The dollar may be the global reserve currency today, but not so long ago, the US was actively trying to promote and prop up another reserve currency, backed by another empire — the British pound.

For most of the 1920s, the US, Britain and France had coinciding interests, with Washington and Paris, supporting London’s efforts to shore up the pound’s value against market forces.

In the early 20th century, the US was at best a middling military power, whereas the sun never set on the British empire’s navy whose gunboats ensured not only its sovereignty but the sanctity of the pound.

Collaboration on shoring up sterling was aided not just by policy, but by personal friendships between American, French and British central bankers, but nothing breaks up friendships quite like a crisis.

And after the Wall Street Crash of 1929, France lost faith in the pound as a store of value, selling it heavily on the global markets, a move that was soon followed by the US.

Because Britain no longer believed France and the US were playing by the rules of the gold standard, by September 1931, the British were forced to substantially devalue the pound, taking it off the gold standard.

Rather than allow gold inflows to increase money supplies (which would have expanded the American and French economies but reduced their trade surpluses), the US and France sterilised inflows, and hoarded gold, forcing their currencies higher against the embattled pound.

With a gold standard, such as the one that was widely in effect from 1871 to 1914, exchange rates were generally fixed so there was no currency appreciation or depreciation.

But prior to the 19th century, the amount of global trade was very low, so exchange rates were generally not a matter of great concern.

Rather than being a means to help domestic exporters, the debasement of most currencies prior to the rise in global trade was a desire to increase domestic money supply to add to the wealth of rulers through seigniorage.

Seigniorage, the difference between what it costs to “create” money as opposed to the goods and services that money can buy, was a useful means to fund wars of conquest or pay down debt.

Particularly during the Napoleonic wars of the early 1800s, countries that wanted to compete economically resorted to mercantilism — employing economic policies that maximized exports and minimized imports.

High tariffs, particularly on manufactured goods, were almost universally a feature of mercantilist policy.

Even when the global economy started to become more integrated, there was little opportunity for competitive currency devaluation because of the gold standard.

Once again though, there’s nothing quite like a crisis to shake things up and during the Great Depression of the 1930s, most countries abandoned the gold standard against a backdrop of high unemployment and reciprocal devaluations.

Abandoning the gold standard during the Great Depression however set the stage for soaring inflation, in a “beggar they neighbour” race to the bottom of currency devaluations that saw no specific country gain a durable edge.

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Give Me Wood of the Bretton Variety

This is why at the end of the Second World War, Bretton Woods was established to ensure that competitive devaluation was no longer an option and because global growth was very high during this period, there was little incentive for a currency war even if it had been possible.

From the end of Bretton Woods in 1971 right up to the turn of the century, some of the conditions that could have fomented a fresh currency war were in place, but countries generally had other priorities and at no point were there enough states simultaneously wanting to devalue, for a currency war to break out.

It wasn’t until 2009, in the aftermath of the 2008 Financial Crisis which saw global trade plummet by 12 per cent, that the ground was fertile for a fresh currency war.

Then-Brazilian Finance Minister Guido Mantega announced that the world was already “in the midst of an international currency war,” with competitive devaluations by China, Japan, Colombia, Israel and Switzerland.

At the time, and despite pressure from Washington to allow the yuan to rise, it appeared that the US and China were “winning” the currency war, holding down the value of their currencies while pushing up the value of the euro and yen.

Fast forward to our current epoch and a reverse currency war appears to be taking place.

After over two decades of quantitative easing and loose monetary conditions, muted price pressures have given way to soaring inflation.

Countries that have only known stagnant price growth have to deal with the worst inflationary pressures over four decades.

From Europe to the US, Turkey to Thailand, inflation is threatening to stoke the fires of an entirely different type of currency war, which has the potential to dramatically upend the global monetary order.

With the US facing the fastest inflation rate in over four decades, the US Federal Reserve has been aggressively raising interest rates, leading to a surge in the dollar.

A rising dollar of course means that America’s imports become cheaper, helping the U.S. manage its inflation, but it makes every other commodity that is measured in dollars more expensive for other countries.

The moribund economies of China, Japan and Europe have meant that these countries have had to track an entirely different monetary policy from the US and kept financial conditions relatively loose.

The Bank of Japan has kept interest rates near zero, as price pressures there have been relatively mild (so far) and Tokyo is keen to ensure that economic growth is stimulated.

Europe is caught in a bind, while the European Central Bank needs to raise borrowing costs, it can’t be as aggressive as the Fed because economic growth is slowing thanks to the Russian invasion of Ukraine and a rapidly slowing economy because of a natural gas crisis as Moscow holds the continent to ransom.

China is stuck in an economic quagmire of its own creation, hobbled by an ongoing real estate crisis and its dogged adherence to zero-Covid lockdowns, with the People’s Bank of China keeping monetary conditions easy.

The only major currency that has held its own against the dollar’s meteoric rise has been the Swiss franc, as the Swiss central bank has raised rates alongside the dollar, but Switzerland is not as significant an economy globally as its currency would suggest.

But even if central banks raise rates, there’s no guarantee that their currencies can square off against the rising greenback as evidenced by the continued decline of the pound against the dollar, despite the Bank of England raising interest rates in tandem with the Fed.

Against this backdrop, something has to give.

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The Dollar Breaking Everyone’s Back

A strong greenback hurts everyone except the Americans because it exports inflation in commodities that the US has an abundance of.

