The Rise and Fall of the Dollar. Part II: Cracks in the Foundation

Part II: Cracks in the Foundation

The defining factor of the dollar's supremacy in the global currency hierarchy is the demand for it as a currency for speculation and risk hedging. The dollar plays a leading role in shaping global value chains, regardless of their sectoral or national affiliation, since prices for virtually all strategic commodities traded on international exchanges are denominated in dollars. This pattern drives heightened demand for dollars as an intermediary currency in foreign exchange operations on the interbank forex market. Currently, the daily global volume of such transactions exceeds the demand for dollars as a means of international settlements in foreign trade by more than 200 times (Fig. 1). Consequently, the dollar's role as a means of international settlements is subordinate to its role as an instrument of international speculation, which is a priori unacceptable for a currency serving as a global price benchmark.

Figure 1 – The Duality of the US Dollar as a World Currency

Source: Calculated based on data from BIS, WTO, SWIFT.

The second destabilizing factor in the global hegemony of the dollar is the US external debt, in which the largest economies (Japan, China, UK) and money market funds (JPM, Fidelity) place their assets. By the end of 2024, the US net debt to the rest of the world reached $26.5 trillion. In the 2010s, the US net external indebtedness was balanced by the net debt obligations of the eurozone and other debtors; however, starting from 2021, the US share in the global volume of net external debt obligations rose to over 90%. The IMF forecasts that this trend will persist in the near future (Fig. 2).

Figure 2 – Net Creditors and Debtors (-), difference between gross external assets and gross external liabilities, as % of world GDP

Source: IMF.

Thus, in nine out of ten cases, investors choose the US dollar as the currency of denomination for their external assets. Given the significant reduction in the size of international dollar reserves relative to the global dollar debt compared to the pre-2008 crash situation, the current risks of destabilizing the world economy appear higher. As is well known, financial crises are man-made phenomena. The only question is whose nerves among the holders of dollar debt will give out first.

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In 1931, few could imagine that Britain would abandon the gold standard. Similarly, the suspension of dollar convertibility into gold in 1971 seemed inconceivable. Nevertheless, it happened—and suddenly—so that few were able to prepare for this shock adequately. Today's numerous forecasts about the dollar maintaining its positions as a key financial asset and means of international settlements in the foreseeable future instill confidence in the immutability of the current status quo. However, the imbalances accumulated in the global economy indicate that the "pillars" on which the dollar's world dominance rests have been seriously deformed from within. Therefore, it is crucial that illusions about sustainable and inclusive development under the dominant financial paradigm dissipate before the entire global overhang of dollar liquidity collapses. There is no unambiguous way out of the current situation. It is obvious that preventing the collapse of the dollar pyramid is no longer possible. To minimize damage at least at a local level, it is necessary to form a more or less clear understanding of the intricacies of the modern global financial architecture. But that is the subject of the next article.

Author: Doctor of Economic Sciences, Professor of the Department of World Economy and World Finance at the Financial University under the Government of the Russian Federation Aleksey Vladimirovich Kuznetsov.