To a greater or less extent, since the 1944 Bretton Woods agreement signalled the end of the gold standard, the U.S. dollar has acted as the world’s de-facto reserve currency. Commodities from oil to diamonds and bushels of wheat are standardly priced in dollars, regardless of where they are bought and sold. And in many countries around the world, crucial prices such as for real estate, rental agreements and contracted salaries also use the dollar in favour of the local currency.
For years there has been a degree of international unease at the economic and financial power this has given the USA. China in particular has on occasion openly expressed its dislike of the status quo and their authorities’ tight control of the renminbi has been the answer. Most countries, however, while sometimes grumbling, play ball with dollar-centric global capitalism by allowing their currencies to float freely. The advantages of doing so have largely outweighed the disadvantages.
However, under Donald Trump, the USA has upped the ante in the way it is weaponising the dollar. He is increasingly using its dominance in global finance as leverage when chasing his foreign affairs interests. And that is starting to send out ripples.
How Is Trump Weaponising The Dollar In Foreign Affairs And Renegotiating International Trade Agreements?
The dominant position of the U.S. dollar in international financial transactions means, as Eswar Prasad, a professor of economics at Cornell University, explains in the Financial Times, means it’s difficult to make any transaction that involves the dollar “without touching a U.S. financial institution”. That then puts all parties involved under the jurisdiction of the U.S. government and regulators and at risk of fines or sanctions.
Sanctions that can be, and are, meted out not only apply to U.S. citizens and entities. Any third party from another country that in any way touches a U.S. financial institution or any other structure can also be sanctioned. A high profile example is the $9 billion fine given to PNB Paribas for sanctions violations. The French bank’s dollar clearing facility was also temporarily suspended.
The USA’s use of sanctions, weaponising the role of the dollar, is nothing new per se and has been a growing habit over the years. But President Trump’s administration is particularly enthusiastic in its use of the mechanism. In 2018 1474 entities were sanctioned by the USA, which is 50% more than the previous record year.
Financial markets have felt the impact. Aluminium prices spiked last year when sanctions were placed on Russia’s Rusal, a major international metals group. They were withdrawn after Oleg Deripaska, the majority shareholder, agreed to give up control. New U.S. tariffs imposed on Turkish steel and aluminium exports, plus sanctions against several senior politicians and businessmen, led to a currency crisis as the Lira plummeted.
International Push-Back Against Dollar Dominance
China and Russia have already made noises around their intent to decouple their trade from the dollar as much as possible. Russian President Vladimir Putin has commented:
“We are not ditching the dollar, the dollar is ditching us. The instability of dollar payments is creating a desire for many global economies to find alternative reserve currencies and create settlement systems independent of the dollar.”
Last year Russia’s central bank sold $101 billion of reserves, converting them in a combination of euro, yen and renminbi. At least 15% of the country’s foreign currency reserves are now held in renminbi. China’s huge ‘Belt and Road’ global infrastructure investment programme was seen as partly an effort to boost international use of the renminbi and the country has experimented with denominating oil futures in its own currency is known to be working on a Chinese-run alternative international payments system. Though practically speaking, there is unlikely to be any major shift towards the renminbi while China’s authorities maintain such tight control of it and prevent it from a free float against other major international currencies.
To an extent, that’s to be expected. What’s more significant is that traditional allies are now doing the same. Europe is grumbling too. Last year Jean-Claude Juncker, the European Commission president, commented on the “aberration” that 80% of the EU’s energy imports are denominated in dollars despite only 2% coming from the U.S.
European countries are also backing a mechanism whose aim it is to sustain the possibility of trade with Iran despite new U.S. sanctions against the country.
But is there any sign any of these grumblings and various actions are actually having an effect and reducing dollar dominance? In a word – no. The uncertainty and volatility that has been sown around the world by President Trump’s pugnacious approach to foreign affairs and trade relations has, in fact, resulted in a flight to safety. And for now that is still dollar denominated asset.
The amount of trade and global currency reserves held in dollars compared to euro has actually increased over the past decade. That’s despite a financial crisis caused by the U.S. mortgage derivatives collapse a decade ago and aggressive weaponisation of the dollar more recently. Long term, the approach is considered to be a risk to the dollar’s dominance of international financial markets and systems. There is a growing trend towards the set-up of systems and institutions that will not be under the control of U.S. say-so. But any significant shift in the balance of power is practically likely to be decades away.
Does U.S. Weaponisation of the Dollar Impact Investors?
Spiking commodity prices and volatile emerging market currencies can certainly have an impact on investors. The problem is, it is currently very difficult for investors to forecast exactly where new sanctions or tariffs might fall or be lifted, affecting different sectors or markets.
More immediately actionable is the USA’s determination to drive the value of the dollar down in an attempt to boost the country’s exports and rebalance its trade deficit. However, that’s also a tricky one for investors, especially those from the UK, to get right. A boost for U.S. exporters as a result of a falling dollar could be counteracted by a drop in the value of dollar-denominated assets against the pound.
If there’s one actionable step investors can take to protect their portfolios over the long term against currency wars the timing and outcome of which it is almost impossible to predict, it is to diversify currency exposure. Consider holding assets exposed to a range of major currencies as well as, if possible, denominated in different currencies.