more about how to protect themselves,” says Alejandro Fiorito of The Conference Board. “So they’re investing – because all of this is costly, politically and also economically – in digital euro, digital yuan, the repo lines. You can believe about this as sort of self-insuring.”
BRICS and the Rise of Alternative Systems
The BRICS nations – Brazil, China, India, Russia, and a growing number of new members – have long advocated for reducing the dollar’s dominance. While a unified “BRICS currency” remains largely theoretical, there’s increasing discussion about establishing financial linkages that bypass the U.S. Dollar, including swap lines for emergency funding and interoperability of central bank digital currencies.
As Francisco Quintana of Edinburgh Law School puts it, “It’s a cumulative set of similar dynamics that are happening throughout the world, in a context in which it’s becoming more and more clear that it may not be the best thing to have such a huge dependence on the US, which is becoming less and less reliable.”
The technological advancements facilitating these shifts are also noteworthy. Cheaper and faster settlement and exchange systems are making it easier to conduct transactions outside the traditional dollar-based infrastructure.
The Cost to the U.S.
Diminishing dollar dominance carries potential costs for the United States. Research from the Federal Reserve Bank of St. Louis points to a decline in the “convenience yield” of U.S. Treasuries – the benefit investors receive from holding the world’s most liquid and safe asset. This decline is attributed to high U.S. Deficits, rising debt, and potentially, waning trust in U.S. Institutions. The St. Louis Fed’s analysis suggests this could make borrowing more expensive for the U.S. Government.
Despite these concerns, U.S. Treasuries remain a popular safe haven asset, with yields falling on Friday amid fears of a software share price crash. However, the long-term trend suggests a gradual shift away from the dollar, accelerated by events like the recent strikes in Iran and the broader perception of a less predictable U.S. Foreign policy.
The trade-weighted dollar has lost 7% of its value over the past year, despite strong U.S. Economic growth and soaring stock prices, according to data from the Federal Reserve Economic Data (FRED) series DTWEXBGS. This reflects not only inflation and interest rate expectations but also a growing sense that the U.S. Policy framework is less stable than in the past.
Looking Ahead
The process of de-dollarization is unlikely to be swift or complete. The dollar’s entrenched position in global trade and finance will not be easily displaced. However, the recent events, coupled with ongoing geopolitical tensions and the development of alternative financial systems, suggest that the world is moving towards a more multipolar currency landscape. The next key indicator to watch will be the International Monetary Fund’s (IMF) updated assessment of global reserve currency holdings, expected to be released in the coming months, which will provide a clearer picture of the ongoing shift.
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