In defense of the dollar

There’s no question about it — the United States dollar is under attack.

Finance is prone to fads, and its latest mania is de-dollarization: the notion that the dollar will soon meet its demise as the world’s preeminent reserve currency.

Everyone seems to hate the greenback. China recently crowed about its “triumphant” purchase of an LNG cargo, which was paid for in yuan and traded through China’s Shanghai Petroleum & Natural Gas Exchange. And Brazilian President Luiz Inácio Lula da Silva has called for development of a new currency for BRIC countries — Brazil, Russia, India, China and South Africa — to dethrone the dollar.

Such events attract media attention, of course, but they may just turn out to be sideshows. Of greater import are China’s arbitrary punishment of Deloitte for alleged audit failures, the summary arrest of the Mintz Group’s corporate due diligence team in Beijing and the political corruption that has long plagued Brazil.

In essence, the devil may be hated, but for all the chatter about its death, neither the numbers nor the stories support the hype. And while it’s true that the U.S. government does itself no favors by applying economic sanctions indiscriminately, spending profligately and printing money, in the immediate future, there’s no replacing the dollar and the institutions that go

along with it.

To be clear, there is a credible threat to dollar supremacy, but that threat comes more from fragmentation than the emer-gence of a true competitor. For America’s rivals, though, fragmentation is good enough, as it damages the dollar system — but less obvious is that it will also be very costly, reduce information and flexibility, encourage fragility and abet repression.

In addition, while technology may help to displace the dollar over time, decentralized finance has lost much of its luster after the last 12 scandal-ridden months in the crypto world — though “smart contracts” and blockchain-based public ledg-ers could offer transparent and enforceable transactions in the longer term, without the dollar serving as an intermediary.

However, the biggest failing of this decentralized nirvana is that there’s no one to complain to if —and when — things go wrong. To whom do you appeal for restitution when a contract fails? Until that important question is settled, trusted legal systems, which in practice means the U.S. and the United Kingdom, will remain the easy fallback.

Much of this de-dollarization narrative — like so many stories that take on a life of their own — seems to arise from social media, as if organically bubbling up from the grassroots. More likely, though, there’s a widespread astroturf campaign afoot to amplify a scant body of isolated “facts” in hopes that something sticks — which would suit America’s economic and geopolitical rivals.

Examined closely, however, the origin story — that the dollar is dominant because trade is denominated in dollars and that the role of the dollar in trade is eroding — is fatally flawed. And it’s not just wrong on the volume of trade, it has things backward in terms of why the dollar is so useful.

First off, trade flows show no sign of erosion. Stories about elaborate new commodities and securities exchanges in Shanghai might seem impressive but most will only have marginal long-run impact. Consider this: Global trade in 2022 totaled $32 trillion, and the dollar is one side of over 72 percent of those transactions — a percentage that’s re-mained steady for 30 years.

But the more salient point is that international trade isn’t the right measure of the dollar’s significance — the gold standard here is its role in financial transactions. And in 2022, the U.S. capital markets turned over $32 trillion per month, on aver-age — equivalent to annual global trade turnover.

That figure doesn’t include funding markets such as repurchase agreements and loans or derivatives in foreign exchange, interest rate and options trading either. At the end of 2022, the Bank for International Settlements reported that the value of derivative contracts totaled over $638 trillion, while turnover of foreign exchange derivatives amounted to $7 trillion per day — with the dollar on one side of 88 percent of all trades — and over-the-counter interest rate derivatives averaged another $5 trillion per day.

That fact is that trade and financial transactions are denominated in dollars because the dollar is trusted.

And that trust has been earned because contracts governed by U.S. (and U.K.) law — i.e. common law systems — embody legal and social norms that have been developed and tested over centuries. Rivals can offer nothing even remotely compa-rable.

In fact, there’s reason to argue that common law — enforceable in U.S. and U.K. courts — not only underpins the value of the dollar but is, in and of itself, the equivalent of a reserve currency. Rather than failing and fading as geopolitics becomes more fraught and contentious, both the dollar and the legal system that defines it will grow in influence and utility.

Simply put, the “dollar” isn’t just a pile of banknotes: It’s shorthand for an intricate web of institutions structured to ensure property rights — laws, rules, clearing systems, messaging systems and relationships among thousands of central and commercial banks, financial institutions and businesses. And perhaps most importantly, common law is built on court sys-tems that function with integrity, transparency and flexibility.

Flexibility is an unusual feature of common law, enabling it to absorb and adapt to changing social norms. In common law systems, there’s a constant interplay between the legal system, legislatures and society in ways that are impossible to achieve in a civil law system — and, of course impossible in authoritarian countries.

And the power of common law is often most evident in the fundamental principle that governs legal actions — full disclo-sure.

This means the complete, often intrusive, disgorgement of all information relevant to any case at hand is mandatory, which makes the legal process less amenable to powerful interests and less susceptible to fraud. Common law has thus proven itself to be uniquely adaptable to new businesses and new ways of conducting business, making it the global legal standard for mobile transactions, maritime, commodity trading, swaps and derivatives, international insurance contracts and, in-creasingly, digital assets.

Poltico