The sharp “risk reduction” choice facing the economy

For decades, I have argued that the US dollar will retain its position as the dominant currency in the global economy. This remains in effect today. No other currency, physical or virtual, can replace the dollar at the center of the international monetary system.

However, the dollar’s global influence faces a number of non-economic challenges, despite its continued status as the world’s “reserve currency.” This is a consequence of the increasing fragmentation international economic system. National security and geopolitics supplant economics in shaping national and international interactions.

Slowly and surely, countries will now be forced to choose between two strikingly diverging paths: cooperate more to strengthen multilateralism and its regulatory framework, or accept economic decoupling as an inevitable complement to greater risk reduction by individual states.

Role dollars as a reserve currency has long been supported by three attributes of the US: its status as the world’s largest economy, the depth and breadth of its financial markets, and the predictability that comes from institutional maturity and respect for the rule of law.

By adopting the dollar as a medium of exchange and a store of value, other countries achieved significant efficiency gains, allowing the US to enjoy what former French President Valéry Giscard d’Estaing called “an exorbitant privilege” in the 1960s. ” – in essence, a greater opportunity to exchange your own currency for goods and services from other countries, while having access to a wider pool of low-cost financing.

This is part of a hidden contract: America benefits in exchange for responsible management of the system. However, the latter aspect of the contract has been questioned over the past 15 years due to the 2008 global financial crisis that originated in the US and the sudden introduction of trade tariffs in 2017.

While these events shook the dominance of the dollar, they did not fundamentally undermine it due to what can be described as the “cleanest dirty shirt syndrome”: the dollar may not be a pristine reserve currency, but it is still considered cleaner than any other currency. for this role.

Over the past two years, this situation has become noticeably more difficult due to the US Federal Reserve’s mishandling of the interest rate hike cycle and the growing emphasis on sustainability in economic and business strategies. Instead of trying to completely replace the dollar, efforts are now being made to create channels around it in the world’s trade and payment infrastructures.

China has maintained its leading role in this by strengthening initiatives to build new regional and global institutions, expanding the use of its own currency in bilateral payments and loan agreements, and revamping its Belt and Road Initiative. But it’s not just China.

The tough sanctions imposed on Russia have helped boost the country’s interest in non-dollar deals. In addition, more and more countries are beginning to consider it expedient to reduce their dependence on the US currency over time. They are watching how Russia has reoriented its trade and replaced the dollar in both export and import transactions, albeit in a cumbersome and costly way.

In the face of these developments, the US and its allies essentially have two options. They can work together to renew versatility in an inclusive way, backed by Jared Cohen of Goldman Sachs. refer as “geopolitical swing states”. This will include modernizing the management, representation and operations of the IMF and the World Bank.

Or they may accept the short-term costs and uncertainties associated with decoupling required to properly mitigate risk. The idea of ​​”de-risking, not dividing” put forward by the G-7 last weekend may sound appealing, but it is likely to lead to an unsustainable middle ground rather than a viable new equilibrium.

From an economic point of view, more inclusive multilateralism, backed by a robust rules-based system, certainly offers great advantages over alternatives. However, it is becoming increasingly clear that the economy is no longer driving the process of trade and international finance. There has been a fundamental shift in the relationship between the economy, on the one hand, and the combined forces of national security, politics, and geopolitics, on the other.

It is an inversion that now contributes both to risk reduction and to the decoupling of cross-border supply chains and cross-border payments, and it is one that a multilateral system, weakened over time, cannot effectively counter without serious new efforts.