It didn’t come as much of a surprise to most observers when, at a press conference on the sidelines of a BRICs summit in July 2018, Russian President Vladimir Putin took a moment to criticize the United States’ decision a few months before to further tighten financial sanctions on Moscow. Putin explained that the move, which came in retaliation for Russia’s interference in the 2016 U.S. presidential election, was “a big strategic mistake,” because it “undermines confidence in the dollar.” Later that summer, Russian Foreign Minister Sergey Lavrov echoed his boss, insinuating that Washington’s increasing use of financial sanctions would hasten “the weakening and demise” of the dollar as a global reserve currency.
Some observers in the U.S. may be tempted to dismiss the Russian claims as mere wishful thinking. After all, Russia is a relatively weak power compared to the United States, frustrated with Washington’s capacity to use its economic dominance as a coercive tool. With no meaningful way to strike back, the Kremlin has no choice but to resort to fantastical assertions about how the flexing of American financial muscle will, paradoxically, lead to its atrophy.
The Russians may very well be engaged in wishful thinking. But it would be a mistake to dismiss out of hand the potential link between U.S. financial sanctions and a politically driven international shift away from the dollar. In fact, such concerns already exist among the upper echelons of the U.S. policymaking community.
Back in 2016, then-U.S. Treasury Secretary Jack Lew warned of “sanctions overreach” in a speech in Washington. “The more we condition use of the dollar and our financial system on adherence to U.S. foreign policy,” he explained, “the more the risk of migration to other currencies and other financial systems in the medium-term grows.”
The dollar’s stature as the most widely used currency in the global economy rests largely on its economic attractiveness to market actors. Yet political forces can also affect the appeal of international currencies. Using the dollar to settle cross-border trade, or using it as an investment currency, makes good economic sense. But it also creates political vulnerabilities.
Lew was merely pointing out that the more the United States exploits foreign vulnerabilities stemming from global dollar use, the less attractive it becomes as an international currency. Ultimately this may push foreign governments and other market actors to look for alternatives.
American sanctions policy appears to be provoking some governments to try to find “de-dollarization” strategies that could limit their vulnerability to U.S. economic pressure.
As Washington has drawn on financial sanctions as a tool of foreign policy with increasing frequency, evidence in support of these claims has grown. This is most apparent in countries that have been targeted by the United States, like Russia, Turkey and Venezuela. However, concerns about growing political risk associated with the dollar’s international use extend beyond countries that feel the direct impact of sanctions.
In short, American sanctions policy does appear to be provoking some governments to try to find “de-dollarization” strategies that could limit their vulnerability to U.S. economic pressure in the future.
Of course, trying to find such strategies is one thing—actually finding them is another. Upending the dollar’s global dominance is not something that can be easily achieved. While a few de-dollarization strategies in response to sanctions have been successful, others have struggled to get off the ground, and still others have all but failed. So far, the cumulative effect these attempts have had on the dollar’s use is tiny. Yet it would still be a mistake for the United States to ignore them and proceed with foreign economic policy as usual.
Washington must weigh the limited advantages of using financial sanctions as leverage on foreign adversaries against the risk that the overuse of sanctions could generate a growing constituency of anti-dollar governments that, over time, could begin to loosen the dollar’s grip on the world economy.
Dollar Dominance and Sanctions Capabilities
Only a small number of national currencies ever see significant use outside the country that issues them. The dollar tops this elite group. It achieved and has maintained its worldwide dominance largely because of its economic appeal, which is based on three qualities in particular. The U.S. currency is backed by large, liquid and open financial markets. It is widely accepted in the global marketplace. And it has earned a reputation as having a stable value over time.
Today, the dollar is used more than any other currency in cross-border payments, including international trade settlements. It is also the most popular international store of value: Investors, including governments, tend to stockpile their wealth in dollar-denominated assets more than in other currencies.
The dollar’s near ubiquity worldwide is what makes America’s sanctions capabilities so potent. Because so many market actors around the world rely on the U.S. dollar in cross-border payments and trade settlements, most international market exchanges are intermediated by banks with American addresses. And because so many also depend on the dollar as a store of value, a great amount of global wealth is deposited in financial institutions that have U.S. operations.
This centrality of the dollar and the American financial system gives the U.S. government enormous power. Operating through the Treasury Department’s Office of Foreign Assets Control, or OFAC, Washington can target—with great precision—individuals, firms and government agencies associated with foreign adversaries by listing them as “specially designated nationals,” or SDNs. Doing so subjects them to a wide range of potential punitive sanctions.
