The world is witnessing a significant shift away from the dominance of the US dollar, and President Trump's aggressive actions towards Iran have only accelerated this trend.
Trump's attack on Iran, with its immature Pentagon codename, Operation Epic Fury, is a stark reminder of the administration's aggressive foreign policy. Beyond the immediate instability it creates in the Middle East, these strikes reinforce a perception of the US acting with disregard for international law and global norms. This is evident in Trump's unpredictable tariff regime and his previous actions against Venezuela.
In the financial realm, these actions contribute to a historic shift away from the US dollar's global dominance. Despite strong economic growth and soaring stock prices, the trade-weighted dollar has lost 7% of its value over the past year. This decline reflects not only inflation and interest rate expectations but also a growing sense that US policies are less stable and predictable than they once were.
Experts predict a move towards a more complex, multipolar system rather than the abrupt replacement of the dollar with another currency, as seen with sterling after World War II. While the US dollar remains the dominant currency for international trade, the use of China's renminbi is on the rise, actively encouraged by Beijing.
However, when it comes to foreign currency reserves, global central banks have been quietly diversifying. The share of reserves held in dollars has decreased from 71% in 2001 to 57% in the last quarter of 2022. This shift has its roots in the 2007-08 credit crisis, when the US Federal Reserve's swap lines with select countries exposed the immense leverage the US holds due to its currency's central role in the global economy.
The increasing use of economic sanctions as a geopolitical weapon, including cutting off access to the Swift international payment system, has highlighted the risks of what academics call "weaponized interdependence." This was echoed by Canadian Prime Minister Mark Carney at Davos, who warned of great powers using economic integration as weapons.
Washington's willingness to exploit its financial dominance has fueled the search for alternatives to the greenback. Technological advancements and new financial structures, such as the European Central Bank's enhanced repo arrangements, are contributing to this de-dollarization trend. Experts see this as a form of self-insurance, with countries like China and Europe investing in digital currencies and other measures to protect themselves.
The Brics countries have long sought to reduce the dollar's dominance, and while a "Brics currency" remains theoretical, there is growing discussion of building financial linkages that bypass the US. This includes establishing emergency swap lines and making central bank digital currencies interchangeable.
For the US, this diminishing dollar dominance will come at a cost. Recent research highlights a decline in the "convenience yield" of US Treasuries, which estimates the cost advantage for the US government in borrowing due to Treasuries' status as a safe, liquid asset. Rising debt and deficits, as well as waning trust in US institutions, are cited as drivers of this deterioration.
With the US debt pile on track to reach 130% of GDP in five years, according to the IMF, this could prove costly in the long run. While US Treasuries remain a safe haven for investors during times of uncertainty, the process of de-dollarization has gained momentum under Trump's chaotic regime. Governments worldwide are quietly building alternatives, and the heavily indebted US of the future may face an uncertain financial landscape.
