By Asish Singh
No discussion on the present global financial system can take off without addressing its birth: the Bretton Woods. While the US produces roughly 20 percent of the world’s economic output, north of half of global currency reserve value is in US Dollars. This unalloyed blessing to the US was the outcome of the Bretton Woods agreement of 1944, which pegged the dollar to gold and other currencies to the dollar. The centrality of the dollar got entrenched when, almost 30 years later, the dollar was disconnected from the value of gold.
For starters, monopoly over the supply of dollars enables the US to magically finance its budgetary, and more importantly, trade deficits with other countries. The Federal Bank’s monetary policies, most importantly quantitative easing, can easily routinize the value of the dollar, a notable competitive advantage. It also functions as a shield against balance of payments crises, since it imports, borrows and services debt in US dollars, which only the US Federal Bank can mint. However, the real deal is the contingent dependency of the world financial and trading networks on the US dollar. And therein originates the might of the US’ sanctions programs. Legislation such as the International Emergency Economic Powers Act, the Trading With the Enemy Act and the Patriot Act permit Washington to weaponize all payment flows which are either in dollars or pass through banking infrastructure which is subject to the US’ coercive clout, such as the Bank for International Settlements and so.
America was less relevant than Serbia in diplomatic conversation during the July crisis of 1914. By 1916, when Europe was burning and its capitals were low on coffers and resources, it was suddenly evident that everyone needed dollars: the currency that enabled access to the last expansive pool of raw materials and industrial resources that had not been already mobilized for war purposes. The end of Bretton Woods meant dollar supply could be expanded without anchoring it to equal value of gold. An interesting tidbit is that by 1970, $11 billion in gold backed $24 billion in dollar exchange reserves with institutions outside the US. Visibly, not every paper dollar could be exchanged for gold. The dollar-gold link was at best a fable. The supply of dollars was now independent of gold. Supply as well as interest rates soared, whipping the influx of hot money (funds that are controlled by investors who actively seek short-term returns) to and between global financial centers and markets. The commanding drivers of this new era of money-led prosperity were Wall Street Banks, whether New York or London. The dollar, and major American or America-linked banks were the facilitators of finance and trade.
The fancy of this new era was growth, flexibility, free trade and markets: The Washington Consensus. Peer pressure demonstrated by financial surge both motivated and compelled countries of the Global South to liberalize their currency regimes. This delved into a wave of dollar-denominated international bank and institutional lending. Of course, dollar-facing, liberalizing regimes were preferred and others were spurned at. The Indian government made the rupee partially floating in 1992. Currency convertibility instilled in developing countries a hope of integration into a neoliberal, raging world economy. This was consequential for trade and capital flows to many developing countries. The export-led growth stories of Japan and South Korea piled onto the peer pressure, deepening global dependence upon the dollar.
After the fall of the Soviet Union, the dollar rode on the back of the unipolar dominance of the USA. Indeed, it was now the world’s de facto global currency. Even in Russia, when Vladimir Putin assumed power, the Russian Treasury preferred to have taxes paid in dollars. The implications of this embrace seem to have profaned Russia. The omnipresent centrality of the US dollar in global payments infrastructure coupled with its dominance in international transactions bestows upon the US unbridled powers to slap financial and economic on other countries. So much so that they are rendered incapable of receiving export payments, purchasing goods in international markets, or own US-dollar denominated assets. The sanctions trend began during the presidency of Bill Clinton and was subsequently thickened during subsequent administrations. Donald Trump’s ‘America First’ policy resulted in a number of payment sanctions being imposed on Iran, North Korea, Venezuela, Syria, and also Russia. Some Chinese individuals and institutions have also been sanctioned for allegedly facilitating payments for Iran and North Korea. One of these is the Bank of Dandong, which in 2017 was blocked out from US financial networks over violations of sanctions against North Korea.
