Regime Change?

The centerpiece of shock and awe of the West’s economic response to Russia’s invasion and bombardment of Ukraine was the freezing of Russia’s central bank assets. In the March 7 edition of his Global Money Dispatch newsletter, the Credit Suisse investment strategist Zoltan Pozsar writes that the G7 seizure of Russia’s foreign exchange reserves marks a regime change in the global monetary system. Pozsar pronounces this new regime Bretton Woods III. He anticipates that Asian sovereigns, fearing that their dollar- and euro-denominated foreign reserves are at risk of expropriation in the event of future foreign policy disputes, will park their surplus funds outside of the reach of Western financial authorities. For Pozsar, this heralds the rise of “commodity-backed currencies in the East” and spells the denouement of dollar hegemony.

In a follow-up piece published on March 31, Pozsar speculates that recent developments will drive China to replace the West as the buyer of last resort of Russian oil. As a result, oil tankers will have to be rerouted from the quicker East-West route via the Suez to a longer passage (one requiring ship transfers) from Russia to China. Geopolitics will shape the reorganization of real infrastructure networks, slowing down supply chains and increasing the cost of credit. Pozsar predicts that this rearrangement of global commodity and money flows presage a new world economic order, one in which China will replace the US as the monetary hegemon. The petrodollar, he envisages, will be replaced by the petro-yuan. 

Pozsar’s analysis—as well as Adam Tooze’s response to it—appreciates the asymmetry in the world economy: between advanced economies that dominate global finance, and developing countries that produce the majority (about sixty percent) of world GDP. Asia may be the center of gravity of world manufacturing, but European and North American firms still command the bulk of the profits embedded in global supply chains. This tension in the global economy is unlikely to resolve anytime soon, but it has become increasingly fractious. The weaponization of trade policy by the previous Republican administration has only been reinforced by the current Democratic one. Treasury Secretary Janet Yellen’s recent speech advocating “the friend-shoring of supply chains”—wherein the US strengthens trade ties with those it shares strategic interests and “core values,” while severing the rest—captures the new mood. (In her speech, Yellen also calls for revitalizing Bretton Woods based on her view that the dollar-based economic order “benefits us all.”)

Understanding this emergent world economic order requires complementing Hyun Song Shin’s famous “matrix of balance sheets” approach to financial globalization, with a lens that sees the global dollar system as a matrix of monetary, military, and legal dominance. We are witnessing the waxing of a new chapter in this system—if we are in a new era called Bretton Woods III, it is the most weaponized form of the global dollar system yet. 

Bretton Woods I

From 1952 to 1973, Bretton Woods I enforced the subjugation of other currencies to the dollar. Getting gold required converting other currencies, say pound sterling or french franc, into dollars, which were alone convertible into gold. Dollar dominance thus hinged upon a stable exchange rate between dollars and gold. This meant limiting the supply of dollars—easily printable compared to producing gold, a scarce commodity. A rising demand for dollars in the late 1960s made maintaining a fixed parity between dollars and gold increasingly difficult. In August 1971, fearing a dollar crash, President Nixon delinked the greenback from gold. No longer could holders of dollars go up to a bank window and exchange them for gold. De facto, the international monetary order known as Bretton Woods was over.

Nixon’s decision to remove the dollar from its gold peg was coupled with the threat of trade sanctions unless the Europeans appreciated their currencies, making US exports cheaper and more attractive to the world market. To his G-10 foreign counterparts, Nixon’s Treasury Secretary John Connally infamously declared: the dollar “is our currency, but it’s your problem.” The United States’ abandonment of its management of the world dollar made for more than a decade of economic disorder marked by high inflation and unemployment.

Pozsar likens the present moment to this structural break in monetary regimes. But we are not back in 1971. When markets appeared unflummoxed in the first week of the Russian war on Ukraine, in the words of the Fed chairman, Jerome Powell, it was because “we have institutionalized liquidity provision.” Powell was referring to the Fed’s swap lines and treasury repo facilities, made permanent last summer, that stand ready to supply dollars to foreign central banks and money markets in case of market turbulence. Compared to the sharp outflow of financial flows from China, and widening spreads on sovereign debt in the European periphery in the days following the Ukraine invasion, the dollar strengthened and inflation expectations in the US appeared well-anchored partly because of the Fed’s assurances that it would stabilize dollar funding markets as the dealer of last resort. 

