Last month, the United States broadened financial sanctions against China while simultaneously promising to prolong Ukraine sanctions on Russia and impose further ones for election interference, the poisoning of opposition leader Alexei Navalny and the SolarWinds hack. In a rare joint statement in late March, China and Russia doubled down on earlier pledges to upend the global reliance on the U.S. dollar, and the long-standing global financial system that enables the U.S. to strong-arm them.
Will the Sino-Russian strategy succeed? My research suggests “dollar hegemony” is stable for many reasons, primarily due to the United States’ financial centrality and ability to secure investments. The measures announced so far, such as de-dollarization, renminbi digitalization, and alternative financial settlement and messaging systems, are unlikely to kick the dollar to the curb. But the reaction from America’s rivals underscores the limits of the dollar as a tool of deterrence.
It’s a high-stakes currency game
If China and Russia devise successful alternatives to the dollar-centered financial system, and if these alternatives gain significant international traction, we would be witnessing a cataclysmic moment in great power rivalry. Currency unipolarity has been a defining feature of the entire postwar era — no currency, not even the euro, has ever come close to rivaling the scale of U.S. dollar use around the world.
An end to America’s dollar primacy and status as a financial hub could mean an end to U.S. macroeconomic perks. And a declining role for the dollar could also undermine the practice of dollar deterrence — the U.S. government’s ability to threaten or deny foreigners access to dollar clearing and, therefore, dollar settlement.
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This is not the first time countries have railed against dollar primacy. In the 1960s, French Finance Minister Giscard d’Estaing denounced the United States’ “exorbitant privilege” while economist Jacques Rueff decried the “monetary sin of the West.”
However, frustration with the system’s inequity pales in comparison with their ire over the discretion it gives the U.S. to exercise dollar deterrence. Should the U.S. lose this unique form of financial leverage, its ability to benefit from the current international order, and influence countries within it, will be sharply curtailed.
What is dollar deterrence?
U.S. dollar transactions are either cleared through the Federal Reserve or through U.S. financial institutions, which means foreigners depend on the U.S. financial infrastructure when settling dollar transactions. The United States’ ability to turn off the tap on foreign banks’ dollar funding can inflict significant costs on those who evade compliance with U.S. sanctions, given this extraterritorial reach.
Global dollar dependence provides the U.S. government with a powerful lever to police geopolitical behavior without intervening militarily. The U.S. has, for instance, sought to thwart Iran’s bid for regional hegemony, particularly its development of nuclear weapons and missile programs, not only by sanctioning Iran but by imposing secondary financial sanctions on countries dealing with Iran.
With significant U.S. dollar holdings, China is particularly vulnerable to dollar deterrence. If China cannot access dollars, this could jeopardize its Belt and Road Initiative, a cornerstone of Beijing’s global ambitions. The latest political rift involving dollar deterrence involves China’s alleged human rights abuses. In addition to targeting officials who allegedly suppressed democratization protests in Hong Kong, Washington is now targeting officials it has identified as participating in reported human rights abuses toward Muslim Uyghurs. The latest U.S. sanctions were announced shortly after Secretary of State Antony Blinken’s fraught meeting in Alaska with Chinese Foreign Minister Wang Yi on March 18.
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Meanwhile, U.S.-Russia relations continue to sour. On March 2, President Biden announced prolonged punitive financial measures against Russian officials to condemn the 2014 invasion of Ukraine, continuing the U.S. pressure in executive orders in effect since 2014. More financial sanctions are being prepared for Russia’s cyber espionage against nearly 20,000 U.S. companies, including SolarWinds. Financial sanctions have already been imposed, together with the European Union, for Russian officials’ poisoning of opposition leader Alexei Navalny.
China and Russia have a three-step plan
China and Russia have vowed to jointly “de-dollarize,” creating alternatives to the current system with a three-step plan that began a few years ago. First, both countries began to cut back the proportion of their bilateral trade invoiced in dollars, privileging settlement in their own currencies.
Second, they have sought to boost the renminbi’s role as an international currency for payments and reserves. To encourage wider adoption of its currency, China has given more than 30 countries renminbi access through bilateral swap agreements. China and Russia each scaled back their U.S. Treasury holdings, with Russia channeling cash into renminbi holdings. And China has ramped up the digital currency drive it began in 2014, with the goal of making it easier to hold renminbi.
The third and last leg of these efforts, still underway, aims to create alternative payments and messaging systems allowing countries to use home and partner currencies instead of dollars or euros to settle trade and investment deals.
This strategy has its limits
While these efforts could undermine the dollar’s long-term primacy, so far China and Russia have only made small dents in a robust structure. Significant obstacles include the long-standing China-Russia rivalry, which is sure to inhibit Russia’s readiness to promote the renminbi.
The ensnaring effects of dollar hegemony and dollar deterrence are real concerns for some countries, as well as companies within nations whose politics do not sit well with Washington, leading to calls for reform of the international currency system. For now, the dollar remains the only truly global currency. Structural advantages including the incumbency effect, relative price stability and strong property rights protection — as well as the liquidity, breadth and openness of U.S. financial markets — suggest this role will continue. Over the past decade, the dollar’s reserve role only fell slightly, and dollar usage in settling international trade actually increased, even as the dollar’s share in global transactions declined marginally last year.
The long-term effect of China and Russia’s measures could nonetheless be considerable. Even if China and Russia fail to offer better alternatives, the more dollar deterrence is used, the more countries will seek options that reduce their vulnerability to this foreign policy tool.
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Carla Norrlöf is associate professor at the University of Toronto, a senior fellow at Massey College and nonresident senior fellow with the Atlantic Council. Find her on Twitter @CarlaNorrlof.