The objective of these measures is to change the behavior of the target or, often, the behavior of a government with which the target is associated, by imposing financial costs on the designated entity and its bedfellows. SDNs can find themselves cut off from the dollar payments system, as the Russian aluminum firm Rusal found out in 2018, or unable to access their dollar-denominated wealth, as Libya’s Central Bank learned in 2011. Both sanctioned entities discovered that, despite the dollar’s overwhelming economic attractiveness as an international currency, exposure to the dollar can carry considerable political risk as well.
The Treasury Department in Washington, Oct. 29, 2010
(Photo by Mike Janes for Four Seam Images via AP Images).
Over the past 20 years, Washington has been employing financial sanctions as a tool of U.S. economic statecraft with increasing frequency. This is evident when looking at OFAC’s list of sanctions programs, each of which can include dozens or even hundreds of SDNs. At the start of the George W. Bush administration, only five foreign governments were targeted under programs like these. By the end of 2018, 22 foreign governments were. Over the past five years, the total number of SDNs on the Treasury Department’s books has grown from roughly 6,000 to 8,000.
As the United States has shown a greater willingness to use dollar dependence as a cudgel against foreign adversaries, it is only natural that those on the receiving end are reconsidering their currency choices. Yet, in many cases, discontented countries are struggling to find a way out of their quandary.
The Russian Bear Bites Back
Following Russia’s 2014 invasion and annexation of Crimea, the Obama administration targeted a suite of entities and individuals close to Putin’s regime with financial sanctions. Over the next several years, the number of similar programs arrayed against Russia ballooned. In addition to the Crimea sanctions, OFAC designated a range of other Russian businesses, politicians and oligarchs because of their links to human rights violations within Russia and to Moscow’s interference in the 2016 U.S. presidential election.
Russia’s response has been a mix of anti-dollar rhetoric on one hand, and policy efforts aimed at de-dollarization on the other. Shortly after being slapped with the first round of sanctions in 2014, the Kremlin pledged it would “encourage everybody to dump U.S. Treasury bonds, get rid of dollars as an unreliable currency and leave the U.S. market.” Russia itself, it added, “will have to move into other currencies, create our own settlement system.”
Since then, Moscow has backed up its words with action. This is most notable in Russia’s foreign exchange reserve holdings. The Central Bank of Russia, which had been buying gold in higher volumes since the 2008 financial crisis, further increased its bullion purchases following the Crimea sanctions. Between 2014 and 2018, the Central Bank more than doubled its gold holdings from 1,000 metric tons to over 2,000.
As the U.S. has used dollar dependence as a cudgel, it is only natural that adversaries are reconsidering their currency choices.
Gold held in Russian vaults cannot be “frozen” by the U.S. Treasury the way that dollar assets held at the Federal Reserve Bank of New York can. Thus, part of the yellow metal’s appeal is that it functions as a hedge against the political risk of expropriation associated with dollar holdings.
An even more notable shift in the composition of Russian reserves took place following the Trump administration’s significant escalation of sanctions against Moscow in April 2018. According to the Central Bank of Russia’s own reports, 47 percent of its reserves were held in U.S. dollars in the fourth quarter of 2017. This dropped to 32 percent in the second quarter of 2018, following the intensification of U.S. sanctions pressure. The dollar’s share of Russian reserves has continued to fall to just 23 percent in 2019. Meanwhile, as Russia has shed its dollar holdings, it has boosted its cache of euros and Chinese renminbi by over 10 percent each.
Russia has also stepped up its efforts to de-dollarize its cross-border payments in response to U.S. sanctions. The idea here is to create a financial infrastructure capable of financing trade settlement in non-dollar currencies without involving banks under U.S. legal jurisdiction. This, in theory, would make it possible for targeted Russian firms to continue conducting international business despite being blacklisted by the Treasury Department. Progress here has been more limited, however.
Moscow’s most public efforts on this front involve China. The two countries’ central banks maintain a currency swap agreement that is designed, in part, to facilitate trade settlement in rubles or renminbi. The agreement, which effectively acts as a renminbi credit line to the Central Bank of Russia, has been used on multiple occasions since 2015, ostensibly for trade settlement purposes. But progress has been slow. While 9 percent of Chinese imports into Russia were paid for in renminbi in 2014, that number modestly increased to 15 percent by 2017, according to Russian media.
U.S. sanctions are clearly a factor behind these moves. During a visit to China last year for talks on streamlining the system for settling trade in their local currencies, Russian Prime Minister Dmitry Medvedev declared that the idea was attractive because “no one will be able to block the development of financial traffic.”
