A Challenge to Dollar Dominance

'Page One' Featured Paper:

The Rise of Alternative Payment Systems:

A Challenge to Dollar Dominance:

by Mr Alberto Cossu, MBA

International Management Consultant & Geopolitical Analyst

Sassari, Italy

Link for Citation Purposes: https://bwwsociety.org/journal/archive/the-rise-of-alternative-payment-systems-v1.htm

The US dollar's dominance in international finance is facing a challenge with the emergence of alternative payment systems[1]. This trend is fueled by concerns about the "weaponization" of the dollar, where the US leverages its control over the financial system to exert political pressure[2]. Aroon Klein writes in a paper issued by Brooking Institution:“Payment systems are primarily thought to function to maximize economic growth. The U.S. dollar’s status as world reserve currency provides America a unique ability to use the payment system to achieve national objectives besides economic growth”.The freezing of Russia's foreign reserves exemplifies this strategy and highlights the vulnerability of countries reliant on the dollar[3].

Alternative systems like China's CIPS and Russia's[4] SPFS offer countries a path towards economic independence and reduced susceptibility to US sanctions. However, these systems face limitations in reach and liquidity compared to the established SWIFT network.

The rise of these alternatives and non-traditional financial systems like cryptocurrencies and digital currencies, along with renewed interest in gold, have significant political and international implications. It could lead to a shift in global power dynamics and potentially create a more multipolar economic order. International organizations like the IMF and G20 will need to play a role in fostering cooperation and preventing fragmentation in the financial system[5].

The future of international payments likely lies in a coexisting landscape, with the US dollar maintaining dominance alongside regional and national systems. Striking a balance between established institutions and emerging systems, along with robust regulations to combat financial crime, will be crucial for a stable and inclusive global financial future.

The greenback reigns supreme. For decades, the US dollar has served as the world's dominant reserve currency, facilitating international trade and financial transactions. This dominance has fostered stability and predictability in the global financial system. However, the power associated with the dollar extends beyond simple economic exchange. The US government, wielding the immense influence of the dollar, can leverage it as a political weapon – a strategy known as "dollar weaponization."

Dollar weaponization involves using America's control over the dollar-based financial system to exert pressure on other countries. This can be achieved through various means, including imposing sanctions that restrict access to dollar transactions and freezing foreign reserves held in US dollars.

In response to such vulnerabilities, a new trend is emerging: the rise of alternative international payment systems. These systems aim to bypass the traditional dollar-centric infrastructure, offering countries a path towards economic independence and reduced susceptibility to US-imposed financial pressure. Understanding this shift requires examining the political and international perspectives at play.

The Weaponization of the Dollar

The term "dollar weaponization" refers to the strategic use of the US dollar's dominance in the global financial system to achieve political objectives. This dominance stems from the post-World War II Bretton Woods agreement, which established the dollar as the world's reserve currency, pegged to the price of gold. Over time, the system transitioned to a fiat currency system, but the dollar's preeminence persisted[6]. This dominance translates into several key control points:

SWIFT (Society for Worldwide Interbank Financial Telecommunication): This messaging system facilitates secure financial transactions between banks globally. The US government can pressure SWIFT to disconnect specific countries or institutions, effectively cutting them off from the international financial system.
Dollar-based Clearing System: The US controls the clearing and settlement of many international transactions denominated in dollars. This allows them to impede or block transactions involving sanctioned entities.
Foreign Reserves: Many countries hold a significant portion of their foreign reserves in US dollars. The US government can freeze these reserves, denying targeted countries access to crucial financial resources.

Historical examples abound when it comes to the US wielding the dollar as a weapon. The Iranian sanctions demonstrate this tactic. Since 1979, the US has imposed various sanctions on Iran, restricting its access to dollar-based transactions and hindering its ability to trade with other nations. Similarly,Venezuela has faced crippling sanctions that have severely hampered its oil exports, a crucial source of revenue, due to limitations on dollar-based transactions.

The mechanisms behind dollar weaponization have significant consequences. Targeted countries experience economic hardship, as their ability to import essential goods, access international financing, and participate in global trade is curtailed. Additionally, this weaponization strategy fosters instability within the international financial system, as countries become wary of relying too heavily on a system they can't fully control.

However, arguments exist against the concept of dollar weaponization. Proponents of the current system point out that the dollar's dominance offers stability and predictability due to its deep liquidity and well-established institutions. They argue that alternative systems, with their limited reach and nascent infrastructure, could introduce greater volatility and risk into the global financial landscape[7].

