Money Talks: The struggle for currency supremacy

PAOLO TASCA

UNITED STATES: A combination of geopolitical tensions and aspirations for economic autonomy is motivating Russia, China, the European Union, and others to move faster to establish new currency and financial systems. These developments naturally raise questions about the US dollar’s central role in global trade and finance – questions that necessarily implicate the future of the existing international order.

The impact of geopolitics on currency markets is clear. Safe-haven currencies like the Japanese yen are showing significant gains, whereas the status of the Russian ruble remains uncertain. In emerging markets like Turkey, erratic policies and abrupt policy changes are sustaining considerable currency volatility. And, of course, America’s own internal economic challenges are major variables to watch. A failure to manage its high national debt and political strife could lead to a decline in global confidence in the greenback.

While developments in Asia, the Middle East, and Eastern Europe have been dominating the economic discourse and driving currency dynamics, there is nothing new about significant exchange-rate movements following major world events. What is new are digital assets, which are further complicating the picture. A particularly concerning trend is the move by countries and entities under the influence of the Communist Party of China (through Hong Kong) to evade the regulatory purview of the United States by adopting digital alternatives to the dollar. The shift toward a crypto-based financial system, operating beyond traditional regulatory frameworks, obviously has the potential to erode dollar hegemony. To some, the evolution of Bitcoin exchange-traded funds and public listings of cryptocurrency companies may suggest that crypto will sit neatly within existing power structures, and they would be correct. The emergence of Bitcoin ETFs could reasonably be categorized as an attempt to “institutionalize” and control Bitcoin through these structures. But the battle for currency supremacy is a multilateral one – where these currencies break new ground is in their lack of allegiance to the dollar or US financial systems. US financial systems and the dollar can interact with digital currencies, but digital currencies do not require them to operate.

Bitcoin and other digital currencies that are not backed by any state are here to stay; and fiat-based digital assets like stablecoins or “state-backed” central bank digital currencies (CBDCs) also will offer new advantages in today’s fiercely competitive global economy.

Still, the question of whether the dollar will be dethroned by a digital asset, a stablecoin, or some other currency ultimately misses the point. What really matters is the mix of possible alternatives that the evolving financial landscape will offer to governments pursuing a geopolitical advantage. In this context, new techno-powered alternative currencies should be understood as pawns in an older battle for strategic dominance for which there is no end in sight. The likely outcome will be a difficult, and potentially destabilizing, transition toward a multipolar currency system inhabited by a complex mix of state- and non-state-backed alternatives.

But this will not happen overnight. Despite successful “experiments” like El Salvador (which gained millions in dollars by simply holding onto Bitcoin reserves), there is no basis to anticipate the imminent end of dollar hegemony. After all, the greenback’s status as the world’s safest reserve currency still aligns well with the needs of countries that boast large trade surpluses – not least China. The US-centered global financial system is what allows these countries to convert their net exports into safe assets. Without the dollar, non-American capitalists outside the US would not have been able to accrue and safely store such immense surplus value from their labor forces.

Technological innovation cannot simply bypass longstanding financial norms or put an end to complex political disputes that have been playing out over the course of centuries. International-relations theory largely rejects the possibility of a harmonic global currency system being built without ulterior motives. According to the realist view, which regards states as rational interest maximizers, currency dominance is another means of ensuring one’s own security and material power. A robust national currency serves this objective for the issuing country.

But this isn’t the only way to look at the currency competition. While liberalism favours economic cooperation and assumes the rationality of national players, states will not hesitate to abandon established norms when threatened, or when seized by other motives. Consider Russia’s abrupt pivot to a zero-sum mindset in early 2022, when it invaded Ukraine and effectively invited sweeping international sanctions. At the end of the day, even the most idea-focused theorists must recognize that innovation and power can mean different things to different states.

The tension between political power and technological progress is also reflected in the intergovernmental organizations shaping the rollout of digital assets. While the United Nations has made strides in shaping crypto-asset policy through initiatives like the Financial Action Task Force’s 2019 Travel Rule, its power is inherently limited by international-relations norms, like the priority of maintaining diplomatic relations with all countries and following the guidance of the G7.

The numbers speak for themselves: as of March 2022, only 29 of 98 jurisdictions had implemented the Travel Rule. Other bodies, such as the International Organization for Standardization and the Bank for International Settlements, have also faced implementation difficulties, owing to cultural and economic-development differences among member states.

Without widespread buy-in, a policy’s impact will always be limited, no matter how well it is designed. So far, there has been little public outcry about major policy moves to address the rise of digital assets. But that can always change, because norms of restraint can quickly fall by the wayside when something (like a new cryptocurrency) threatens a state’s power.

A digital asset’s potential for wider adoption and use is most enticing not to the countries that already dominate international organizations, but to those that stand to benefit the most from a currency disruption. Academics, policymakers, and innovators can all agree that digital assets hold the promise of empowering emerging economies and encouraging healthy, if not groundbreaking, competition.