US sanctions as a practice attained higher height with the enactment of the Hong Kong Autonomy Act, which subsumes punitive measures against lenders that do business with sanctioned officials, including bans on receiving loans from American banks, participating in foreign-currency and banking transactions, and investing in equity or debt. The US may also freeze the assets of designated institutions. While the applicability of the law is not restricted particularly to Chinese institutions, it was drafted with the likes of the Bank of China (BOC), Industrial and Commercial Bank of China, and China Construction Bank in the view. The prospect of losing access to the international reserve currency is a potent threat. China’s four largest state-owned banks held about $1.1 trillion in dollar-denominated liabilities at the end of 2019, according to Bloomberg Intelligence. In addition to handling trade transactions for Chinese businesses, they also serve as sources of financing for Beijing’s Belt and Road infrastructure initiative.
The vast and complex structure of the US financial system lends itself well to the inference that non-US international banks would most likely comply with US sanctions to protect their overseas network and US dollar-denominated transactions that are ultimately dependent for clearance upon the US Clearing House Interbank Payments System (Chips). Chips constitute the primary settlement network for large-value domestic and international US dollar payments. The framework has 47 member participants – including the Bank of China and the Bank of Communications, two of China’s five largest state-owned banks – which must observe the US sanctions programmes to avoid being stripped of membership. The US also influences and/or arm-twists the Society for Worldwide Interbank Financial Telecommunication (SWIFT), which is the world’s largest electronic payment messaging system, to disclose information about transactions to the US for terrorism/laundering-related investigative purposes on any targeted bank. The network’s 11,000 members ping each other more than 30 million times a day.
Per data from Swift, more than 50% of global transactions on its platforms are denominated in dollars. As a substantial chunk of dollar transactions are routed through American banks, the US might exert that those transactions pass through US soil, thus claiming legal jurisdiction over them. Clearly, the US boasts a mammoth sway over the locus of international transactions. As the Economist puts it, “America is uniquely well positioned to use financial warfare in the service of foreign policy.”
The US and EU have exercised the ‘financial nuclear weapon’ on Russia: SWIFT sanctions. The intention of the moves is to “further isolate Russia from the international financial system”, a joint statement stated. The measure has cut off a number of Russian banks from the main international payment gateway. Before this, only Iran had been cut off from SWIFT. Its is a cautionary tale for Russia. After the Iranian banks were offboarded from SWIFT, the country lost almost half of its oil export revenues and 30 percent of foreign trade. The impact on the Russia economy could be equally worse in the short term, more so because Russia counts heavily on SWIFT due to its multibillion exports of hydrocarbons denominated in U.S. dollars. The cutoff is set to terminate all international transactions, trigger currency volatility, and cause massive capital outflows, which is well underway: the Russian ruble has plunged by more than 40 percent over the past few days. This counts among the largest currency collapses on record and outstrips Russia’s 1998 currency collapse. Destruction of the ruble’s value in turn has led to the Russian stock market losing about half of its value since the invasion.
The levers of this West-facing financial system are largely with the USA, and then with its transatlantic allies. This projection of political rivalries into the global economic system is a major concern of the international political economy (IPE). This yields what we know today: a global economy of rivalries between individual states. For example, Afghanistan, Iran and others, such financial sanctions might as well fetch the US easy control of the government and its financial maneuvers, by proclaiming that all international trade flows and investments to the country be subject to the US Treasury’s approval through a system of licensing.
Another way the US can throw around its weight in the global financial system is through the confiscation of foreign exchange reserves in American and other partner banks. This has been demonstrated in the US, Japan and European Union collectively freezing the Russian Central Bank’s $650 billion in international dollar reserves which Russia had stockpiled before invading Ukraine to cushion the ruble from the devastating effect of capital outflows. Also, the US recently froze $7 billion in Afghanistan’s foreign exchange reserves deposited in the New York Federal Bank. At a time when, according to the UN, more than half of the population is under threat of starvation, on February 11 the Biden administration would split the funds equally: between compensation for 9/11 victims and humanitarian aid for the Afghans.
However much a contemporary commenter may prattle about the West losing its grip over the world economy, the West is not going to recede anytime soon. We have traced in this article the contingencies of war, development and peer pressure that pushed the US dollar into prominence. It led eventually to the co-optation of neoliberal economic features into geopolitics, along the faultlines of a dollar-dominated financial system.
Asish Singh is a freshman student of International Relations at Ashoka University.