Despite these arguments, the recent freezing of a significant portion of Russia's foreign reserves held in US dollars and other Western currencies has reignited debate about the weaponization of the dollar. [8]

The Case of Russia's Frozen Reserves

The freezing of a significant portion of Russia's foreign reserves in February 2022 marked a turning point in the history of international finance. In response to Russia's invasion of Ukraine, the US, along with its allies in Europe and elsewhere, took the unprecedented step of freezing a large chunk of Russia's foreign reserves held in their jurisdictions. Estimates suggest this amounted to hundreds of billions of dollars, severely hampering Russia's ability to access critical financial resources.

This action dealt a significant blow to the Russian economy. With a large portion of its foreign reserves inaccessible, Russia faced difficulties in stabilizing its currency, the ruble, which underwent a dramatic devaluation. Additionally, the limitations on dollar-based transactions hindered Russia's ability to import crucial goods and services, leading to shortages and inflationary pressures.

The motivations behind this unprecedented action were primarily political. Western powers aimed to cripple the Russian economy and exert pressure on the Kremlin to halt its military operations in Ukraine. This strategy aimed at inflicting economic pain on Russia, forcing them to reconsider their invasion plans.

However, the geopolitical implications of freezing Russia's reserves extend far beyond the current conflict. This action highlighted the vulnerability of countries that rely heavily on the US dollar system. Russia, despite being a major power, was not immune to having its financial resources frozen. This event serves as a wake-up call for many countries, prompting them to explore alternative avenues for conducting international trade and managing their foreign reserves.

Russia has unsurprisingly responded with a series of measures to mitigate the impact of frozen reserves. One strategy has been to diversify its foreign reserves, aiming to reduce dependence on US dollars and Euros. Russia has increased its holdings of currencies like the Chinese yuan and gold. Additionally, they have actively promoted their own alternative payment system, SPFS (System for Transfer of Financial Messages), aiming to bypass the traditional SWIFT network.

The long-term consequences of this episode for the global financial system remain unclear. The freezing of Russian reserves could lead to a fracturing of the current[9] dollar-centric system, with countries increasingly seeking alternatives to protect themselves from similar actions in the future.

The US dollar remains the world's dominant currency despite predictions of its imminent demise[10]. Several factors contribute to this because the US economy is still the world's largest, with a deep and liquid financial market. No other currency has the same combination of stability, liquidity, and global acceptance as the dollar.

Currencies of other countries, such as the euro and the renminbi, are hindered by factors such as political fragmentation, a lack of a robust institutional framework, and volatility. In times of economic or geopolitical turmoil, investors tend to flock to safe assets like the dollar and US Treasuries. The US is a net debtor to the rest of the world, and its foreign liabilities are denominated in dollars. This means that a depreciation of the dollar would benefit the US at the expense of its foreign creditors.Despite some weaknesses, such as the US's growing public debt and weakening democratic institutions, the dollar is unlikely to lose its dominance in the short term.

The Rise of Alternative International Payment Systems

In response to the perceived weaponization of the dollar and the vulnerabilities it exposes, a new trend is gaining momentum: the rise of alternative international payment systems. These systems aim to bypass the traditional dollar-centric infrastructure, offering countries a path towards economic independence and reduced susceptibility to US-imposed financial pressure.

One prominent example is China's Cross-Border Interbank Payment System (CIPS). Launched in 2015, CIPS facilitates cross-border transactions in yuan, aiming to challenge the dominance of the US dollar in the region. Similarly, Russia, following the freezing of its reserves, has actively promoted its System for Transfer of Financial Messages (SPFS) as an alternative to SWIFT. These are just two examples of a growing number of regional and national payment systems seeking to carve out a niche in the global financial landscape.

However, these alternative systems face significant challenges in their quest to dethrone the dollar. Their primary weakness lies in their limited reach and liquidity compared to the established SWIFT network[11]. The dollar's deep liquidity makes it the preferred currency for international transactions, allowing for quicker settlement and lower transaction costs. Additionally, the existing network effects of SWIFT, with its vast network of participating banks, make it difficult for new entrants to gain widespread adoption.

Despite these limitations, alternative systems offer several potential benefits for countries seeking to reduce their reliance on the dollar. Increased economic independence is a key advantage. By conducting international trade in their own currencies or through regional systems, countries can lessen their vulnerability to US sanctions and the whims of US foreign policy. Additionally, alternative systems can potentially lower transaction costs for participating countries, as they circumvent the fees associated with dollar-based transactions.

However, the rise of alternative systems also presents potential risks. The proliferation of competing systems could lead to fragmentation in the global financial landscape, hindering efficiency and increasing complexity. Concerns also exist regarding the regulatory frameworks of these new systems. Without robust regulations to combat money laundering and financial crime, alternative systems could become havens for illicit activities.

The road to widespread adoption of alternative payment systems remains uncertain. Displacing a well-established system like SWIFT is a monumental task. However, the recent events surrounding Russia's frozen reserves have undoubtedly accelerated interest in these alternatives. The future of international payments likely lies in a co-existing landscape, where the dollar maintains its dominance alongside regional and national systems catering to specific economic blocs and trade relationships[12].

