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The US-Israel war on Iran is expensive. It’s expensive in terms of human lives, first of all. It’s expensive too, in pure currency – about $12bn a week for the US. And it’s expensive in how it’s causing the tectonic structures that underpin our global economy to shift. De-dollarization, the name given to the process countries undertake in unwinding their reliance on the dollar, promises to reorder the world, reducing American power globally. Its impact will be felt domestically in what we pay to borrow and whether we can afford to borrow at all.
Iran’s near-total blockade of the strait of Hormuz has had a dramatic impact on the prices of oil and natural gas, which puts major inflationary pressure on the economy of every country in the world. Practically, inflation makes people and businesses poorer, a process that reinforces itself if it’s not stopped (which is partly why central banks exist).
But not all boats are blockaded. In March, about 100 vessels passed through the strait, roughly the number that passed through the waterway each day before the Americans and Israelis started the war. According to the Guardian, the Iranian government is requiring some ships to pay a toll of roughly $2m. But it’s the currency in which the toll has been collected – Chinese yuan – which may suggest a concrete challenge to American power in the world.
The global economy, like any economy, exists through the voluntary beliefs of a critical mass of its participants. And like any group activity, having reference points, or referees with rules, helps facilitate how easily things work. After the second world war, the US dollar emerged as the world’s reference point when many countries adopted it as a reserve currency – we had the largest, most stable economy. The belief that the US is a well-governed country whose leaders would make decisions designed to strengthen the economy explains the fact that nearly 60% of reserves held globally are US dollars.
Practically, a reserve currency is something countries amass to support their own claims on stability. It’s a store of cash that treasuries and central bankers can point to to say: “Even if our economy weakens and inflation increases, we have a lot of US dollars and those will always be valuable.” Before the dollar, many countries held reserves of gold – and some still do.
The stable demand by other countries (and private businesses, and people) for US dollars is important for a few reasons.
First, it means our country can borrow, seemingly indefinitely, without having to curtail expenses. We can fight wars without worrying too much about the national debt ($39tn, in case you’re interested) and we can cut taxes for the rich or spend a lot on infrastructure without worrying too much too (in the near term, at least). Other countries, which aren’t systemically indispensable, can’t do that. It’s a lesson Liz Truss learned the hard way when she tried to cut taxes while borrowing to make up the resulting revenue shortfall. Lenders balked, and her government failed.
The status of the dollar as the world’s reserve currency also means the US government can punish adversaries through sanctions. When it chooses to, the US can force the Swift communications network – the infrastructure used to connect banks around the world with one another – to cut off and isolate banks in sanctioned countries, a little like how Iran is preventing US-aligned boats from passing through the strait of Hormuz.
Our leverage in enforcing compliance originates in part through our control of the global, US dollar-denominated economy. For those sanctioned countries, the cost of doing business rises dramatically. International settlements for trade become impossible or very difficult. Imagine having to pay for everything in cash – and imagine doing it in a currency no one else will accept.
That was the experience of Russia when the country was sanctioned after it invaded Ukraine. The Russians reacted by working with China and a handful of other countries to accelerate efforts to replace Swift and the US dollar as the reference currency for much of what they do, effectively nullifying a lot of those sanctions. Their systems, SPFS and CIPS, exist outside the world of the dollar. They can exchange goods and commodities seamlessly in ruble-yuan transactions. Brazil, India and South Africa are said to be working to integrate with the Chinese system.
Now, Iran’s effort to decouple trade through Hormuz from the dollar has put new impetus behind efforts to shake off the dollar’s dominance. In the years ahead consumers in Asia, which is where most of the oil and gas is bound for, may choose to pay in Chinese currency which then can also be used to buy Chinese goods. In aggregate and over time that weakens the value – the real utility – of the dollar, thereby weakening global demand for dollars.
The upshot for Americans is that this country will be less powerful globally. The ability to apply financial sanctions only works if you control the levers of international finance and now there are alternatives. Our borrowing costs will also go up as demand for the dollar diminishes – which means higher prices across the board. In the longer term it may also mean austerity – if we can’t borrow to finance spending (which we can only do because we’re systemically indispensable), we’ll have to cut expenses to balance budgets. That may require some thinking and planning, neither of which successive American administrations seem to be good at doing.
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