About the author:
Zhang Chao, Taihe Institute Fellow
The world economy is being dominated by the US dollar as it maintains its status as the global reserve currency. However, the financial world is another arena where the competition is intensifying between different currencies, including yet-to-be issued official digital versions. As the Trump administration’s instinctive and ever-changing policies shocked the financial world during his tenure at the White House, the other major players of the global financial system have stepped up their search for an alternative in earnest. While the European financial actors are seriously contemplating to break the monopoly of Mastercard and Visa in payment systems and eliminate reliance on the US dollar, which they say is a matter of sovereignty, those who are on the eastern shores such as Russia and China, and their major financial institutions, are thinking about ways to create alternatives to SWIFT.
Taihe Institute’s research fellow Zhang Cao has answered our questions about the issue:
1. Is there a compelling reason or need for a US-dollar free payment system?
China, Russia, and the rest of the world outside the U.S. deserve a clearing and settlement system that no longer uses the US dollar. All countries other than the US, need a clearing and settlement system that does not rely on the dollar, in order to provide growth opportunities for individual nations and to free the global economy from the US dollar’s control. It is the fair and reasonable solution to an outdated system that has put too many eggs in one basket.
2. What would it require to create an alternative system and how long would it take?
A replacement system would require the interconnection and unification of the various international currency clearing and settlement systems.
Technically speaking, the system could be set up quickly; it is not difficult in terms of information technology. A conservative estimate is that the technical issues could be solved in six to twelve months. The greater challenge lies in the politics of such change as international political consensus is notoriously a slippery agenda. Consensus within the European Union has, historically, been difficult to achieve, but it would represent an excellent example of commitment to the rest of the world if it were achieved.
Political obstacles notwithstanding, I believe the EU would like to see the Euro join a new unified clearing system to break away from the US dollar dominance and create a level playing field.
3. What could be the possible stages of such a transition?
SWIFT is currently the leading provider of secure financial messaging used to transfer money between different banking locations. SWIFT is not a clearing and settlement system, but rather, a unified network for messaging transactions around the world. Every currency has its own clearing and settlement system. SWIFT functions as the main clearing and settlement system for the US dollar, but China also has a clearing and settlement system for the RMB.
To replace SWIFT and get rid of the dollar control, a new and universal clearing and settlement system should be first created based on international system unification. Once that has been realized, a commonly recognized messaging network would need to be adopted.
4. There is skepticism about the prospect of an alternative global system. Overall, how feasible is it and what are the pros and cons?
I am sure it is possible to build per se. What needs to be calculated and endorsed are the economic and political costs and responsibilities of creating a global clearing and settlement structure and replacing SWIFT.
Countries that currently use the dollar as a reserve currency would be affected if the currency is over-issued. An excessive supply of the US dollar causes foreign exchange reserves to shrink in dollar-holding countries and their wealth is reduced at no cost to the U.S. Treasury.
The latest data shows that the US dollar’s share of the global reserve currency has dropped from a high of over 70% in 1995 to less than 60% today. The International Monetary Fund’s (IMF) “Currency Composition of the Official Foreign Exchange Reserves (COFER),” released on March 31 of this year, shows that claims in the U.S. dollar continued declined by 2.8 percent in 2020.
If the lost wealth is more than the political and economic costs of creating a system, there will be a strong international move to create a system to replace SWIFT, leaving only technical issues to be sorted out. Therefore, it is a matter of doing and monitoring a cost-benefit analysis.
5. How about the Euro aspirations? Does the EU also consider moving away from a dollar-controlled payment system?
One reason for a decline in US dollar representation in global reserves is that countries have sought to diversify their currency holding to reduce their exposure to the dollar. The launch of the Euro in 1999 played a significant role in the attractiveness of expanding the mix of national currency reserves, as did increasing confidence in the RMB. As I said, I believe EU officials would ideally trust this trend and free the Euro from US dollar dominance.
Europe’s inclination in this regard was catalyzed by policy divergences created between the U.S. and its allies during the Trump administration. Germany’s move to repatriate gold from the Federal Reserve further indicated that Europe wishes to disengage from the U.S. dollar, and in July 2020, major European banks teamed up to launch the European Payments Initiative aiming to create a unified Europe-wide clearance and settlement system.
6. Russia’s Deputy Foreign Minister Alexander Pankin said Russia is working on creating an alternative to SWIFT and that modern fintech solutions can be applied to break the US monopoly in interbank payment and information transmission.
The mechanics of building new fintech is relatively straightforward and fast.
When the U.S. kicked Iran out of SWIFT, the latter had to deal with risks to its national security, people’s livelihood, and foreign relations. China and Russia could similarly be adversely affected by the dollar’s international dominance. Costs of reserving dollars has risen due to various factors. It is coming to a point where China, Russia and other emerging economies would be best served by their own unified clearance and settlement system. The British pound and the Japanese yen may not join in but if Europe participates, it would draw in more countries and the de-dollarization of international financial markets would be complete.