Another challenge is looming, the central banks in recent years have been purchasing gold at record levels. Buyers include China, India, Russia and a number of other nations such as Poland. These countries are reacting to growing doubts about the long-term value of the dollar, which in turn is a symptom of the perceived decline of the United States[13].

Moreover another sign is the popularity of cryptocurrencies, originally a high-tech cry for help in the face of increasingly unreliable fiat currencies. The problem here has been that most creators of cryptos, notably Bitcoin, don’t understand that a currency must be stable in value if it’s going to be used to conduct commercial transactions, especially long-term contracts.

Finally, BRICS is moving forward with creating an independent payment system based on digital currencies and blockchain. [14]. The 5R common currencies project is in progress and is expected to be implemented in the next future.[15].

Political and International Perspectives

The rise of alternative international payment systems carries significant political and international weight, potentially reshaping the global power landscape and altering the fabric of international relations.

The dominance of the US dollar has historically been intricately linked to American political and economic influence. The emergence of alternative systems could weaken the dollar's grip on global finance, potentially leading to a more multipolar economic order. Countries that develop and utilize these systems can gain greater economic autonomy and leverage them to advance their political agendas. China's CIPS (Cross-Border Interbank Payment System) exemplifies this ambition, aiming to establish the yuan as a leading reserve currency and challenge the US dollar's global preeminence.

International relations could be impacted in two distinct ways: cooperation or competition. Cooperation could emerge if different systems find ways to interconnect and facilitate cross-border transactions efficiently. This would require establishing clear communication protocols and harmonizing regulatory frameworks. However, competition is also a potential outcome. Countries promoting their own systems might engage in a zero-sum game, vying for dominance and potentially hindering global financial stability. Imagine a scenario where regional blocs favor their own systems, hindering seamless international trade.

International organizations like the International Monetary Fund (IMF) and the G20 can play a crucial role in navigating this new landscape. They can facilitate dialogue and collaboration between countries developing alternative systems to ensure compatibility and prevent fragmentation. The IMF, with its expertise in financial stability and regulatory frameworks, can offer guidance and best practices for these new systems. The G20, representing the world's leading economies, can promote a coordinated approach to ensure a smooth transition towards a more diversified financial system.

The proliferation of alternative systems also presents new regulatory hurdles. Money laundering and financial crime are major concerns. Without robust regulations and international cooperation, these new systems could attract illicit actors seeking to circumvent established anti-money laundering measures. Imagine a scenario where a system with lax regulations becomes a haven for criminal activity. International organizations need to work together to develop and enforce clear regulations that apply across all payment systems.

The future of international payments likely lies in a coexisting landscape. The US dollar, with its deep liquidity and established infrastructure, will likely retain its dominance for some time to come. However, alternative systems can play an increasingly important role, catering to specific trade corridors and regional economic blocs. This coexistence requires continued dialogue, collaboration, and a commitment to fostering a stable and inclusive global financial system.

Striking a balance will be crucial. Countries promoting alternative systems need to prioritize transparency and robust regulations to avoid becoming havens for illicit activity. Established institutions like SWIFT need to adapt and remain competitive by offering efficient and cost-effective services. International organizations need to play a proactive role in fostering cooperation and preventing fragmentation. Ultimately, the goal should be a diverse and efficient international payments system that facilitates global trade and economic growth, while mitigating the risks of financial crime and instability. This future will require a willingness from all players – established and emerging – to prioritize cooperation and a shared commitment to a stable global financial order.

Conclusion

This article explored the rise of alternative international payment systems in response to the perceived weaponization of the US dollar. We examined the political and international implications of this shift, including potential changes in power dynamics and the challenges of fostering cooperation between competing systems. The role of international organizations like the IMF and G20 in ensuring a stable and inclusive financial future was emphasized. While the US dollar will likely retain its dominance in the near future, alternative systems offer countries avenues for economic independence and reduced vulnerability to sanctions. The future of the dollar will depend on how the US manages its economy and how other countries develop their alternatives A new international order will likely emerge in the global finance system based on a multipolar structure

The long-term impact of these alternative systems remains uncertain. Will they lead to a more fragmented financial landscape, or can cooperation pave the way for a coexisting and efficient system? Further research is needed to explore the regulatory frameworks required to mitigate financial crime and ensure the stability of these new systems. Ultimately, the future of international payments hinges on the ability of established and emerging players to collaborate and prioritize a global financial system that fosters economic growth and stability.

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[6] https://www.brookings.edu/articles/payment-systems-changing-role-from-economic-growth-to-the-new-foreign-policy-lever/

[7] https://www.cfr.org/backgrounder/dollar-worlds-reserve-currency https://www.jpmorgan.com/insights/global-research/currencies/de-dollarization