Could Weaponization of the Dollar as a Foreign Policy Billy Club Accelerate De-Dollarization?

You can effectively use a stick to keep people in line. But you might find yourself in trouble if they pick up a bigger stick.

The United States could be in danger of finding this out the hard way.

The U.S. government uses the dollar’s status as the global reserve currency as a foreign policy tool. Could this hasten the dollar’s demise?

The U.S. and other Western countries aggressively sanctioned Russia in the wake of its invasion of Ukraine. America and her allies locked Russia out of the SWIFT financial system and froze around $300 billion in Russian central bank assets.

Now there is talk of escalating economic warfare against the Russians. Treasury Secretary Janet Yellen recently floated the idea of liquidating frozen Russian assets and using them to rebuild Ukraine.

It is necessary and urgent for our coalition to find a way to unlock the value of these immobilized assets to support Ukraine’s continued resistance and long-term reconstruction. I believe there is a strong international law, economic, and moral case for moving forward. This would be a decisive response to Russia’s unprecedented threat to global stability.

Even if you believe this would be a justifiable and effective policy, it’s important to understand that the U.S. is playing with fire.

And the rest of the world is watching.

An AP report on Yellen’s comments conceded that the strategy doesn’t come without risk.

There are tradeoffs since the weaponization of global finance could harm the U.S. dollar’s standing as the world’s dominant currency.

The Dollar as a Weapon

The United States projects power around the world with its powerful military, but that’s not America’s only source of strength. It also uses the dollar to achieve foreign policy goals.

The U.S. government utilizes a “carrot-stick” approach. It showers billions of dollars of foreign aid on its friends. But enemies can have access to their own dollars cut off, as Russia learned.

The dollar’s status as the global reserve currency along with the SWIFT system provides the U.S. significant leverage over other nations.

The Society for Worldwide Interbank Financial Telecommunication (SWIFT) system serves as the global economy’s superhighway. In effect, it operates as a global financial messaging service, facilitating cross-border payments. As the SWIFT website puts it, “SWIFT is the way the world moves value.”

Since the dollar serves as the world reserve currency, SWIFT effectively facilitates an international dollar system.

After the invasion of Ukraine, the U.S. and its allies quickly imposed economic sanctions on Russia, and they escalated quickly. Officials initially indicated Russia would not be locked out of SWIFT, but a few days later, the United States, the European Union, the UK, and Canada issued a joint statement announcing SWIFT would disconnect “selected” Russian banks from the global payment system.

This wasn’t the first time the U.S. used SWIFT and the dollar as a stick to advance its foreign policy goals.

In 2014, the Obama administration locked several Russian financial institutions out of SWIFT as relations between the two countries deteriorated over Ukraine and Crimea.

A few years later, the Trump administration threatened China in an attempt to force that country to join in sanctioning North Korea.

"If China doesn't follow these sanctions, we will put additional sanctions on them and prevent them from accessing the U.S. and international dollar system, and that's quite meaningful," U.S. Treasury Secretary Steven Mnuchin said at the time.

Economic sanctions can certainly advance foreign policy goals. But there is a big potential downside when the U.S. uses its economic privilege to bend other countries to its will.

Trading Dollars for Gold

Using dollars as weapons may seem like an effective way to keep the “bad guys” in line, but it comes with risk.

Consider this - if you recognize something makes you vulnerable, what do you do?

If you’re smart, you take steps to eliminate or at least minimize that vulnerability.

So, if you’re worried that the U.S. and its allies might cut off your access to dollars, what would you do?

Minimize your dependence on dollars.

In other words, if you are concerned that the U.S. could pull the "dollar rug" out from under you, why not pull out from the dollar system first?

This is already happening.

And if enough countries diversify away from the dollar, it could ultimately undermine the greenback’s role as the world reserve currency. 

During an interview with Kitco News, Aberdeen Standard Investments Director of Investment Strategy Bob Minter said he believes we are seeing a strategic pivot away from the U.S. dollar amid geopolitical tensions. He pointed out that many emerging market countries are diversifying their reserves to minimize their dependence on dollars – and ostensibly minimize U.S. control over their foreign policy.

"All four presidents have used the dollar's reserve status as a means or an arm of U.S. foreign policy,” Minter said, referring to Bush, Obama, Trump, and Biden.

If I were in charge of an emerging market country's foreign currency reserves, I would want to diversify away from the dollar. ... You harden your currency with gold...

This is almost certainly one of the underlying reasons so many central banks, including China, are buying gold.

When Poland's central bank president Adam Glapiński announced an expansion of Polish gold reserves, he pointed out that it would increase the country’s security and financial independence.

Gold will retain its value even when someone cuts off the power to the global financial system, destroying traditional assets based on electronic accounting records. Of course, we do not assume that this will happen. But as the saying goes – forewarned is always insured.

Central bank net gold purchases totaled 1,037 tons in 2023. That fell just 45 tons short of 2022’s multi-decade record, continuing a multi-year trend of strong central bank gold buying.

China was the biggest buyer in 2023. The People’s Bank of China officially reported a 225-ton increase in its gold reserves.

Central bank gold buying is expected to remain hot for at least the next several years.

There are also indications that many countries are bringing their gold home, removing the possibility of foreign banks in the U.S., England, and other countries seizing it.

According to a 2023 Invesco survey, a “substantial percentage” of central banks expressed concern about how the U.S. and its allies froze nearly half of Russia’s $650 billion gold and forex reserves.

The same survey revealed that around 68 percent of central banks plan to keep their gold reserves within their borders. That’s up from 50 percent just four years ago.

Interestingly, Federal Reserve Chairman Jerome Powell dodged questions from Rep. Alex Mooney, (R-W.Va.) about transfers of gold out of Fed vaults.

There have also been moves to create alternatives to the SWIFT system and to use currencies other than the dollar in transactions.

The Russians developed their own payment system several years before invading Ukraine. Last year, Indian Oil Corp. bought a million barrels of oil from Abu Dhabi National Oil Company in a dollar-free transaction. And Saudi Arabia has indicated it is open to discussing trade in currencies other than the U.S. dollar.

After Russia launched its war with Ukraine, IMF Managing Director Gita Gopinath warned that aggressively sanctioning Russia could erode dollar dominance by encouraging smaller trading blocs using other currencies. It seems her warning was prophetic.

American allies are even wary of the U.S. using the dollar as a club. After the Trump administration pulled the plug on the Iran nuclear deal, the EU announced the creation of a special payment channel to circumvent U.S. sanctions and allow trade with Iran to continue. 

De-dollarization would be a disaster for the United States.

The dollar’s status as the reserve currency indirectly supports the U.S. government’s ability to borrow and spend. Demand for dollars props up the greenback’s value and somewhat shields Americans from the impact of its inflationary monetary policy.

A de-dollarization of the world economy would cause the value of the U.S. currency to crash and likely spark a currency crisis. This would further erode the purchasing power of the dollar and drive prices even higher. It could even lead to hyperinflation.

We can debate the efficacy of economic sanctions, but it’s always wise to be careful when you start swinging a billy club. You never know when people might start to swing back.

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