As custodians of the dollar—involved in dollar creation and issuance as well as payments clearing and settlement—the Federal Reserve and US Treasury have unparalleled power over the world financial system. An asymmetric world financial system undergirded by a single currency fuels instability. Leaving world money up to the vicissitudes of global currency markets made for decades of financial crises, mostly on the periphery of the global financial system. However, when a gigantic financial bubble burst in the epicenter of the world dollar order in 2007, crisis-fighting interventions became a core part of the Fed’s mandate. Interventionism was its new mantra. 

If sanctions are the iron fist, swap lines are the velvet glove of the world dollar order. In the last two global financial crises, the Fed’s dollar swaps to foreign central banks—amounting to almost a trillion in 2008 and half a trillion in 2020—were granted to a dozen central banks. In the aftermath of the global financial crisis of 2008, the dollar emerged even more potent in its role as global reserve and trade vehicle currency. The post-2008 global dollar financial cycle means that the dollar dictates fluctuations in world trade, international lending, stock market returns, and global growth. Sovereigns lacking monetary and fiscal autonomy must endure tighter budget constraints, more volatile business cycles, and in times of crisis, sovereign debt defaults. The monetary infrastructure of US hegemony is more expansive and entrenched than ever before.

Bretton Woods II 

Undoubtedly, the G7 seizure of Russia’s foreign exchange reserves will prompt China to reconsider its own foreign reserve accumulation strategy in dollars and euros. It may indeed accelerate a push to internationalize renminbi markets down the road, and countries might be incentivized to switch from SWIFT to Cips, the lesser used Chinese cross-border payments system which spans 100 nations. But for now, China remains firmly ensconced in the US’s vast monetary infrastructure. Its lending—purchases of US treasuries or loans financing the Belt and Road Initiative—continues to be largely in dollars. And despite all the talk of Russia and China aligning against Western powers, at the moment it appears that China is blocking the financing of Russian oil sales in order to avoid secondary sanctions imposed by the US. Network externalities are a powerful force in economics.

While Pozsar argues that the People’s Bank of China “can dance to its own tune,” China cannot escape the fact that the world economy continues to dance to the tune of the dollar. The foreign exchange reserves of governments, global trade, and international debt are all disproportionately denominated in dollars. Export-oriented emerging market economies rely on advanced economy consumers to purchase what they make. Countries pile their export revenues into financial assets denominated in dollars and euros. From the late 1990s onwards, the global economy was characterized by export-oriented economies pegging their currencies against the dollar. Export earnings were poured into the dollar-denominated foreign exchange reserves and the sovereign wealth funds of manufacturing and commodity exporters. The arrangement was provocatively described by Michael Dooley and Peter Garber as “Bretton Woods II,” a collateralized debt swap in which dollar-denominated sovereign reserves purportedly functioned as collateral to secure multinational corporate investment in formerly communist nations like China. 

The Bretton Woods II hypothesis assumed that the global financial hierarchy was stable. China accumulated more than three and a half trillion dollars in its foreign exchange reserves. Part of this is money that could have been spent on improving the social welfare of Chinese citizens. Two decades later, massive accumulation in dollar-denominated assets continues to buoy up the dollar. The question is: are foreign central banks still willing to bear disproportionate risk by purchasing huge amounts of low-yielding US or euro-debt when hard currency issuers have brandished their ability to expropriate their foreign reserves?

In a new paper, Dooley, Garber, and David Folkerts-Landau affirm that present events validate their Bretton Woods II thesis. For them, sanctions are not only justified but indeed the “natural” outcome, should countries renege on the “global social contract.” Collateral should be seized if actors behave badly. For them, the “sequestration” of Russian assets sets an example for other nations that the US is capable of exercising its power to usurp dollar assets. The seizures, they argue, will only reinforce to “geopolitically risky” economies that they must put up more collateral to participate in global supply chains.

Pozsar hazards that China will no longer stabilize global dollar supremacy going forward; that for a variety of reasons—from resource scarcity in the face of climate change and the critical need for commodities in green infrastructure—countries in the East will peg to commodities instead. He neglects to mention that, unlike China, the US is a major oil and gas producer. Ironically, the war has been very good for the US fossil fuel industry. The unprecedented release of US strategic petroleum reserves to ease the supply disruptions wrought by the war were coupled with penalties against US companies not drilling for more oil. The Biden administration’s newly announced joint task-force with the European Commission (which aims to achieve so-called energy security by weaning Europe off of Russian energy) all but guarantees a bigger European market for US liquified natural gas (LNG) at least until 2030. Committing to helping secure energy contracts for US LNG suppliers is a complete turnaround for Europe, which had stopped new US LNG contracts because of ESG concerns. The surge in US LNG exports to Europe is but one indication of how the US is poised to emerge strengthened by the present crisis.

