Weekly Geopolitical Report – The Dollar Problem: Part I (October 1, 2018)

by Bill O’Grady

In May, the Trump administration exited the Joint Comprehensive Plan of Action (JCPOA), otherwise known as the Iran nuclear deal.[1]  In conjunction with its exit, the U.S. implemented new sanctions and the goal of U.S. policy is to reduce Iran’s oil exports to zero barrels by November.

The other parties in the agreement, China, Russia, the EU and Iran, are unhappy with the U.S. decision.  The EU is working to create a payment structure which will not use the U.S. financial system.[2]  The plan, which creates a special purpose vehicle that will process trade-related payments between Iran and the EU, could become an alternative to the S.W.I.F.T. network, the current system.  Although S.W.I.F.T. is headquartered in Europe, it is dominated by the U.S. financial system because of the dollar’s reserve currency role.

Because the U.S. has a tendency to implement financial sanctions against its perceived adversaries, there have been growing calls for an alternative to dollar-based trade.  It is not clear whether an alternative system would end up facing U.S. sanctions as some of its users will likely also use the American financial system.  Still, the concern about the U.S. “weaponizing” the dollar has raised the idea of a global reserve currency.

In Part I of this report, we will introduce the characteristics of a reserve currency, including a discussion of the costs and benefits of providing the reserve currency.  Part II will begin with a short explanation of the S.W.I.F.T. network and its importance to international finance.  From there, we will discuss the potential competitors to the dollar, examining the possibility of competing trade blocs.  As always, we will conclude with potential market ramifications.

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