The Dollar’s Other Discontents
Russia is not alone in its efforts to get out from under the thumb of the dollar. After the U.S. targeted Turkish President Recep Tayyip Erdogan’s government with financial sanctions in 2018 for the imprisonment of an American pastor, Turkey seemingly borrowed a page from Russia’s playbook.
For instance, Ankara’s gold holdings have increased from around 100 metric tons in 2017 to nearly 400 tons in 2019. And, despite Turkey’s total foreign exchange reserves remaining stable since the sanctions were imposed, its dollar holdings have fallen, according to U.S. Treasury data. Together, this suggests that Turkey has diversified its reserves away from the dollar as its relations with the United States have deteriorated in recent years.
While not nearly as vocal on the matter as his Russian counterpart, Erdogan called for the end of dollar dependence while also hailing the attractiveness of gold, which comes without any “political allegiance.”
The struggles of sanctioned countries to find suitable alternatives to the dollar speaks to their own economic limitations.
Washington’s move to target Turkey with sanctions may also help explain a three-way deal between Ankara, Moscow and Tehran to work toward displacing the dollar in their own commodity trades. Of course, agreements like this are easy to put on paper; they are far more difficult to put into action.
Since 2015, the United States has also steadily ratcheted up financial pressure on Venezuelan President Nicolas Maduro’s regime for democratic backsliding and human rights violations. The Treasury Department listed more than 80 individuals with close ties to Maduro as SDNs, cutting them off from their dollar assets and preventing them from making cross-border transactions using the currency. PDVSA—the state-run oil company, and a major exporter and vital source of foreign exchange for the Venezuelan government—has also been designated, as has the Central Bank of Venezuela.
In response to a new round of OFAC measures in 2017, Maduro declared that if the United States uses the dollar as a weapon against Venezuela, the country will “use the Russian ruble, the yuan, yen, the Indian rupee, the euro.” In truth, though, Venezuela has found itself so isolated by U.S. sanctions that it has resorted to physically moving gold around the world to sell on the black market in exchange for euros to keep its economy on life support.
Members of the Bolivarian militia attend a protest against U.S. sanctions on Venezuela,
in Caracas, Venezuela, Aug. 7, 2019 (AP photo by Leonardo Fernandez).
With Russia’s help, Venezuela has also launched its own cryptocurrency, dubbed the petro. The monetary unit was designed to facilitate international trade settlements using blockchain technology rather than relying on financial institutions that enforce U.S. sanctions as intermediaries. So far, however, the petro has been a failure.
The struggles of sanctioned countries to find suitable alternatives to the dollar speaks to their own economic limitations. None possesses a financial system or currency capable of substituting for the U.S. financial system and the dollar. The extent to which any targeted country can truly exit the constraints of the dollar-dominated international financial system depends on the willingness of Europe and China to take on the current system. But here again, Washington’s expanded use of sanctions is creating incentives for them to do so.
Could Europe or China Loosen the Dollar’s Grip?
The typical way that the United States executes its financial sanctions is through the use of primary sanctions. These require any bank maintaining an American branch—which includes just about every major bank in the world—to halt any transaction involving an SDN. Banks that flout these rules can be fined billions of dollars, as some have found out to their regret. For example, BNP Paribas was fined $9 billion in 2015 by the U.S. government for allegedly conducting business on behalf of sanctioned entities in several targeted countries. With such costly consequences looming, banks tend to effectively self-enforce OFAC’s directives.
On occasion, however, Washington implements penalties that pack an even greater punch, compounding primary sanctions with secondary sanctions. These measures provide an extraterritorial means of punishment that further exploits global dollar dependence and the centrality of the U.S. financial system.
Secondary sanctions require an additional degree of separation between any financial institution operating in the U.S. and an SDN. When applied, they not only require that banks cease doing business with or on behalf of targeted entities; they require that banks cut ties with any other financial institution or business that maintains a working relationship with the SDN. In short, secondary sanctions make the SDN classification contagious, as any actor that conducts business with a target becomes a target itself.
This is precisely the tool that the Trump administration employed when it pulled out of the multilateral Iran nuclear deal in May 2018. The withdrawal meant that European firms, which had reentered the Iranian market in 2015 when the deal was reached, were faced with a choice: continue doing business with Iran only to be blacklisted by the U.S. Treasury, or write off all past investments and contracts in Iran. Losing access to the dollar-based financial system was too steep a price to pay. Most firms opted to cut ties with Iran.
Governments may want to wish away the dollar’s grip on the world economy, but private entities remain unwilling to engage in workarounds that could risk their own reputations.
