Predictions about the demise of the U.S. dollar as the main international currency seem to be gaining momentum amid the recent drastic and unpredictable economic policy measures of the U.S. administration
It is, of course, not the first time the U.S. has acted unilaterally and disrupted the prevailing rules-based system and not the first time that this is driven by balance of payments concerns.
In August 1971, the suspension of the dollar's gold-convertibility by President Richard Nixon, the "Nixon shock," was motivated by a desire for a devaluation of the dollar to help redress the country's chronic external deficits. It was also to produce a less dominant role for the dollar and the burden it represented for the U.S.
Concerns about the dominant role of the dollar were not new, even then. Already during the 1960s, it led to the introduction of the International Monetary Fund Special Drawing Right, or SDR, as a new instrument for managing international liquidity.
In September 1972, at the IMF annual meetings, U.S. Treasury Secretary George Shultz proposed a new monetary system. He wanted to increase the role of the SDR as the new
Attempts to restore a new international monetary order were accompanied by a significant decline of the dollar in central banks' foreign exchange reserves, seen as a proxy for the importance of certain currencies in the international economy. The share of the dollar declined from representing three quarters of central banks' foreign exchange reserves in 1970 to representing half in 1980.
The dollar recovered, and represents about three fifths of central banks' foreign exchange reserves today. This is due largely to the use of the dollar by emerging markets. Emerging markets integrated into the international economy without using their own currencies. A historical abnormality. Today, emerging markets including China represent nearly half of world GDP and yet their currencies play no significant roles in international transactions. It represents a persistent source of tension.
The president's rough-and-tumble trade negotiations have throttled financial markets, causing investors to flock to the safety of dollars and Treasuries. But some economists say this style of policymaking could have hurt the U.S.'s safe haven status in the long run.
The dollar's prominence benefits from the considerable network effects of using a single currency. Those are reinforced by reliance on cross-border payments and settlement arrangements that require large trading volumes and a high level of concentration to offer transaction efficiencies. This has perpetuated reliance on existing arrangements.
The economic policy case for greater diversification in international currencies is strong. The dollar is the national currency of the U.S. and is managed to meet national and not international policy objectives. Using more currencies would provide multiple pools of liquidity, reduce reliance on monetary conditions in a single country and therefore seems the more prudent approach to meet the diverse needs of the international economy to conduct balance of payments adjustments and accommodate adverse shocks effectively.
MBridge is the most concrete example of a platform that aims to facilitate the use of local currencies. Launched in 2021, the project is a fund transfer platform and today operates in preproduction mode. Participant commercial banks can use central bank digital currencies, or CBDCs, as settlement instruments to settle cross-border obligations for international trade and foreign exchange whereby all participants from all jurisdictions can transfer and exchange CBDCs directly. The approach does not rely on correspondent banks and all transactions are instantly processed for foreign exchange on a payment versus payment basis. This should eliminate most settlement-related risks and afford banks significant capital and liquidity savings. Therein lies the opportunity to enable smaller currencies to offer needed efficiency in payments.
The transition to a more diversified international monetary system will not be automatic. Earlier attempts failed, including the U.S. sponsored shift to SDRs, mostly as there was no agreement on sharing the transition costs. Emerging markets may need to be willing to proactively facilitate a path toward using their own currencies. Central banks may be required to assume some of the foreign exchange risk and implied costs and provide liquidity in their own currencies by being buyers of last resort. It will eventually be reflected in central banks' willingness to hold smaller currencies, leading to a recomposition of central banks' foreign exchange reserves.
U.S. President Donald Trump posted on social media that countries that seek alternatives to the dollar "should expect to say goodbye to selling into the wonderful U.S. economy." Those retaliatory threats may discourage some countries but seem to energize others. Considerations for reducing reliance on the dollar have not been as serious for decades. Proposals like a "Mar-a-Lago Accord" — in reference to the 1985 "Plaza Accord" — for producing a weaker dollar seem to be cyclical fixes only that are unlikely to lay the foundations for sustained international currency diversification.
The end of dollar dominance has been predicted many times before. But today, the risks of relying on a single national currency have become much harder to ignore. Engineering an orderly transition toward greater currency diversification therefore seems more urgent than ever. It would strengthen financial resilience and may offer a more viable path toward sustained international economic integration. MBridge may not be the only solution but it demonstrates a possible, coordinated and orderly path forward toward greater international currency diversification. Like the Schultz proposal, ideally, the U.S. would support such a move.