Weaponizing world money

A naive perspective on Bretton Woods takes a benign view of dollar hegemony, but world money has always been geopolitical.

In the mid-twentieth century, sterling still financed almost half of world trade. Oil extracted from Iranian oil fields by British-owned companies was sold in pound sterling. In 1950, the British government ordered sterling area members—its colonial currency bloc which mandated that member governments deposit their hard currency earnings in London—to reduce their purchases of dollar oil produced by American firms and purchase “sterling oil,” instead. Despite having left the Commonwealth, Egypt was coerced into the same arrangement. (Upon leaving the colonial union, when Egypt asked for its sterling balances to be converted into dollars, the UK broke its agreement with Egypt, suspending sterling convertibility just as it had done earlier with India’s foreign exchange reserves.) In 1951, when Mossadegh nationalized the assets of the Anglo-Iranian Oil Company, the British imposed a sanctions blockade on Iran. By 1953, a joint CIA-MI6 operation had ousted Mossadegh from office. When Gamal Nasser nationalized the (British-French) Suez Canal Company in 1956, interrupting the movement of sterling oil through the Mediterranean, Britain, France, and Israel occupied the Suez.

Since 1950, almost half of all global sanctions have been imposed by the US. Economies such as Iran—sanctioned by President Jimmy Carter in 1979—have been prevented from fully participating in the global economy for decades. The globalization of the 1990s brought with it an increase in sanctions. And the aftermath of the 2008 global financial crisis brought still another increase across the board. Unilateralism is one of the defining features of the sanctions regime: they have mostly been imposed by European states on African nations. 

Imposed by powerful states on the less powerful, sanctions are the ugly, coercive underbelly of the global economy. It is not unprecedented for the Western powers to expropriate the assets of another country’s central bank. As recently as 2018, the Bank of England impounded $1 billion in Venezuelan gold in 2018 held in its vaults. This occurred despite foreign sovereign immunity acts in US and UK law that clearly articulate the sovereign exception i.e. immunity from asset seizure. 

The US withdrawal from Afghanistan appears to be a test case for the Biden administration’s use of sanctions as an economic weapon. Biden’s drawdown of US troops in August 2021 put an end to bulk dollar shipments—delivered weekly in pallet-loads carried on planes—to Kabul. (Economies with weak credit and banking systems depend on cash, and the dollar is cash, bar none.) Military withdrawal was followed by monetary warfare. Imposing financial sanctions on the new Taliban government, the US Treasury blocked Da Afghanistan Bank, the country’s central bank, from accessing its foreign exchange reserves held at the New York Fed. Afghanistan relies on auctioning dollars to set its monetary policy. Sanctions seized up DAB functioning, catalyzing a banking crisis. As the dollars disappeared, Afghanistan’s economy imploded. In February 2022, deploying the International Emergency Economic Powers Act, the Biden administration consolidated and froze Afghanistan’s foreign exchange reserves held at the Fed. Later that month, confronted by the worsening famine in the country, the US relaxed some of its sanctions.

Recent months have seen the extension of this economic warfare. The array of US sanctions against Russia included blocking Russian financial institutions from payment transmission and clearing via financial infrastructures such as SWIFT and seizing the overseas assets of Putin and his associates. These actions were enabled by the legal umbrage of emergency powers whose enhanced use dates back to the 2001 USA Patriot Act. The economic war also entailed a flurry of diplomatic interventions. This included sending American envoys to Venezuela to negotiate reopening its petroleum reserves to world markets (which requires removing US sanctions on the country); cajoling OPEC members to produce more oil to tamp down increases in energy prices; a G7 declaration in which the US joined Europe in committing to cap fossil fuel prices if necessary; and sending the US deputy national security advisor and architect of the sanctions, Daleep Singh, to India to scold its government for purchasing discounted Russian oil (no such anger was meted out for the Germans who have continued purchasing Russian energy). Exerting pressure on oil-producing nations to increase production while assuring G7 citizens that energy independence was inextricably linked with clean energy in the long run, legislating new regulations on cryptocurrency, and pressing forward on a Fed-backed digital dollar were some of the moves made by the Biden administration. These Herculean efforts to stabilize the petrodollar order came on the heels of a policy dilemma faced by the Fed in which curtailing inflation via interest rate hikes are likely to have a detrimental impact on the world economy. 