European policymakers were quick to express their displeasure, and their primary target was the dollar. German Foreign Minister Heiko Maas called for the establishment of “payment channels independent of the U.S. [financial system].” French Finance Minister Bruno Le Maire echoed this statement, saying Europe needed “totally independent financing instruments” from the United States. Then-European Commission President Jean-Claude Junker said it was now time for the euro to “play its full role on the international scene.”
China has also recently felt the sting of U.S. secondary sanctions. In September, four Chinese shipping companies were blacklisted by the Treasury Department for helping Iran transport and sell oil. Another group of Chinese firms was designated by OFAC for conducting business with North Korea—another case where Washington has relied on secondary sanctions to further squeeze a target. While China blasted the moves and called for the lifting of the sanctions on its companies, Beijing has resisted publicly calling out the dollar.
The extent to which America’s reliance on financial sanctions results in the erosion of the dollar’s dominance depends greatly on whether Europe or China is willing to mount a concerted and long-term effort to create an economically attractive alternative.
China launched an international financial network based on the renminbi in 2015 known as the Cross-Border Interbank Payments System, or CIPS. The system remains small, but transactions using CIPS have grown steadily each year. Nearly 900 banks have joined, including many from economies hit with American sanctions like Russia and Turkey.
In response to the Iran sanctions, Britain, France and Germany collaborated to create a special mechanism to skirt them, dubbed INSTEX, that aims to facilitate business transactions with Iranian entities outside of the dollar-based financial system. INSTEX, which operates through a complex barter system, has attracted a large number of countries to join—including Russia and China. Despite a clear show of support from governments, though, reports indicate it has yet to enable any transactions.
The tepid response from businesses suggest that, while governments may want to wish away the dollar’s grip on the world economy, private entities remain unwilling to engage in workarounds that could put their own reputations at risk.
A Tarnished Reputation
The U.S. dollar remains the global economy’s indispensable currency. Its centrality gives the U.S. government the unrivaled capacity to financially isolate foreign targets, often with devastating consequences. And yet, the use of sanctions tarnishes the dollar’s fundamental appeal as an international currency. As Washington has brandished its coercive capabilities with increasing frequency in recent years, unease about dollar dominance is growing in capitals around the world.
So far, the responses have been ad hoc and generally uncoordinated. Targeted governments have sought to reduce their holdings of dollar assets by buying gold and other currencies. But a handful of countries shifting assets away from the dollar will barely dent the greenback’s position as the world’s top reserve currency. After all, there are limits to how much bullion any central bank will want to hold. Meanwhile, the Chinese renminbi’s appeal remains constrained by the currency’s lack of full convertibility. And while the euro is an attractive reserve asset, the European debt crisis highlighted structural problems that must be addressed before it can be considered a sound replacement to the dollar.
The growing use of sanctions tarnishes the dollar’s fundamental appeal as an international currency.
In cross-border payments, progress is even more incremental. Governments hit with financial sanctions have reached deals with other disgruntled countries that pledge to promote settlement of trade in local currencies, thereby bypassing the dollar network. However, getting local banks and businesses to change how they have always conducted international business is hard. In most cases, the economic incentives are just not there. Efforts to use cryptocurrency to flout OFAC edicts have so far fallen flat.
All of these factors combine to make dislodging the dollar from its position atop the global currency hierarchy an incredibly tall task. As a recent study on the subject of weaponized economic networks puts it, “once established … centralized network structures are hard for outsiders to challenge.”
Nevertheless, if the United States cares about maintaining the dollar’s preeminence, it ought to heed the warning of former Treasury Secretary Jack Lew. The mounting use of financial sanctions has raised global awareness of the links between dollar centrality, American power and political vulnerability.
If the pace of financial sanctions continues to grow over the next decade as it has over the past one, the constituency of foreign governments and businesses willing to invest time and resources into the creation of alternative financial mechanisms and infrastructure will grow. Such a scenario will only increase the attractiveness of cross-border payment systems based on the euro or renminbi. As more business migrates to one of these platforms, network effects could kick in, drawing even more activity away from the dollar.
Over time, this would diminish the United States’ ability to use sanctions as a tool of foreign policy. All of which underscore the fundamental challenge when it comes to leveraging the U.S. dollar’s dominance: To preserve the tool, Washington must be prudent about its use in the first place.
Daniel McDowell is an associate professor of political science in the Maxwell School at Syracuse University, specializing in international political economy. He is the author of “Brother, Can you Spare a Billion? The United States, the IMF, and the International Lender of Last Resort,” and a regular contributor to World Politics Review.
