BRICS+, US isolationism and the implications for the dollar

In what economists call the international rules-based order of the 1990s and 2000s, the US was in an enviable position. If machinations of the “Washington Consensus” were likened to those of a football match, then the world’s biggest economy was the game’s most valuable player and also its referee. It set the rules that best suited its capabilities and its style of play.

But in a world that will see a more powerful grouping of BRICs+ nations compete for power and influence with both the US and Europe (for more, see "BRICS+ and contested global leadership: implications for investment management"), Washington’s role in the global economic and monetary system will be a much diminished  one.

And perhaps the most visible manifestation of its reduced heft will be a steady erosion of the US dollar’s status as a reserve currency.

The greenback has for decades been the undisputed medium of exchange, investment currency and unit of account worldwide. It still accounts for more than half of foreign currency reserves, half of global payments and some 80% of foreign exchange transactions.

And yet in recent years, even as the US economy and stock markets  have been in the ascendant, the dollar has seen a steady but persistent weakening of its standing. The evidence is visible in the foreign exchange reserves held by official institutions. Central bank holdings of dollar-denominated assets have been falling.

Emerging market central banks have been at the forefront of this trend – understandably so – as the US re-configures its trading and political ties. In other words, it appears that the US’s imposition of measures such as economic sanctions, asset freezes and the threat of suspension from the SWIFT payment systems has made dollar reserves much less safe than in the past.

Winners from the dollar's demise

Ironically, the US strategy to weaponise the dollar and its economic / financial clout via sanctions hasn’t met with much success. Russia’s economy has not collapsed despite being cut out of large parts of the world financial system while China has made significant progress in achieving technological independence. The risk for the US at this delicate juncture is for the Trump administration to overplay its hand when it comes to erecting trade barriers, exposing the country to aggressive retaliation or product boycotts. Economic nationalism and isolation are growth-killers in the long run and are certain to reduce the appeal of the dollar among international investors.

Another possible threat to the dollar’s global standing comes in the form of cryptocurrencies. While stablecoins, which are pegged to the greenback at a one-to-one ratio, should further boost the role of the dollar, bitcoin and other digital currencies have the potential to become de facto reserve currencies, provided they are universally accepted, recognised or enforced as legal tender. While such conditions looked unlikely to be met a year or so ago, the sands are shifting in cryptocurrencies’ favour. In Switzerland, for example, there will likely soon be a referendum to force the Swiss National Bank to hold bitcoin in its reserves.

Meanwhile,  former German finance minister Christian Lindner has suggested the European Central Bank should consider bitcoin as an alternative to the dollar. All the while, Russia and other US-sanctioned countries have been using domestically-mined bitcoin to bypass western sanctions on trade.

Taking these developments into account, we expect the US dollar to depreciate materially over the next five years, especially relative to the Swiss franc, the euro and emerging market currencies.