The scale and scope of Russian financial sanctions and their shifting tactical nature—which initially targeted the country’s two biggest banks and exempted Russian energy exports from sanctions but then evolved into expropriating Bank of Russia’s foreign reserves and an import ban by the US on Russian petroleum—is a blow to its rents-driven economy. This economy has been shaped by the legacy of US-led shock therapy that crashed the ruble in 1998. The sanctions cascaded into the removal of Russian investment grade bonds from the three major bond market indices. The departure of Western corporations including BP, Russia’s largest foreign investor, has compounded its economic free fall.

Although capital controls and interest rate hikes imposed by the Russian central bank have lifted the ruble from its collapse in the early days of the Ukraine war, frozen out the global financial infrastructure, Russia’s external debt of around $194 billion is increasingly illiquid. Russia’s recent interest payments worth $117 million on its dollar-denominated sovereign debt, processed via US correspondent banks, were approved by US authorities, averting sovereign default. However, on April 4, the US treasury did not allow about $600 million in outstanding principal and coupon payments on Russian bonds to be processed. US national security advisor Jake Sullivan announced that the US would no longer permit Russia to make debt payments through US banks. The explicit intention of catalyzing a “non-friendly” nation into a sovereign debt crisis evokes that decisive moment in 1956 when Eisenhower threatened the British government that the US would tank sterling securities unless the Brits pulled out of Suez. It was the one instance of US sanctions accomplishing their intended foreign policy objective. 

Bretton Woods III

The emerging economic order thus exhibits an escalation of dollar weaponization. The G7 seizures of Russian central bank assets are unprecedented in their scale. Russia’s foreign exchange reserves held offshore are estimated at $300 billion: two orders of magnitude larger than those of Afghanistan. The world’s third largest oil producer, Russia accounts for more than a tenth of global oil and gas production. Its petrodollars—dollars earned through sales of oil exports—are deposited offshore in global money markets. (Prior to the sanctions, 80 percent of Russia’s foreign exchange transactions and half its trade was conducted in dollars.) Russia’s turbo-capitalists have billion-dollar investments in the world’s financial capitals. Not just private wealth in real estate in Knightsbridge or football clubs like Chelsea—whose sale by its Russian magnate Roman Abramovich has been complicated by sanctions placed on him by the UK government—but also sovereign funds lent out in London’s money markets. According to Pozsar, Russia has lent out about $200 billion in the global foreign exchange swap market. (London is a dominant hub of this global market.)

The coordinated G7 asset seizure of Russia signals how the western economic order has coalesced at the very echelon of the global monetary hierarchy. This comes at the cost of wider multilateralism. The neutral stance adopted by thirty-five economies to abstain from the UN General Assembly vote condemning Russia is a complex one—signaling conflicting allegiances in the face of hardening battle-lines. (This sentiment was vividly captured by Daleep Singh on his recent trip to India: “Friends don’t set red lines . . . We are very keen for all countries, especially our allies and partners, not to create mechanisms that prop up the ruble and that attempt to undermine the dollar-based financial system.”) One third of the world, mostly in the Global South, lives under US sanctions. War-propelled supply shortages in wheat and other commodities on top of pandemic-related strife is compounding precarity in these countries. Following fuel and food riots, states of emergency have been declared in Sri Lanka and Peru.

Economic lawfare is part of this freshly weaponized landscape. Consider the global dollar system itself as a money-military matrix backed by legal armature. Its major capitals are New York and London. The largest cross-border financial flows are between Wall Street and the City of London. The Eurozone with its budgetary strictures is a peripheral monetary jurisdiction in the offshore-dollar system. Much of the world’s money—from international debt securities to gold—is housed in New York and London. A one-square-mile that holds the world’s largest foreign currency markets, in key forms of dollar-financing such as derivatives, the City of London surpasses Wall Street. More than ninety percent of derivative contracts such as foreign exchange swaps—a key form of global funding—are dollar-based. New York and London also dominate the global legal profession. Half of dispute resolution across the world occurs in the courts of England and Wales and about a quarter occurs in New York State. Transnational law bears the insignia of American unilateralism. The US second circuit, which includes New York (the jurisdiction involved in the DAB imbroglio), leads in applying extraterritorial judicial rulings. Meanwhile, the US bristles against other sovereign states applying their laws extraterritorially against US residents. Lawyering through the sanctions has proven very lucrative for Anglo-America. 

Interwoven into Anglo-American legal and financial wealth-defense networks is a transnational security apparatus. Five Eyes, the world’s most powerful intelligence-sharing network, is an Anglosphere arrangement. The forever wars were led by the US and the UK as joint occupying powers. The global span of Britain’s military network is only second to that of the United States. Aukus, the 2021 defense pact between the US, the UK, and Australia, signals a renewed “interoperability” between forces. While not directly mirroring it, this new cooperation is occurring alongside increases in the Australian and Canadian dollars in foreign exchange reserves. The coincidence of hard and soft power—Five Eyes and Fedwire—represents the integration of military, legal, and economic force.

Cui bono?

We are all subjects of this new if nebulous economic order—it can be called “Bretton Woods III”—marked by acute dollar encroachment and its weaponization of the world economy. Resurgent state interventionism in the wake of the pandemic has been followed by renewed state aggression. While codependency between China and the US (evocatively described as “Chimerica”) was a characteristic trait of Bretton Woods II, Bretton Woods III is a virulent strain of the global dollar system. The Russian invasion of Ukraine—whose roots go back to NATO enlargement in Eastern Europe—countered by a Western economic blockade unravels its logic in real time. While Anglo-American sanctions against Iran were intended to decimate its oil exports, US sanctions against Russia exempted its energy sector. Excluding Russian petroleum and gas exports (as well as agriculture and derivatives contracts) from sanctions—to stabilize fossil fuel prices and financial markets in the West—to an Anglosphere import ban on Russian energy is the unfolding and unpredictable shape of weaponized globalization today. 

The last few weeks have highlighted the destruction wrought by weaponizing the world dollar. Lawfare between Russia and the G7 has only intensified. Demands by the Russian government for its gas exports to be paid in rubles rather than dollars were deemed a breach of contracts by the German government. The United States’ block of Russia’s payments on two dollar-denominated sovereign bonds (underwritten in English law) has led Putin’s administration to seek legal action in its own courts against the measures preventing Russia from paying back its debt and recovering its seized central bank reserves.

That the appreciating dollar will once again inflict pain on the poorer parts of the global economy is already evident. Stability at the core of the global dollar system, ensured by any means necessary, will be countered by tremendous instability in the periphery. The complexities of wielding the world dollar as a weapon in economic warfare restage the old dilemmas of hegemonic currency management. There are at least two ways a weaponized global dollar regime can play out. Aligning regimes in the Indo-Pacific and MENA with the North Atlantic apex of the world dollar order via military and monetary aid is the predictable path. (Countries receiving dollar liquidity tend to be entwined in the global networks of US banks and military networks.)

Proponents of benevolent hegemonic stability like Charles Kindleberger and Ronald McKinnon, meanwhile, advocated for defanging the dollar order via multilateralism. For McKinnon, this meant that the Fed should take its responsibility as the world’s central bank more seriously. (This is not an easy task: curbing inflation through interest rate hikes has deleterious financial outcomes for developing economies that conduct business and borrow in dollars, and raises questions regarding the ability of a sovereign currency to suffice as stable world money.) The current Fed under Powell has taken a step in this direction through in its wider liquidity provisioning to sovereigns. The swap line network could be expanded much further. A yet more democratic complement to swap lines would deploy the surveillance and forensic technologies at the hands of the Fed and Treasury to shut down tax evasion and offshore tax havens. A step in this direction, last year’s global minimum tax deal has yet to be implemented.

The G7 energy ministers’ March 10 joint statement in response to the Ukraine invasion advocates cleaner routes to energy independence. Promising “uninterrupted flow of energy for the most vulnerable populations,” the statement at first glance reads like messaging written by a progressive green organization, but ultimately entangles clean energy with the deleterious nationalism of “energy security.” Perverse politics can follow from this marriage: Boris Johnson is courting Saudi money to finance a sustainable aviation plant in the UK, while persuading Saudi Arabia to increase oil production. 

A defanged world dollar order would involve basic income provisioning for vulnerable communities via Fed accounts, fair debt restructuring for poor economies whose futures have been hobbled by onerous debt burdens (countries with large dollar-denominated debt are at increased risk for banking crises), and public financing for green infrastructure in the Global South. Yet the world economy seems to be headed in the opposite direction. World military expenditures surpassed an unprecedented two trillion dollars in 2021. US expenditures alone make up forty percent of this figure. Concurrently, the global campaign to vaccinate the poorer nations against the virus has faltered. The American administration has the capacity to de-weaponize globalization. But this would require a shift in strategy away from “friend-shoring” via military and monetary alliances towards a truly new multilateralism in international monetary affairs. Giving up some of the dollar’s exorbitant privileges may free the US from some of the burdens of economic hegemony.