Because the world’s commodities are priced in dollars, every other citizen on the planet except the Americans, has to pay more for everything from coffee to coal.

Add to the dollar’s dictatorship, the decision by Washington to level sanctions against Moscow that effectively froze the world’s 10th largest economy out of the global financial system, because of the greenback’s central role and it’s obvious why the world will be agitating for alternatives.

Weaponising the dollar in this way, the US and its allies risk provoking a backlash that could undermine the greenback and fracture the global financial system into rival blocks that could leave everyone worse off.

But as if that’s not bad enough, even close allies of the US such as Europe and Japan, are reeling from the seemingly unstoppable rise of the dollar.

Europe is suffering under soaring inflation and the seeming impotence of its leadership class to do anything about it, while Japan has seen the yen fall to its lowest level against the dollar in over two decades and it’s just a matter of time before higher prices hammer the Japanese economy.

Historically, wars have tended to upend the dominance of currencies and seeded the ground for the growth of new monetary systems.

And while the Russian invasion of Ukraine has yet to spillover into a wider continental war in Europe, mainly because Moscow appears to lack the resources to wage such a conflict, the impact of punitive financial measures against Russia could plant the seeds for an upheaval of the existing global monetary system.

Although Russia’s invasion of Ukraine has drawn widespread criticism, it has not attracted global condemnation, with many countries such as South Africa and India, still more than happy to trade with the belligerent.

Pragmatism, rather than politics, has prevailed, evidence that economic realities often trump more esoteric pursuits.

Earlier this year, CEO of the world’s largest investment group BlackRock, with some US$10 trillion in assets, Larry Fink, noted in his annual letter to shareholders that,

“The Russian invasion of Ukraine has put an end to the globalisation we have experienced over the last three decades.”

Fink went on to posit that the result of de-globalisation could be greater use of digital currencies, without specifying whether these would be centralised or decentralised.

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Bitcoin for a Better World?

At present, only two countries have recognised Bitcoin as legal tender, including El Salvador and the Central African Republic, neither of which are major economies by any stretch of the imagination, but both of which use dollars for daily transactions and settlement.

Whereas the idea of using anything that undermines seigniorage from the regent will be anathema for most governments, because of the permissionless nature of cryptocurrencies, citizens may choose not to consult.

With inflation hitting 48.4 per cent in Argentina in 2021, citizens have long grown accustomed to working in the digital economy and accepting cryptocurrencies as payment for their services.

There is the real possibility that the rest of the rich world, excluding the United States, could see rapid inflation sapping growth and increasing the lure of cryptocurrencies, volatile or otherwise.

Sanctions and capital controls have also provided food for thought for the world’s citizens who live under regimes that would like to keep whatever wealth they can cling to, well within the confines of their borders.

Debilitating capital controls helped to shore up the Russian ruble as western sanctions started to bite, leading to a surge in cryptocurrency usage by ordinary Russian citizens, eager to spirit their wealth offshore.

Crushing zero-Covid lockdowns have seen Chinese citizens use a variety of means to carry their fortunes out of the Middle Kingdom in search of greener pastures, including cryptocurrencies.

Beyond ordinary citizens, central banks have also been diversifying out of dollar reserves.

Of the US$12 trillion worth of foreign currency reserves held by central banks around the world at the end of 2021, the dollar accounted for around 60 per cent, according to the latest International Monetary Fund data, down from 71 per cent in 1999, when the euro was launched.

And while the euro, long seen as the primary dollar alternative, now accounts for around a fifth of central bank reserves, it’s also fallen by over a fifth against the greenback as well.

If the value of holding foreign currency reserves is that it should preserve the ability of a country’s government to buy necessary imports, then the euro and the yen have seen their reputations hammered by an ascendant dollar.

Sri Lanka’s economic collapse is perhaps just the tip of the iceberg as more emerging markets saddled with oppressive levels of dollar-denominated debt fall into default, with Pakistan looking to be the next likely candidate.

And while CHIPS, China’s alternative to the US-dominated SWIFT system of global bank transfers could find some client states, citizens of the free world aren’t likely to want to sign up to an interbank transfer system helmed by a communist state.

Against his backdrop, many would argue that Bitcoin is not suited as a medium of exchange, especially given its volatility, but that volatility takes reference against the dollar.

Because the world has run on dollars for so long, it’s easy to forget that the absolute “value” of most commodities hasn’t actually changed, it’s the US Federal Reserve’s policies which have caused the dollar to fluctuate.

To be sure, given how there will only ever be a fixed amount of Bitcoin, the prospect of it appreciating substantially against the dollar means that its potential to serve as a store of value will undermine the willingness of people to use the cryptocurrency as a medium of exchange.

But such a view also necessarily assumes that the world will continue to revolve around a singular currency or equivalent, as opposed to a more distributed concept of value transfer.

As the world becomes more fragmented, it’s entirely possible for the choice of operating currencies to become more fragmented as well.

That’s not to say of course that the dollar’s demise is inevitable, far from it.

America’s willingness to back up its currency and open global trading lanes with its formidable navy means that for the foreseeable future, the dollar will continue to loom large over global commerce and finance.

But the Russian invasion of Ukraine and the weaponisation of the dollar by America and her allies will at the very minimum provide some urgency in the search for alternatives to those who prefer to operate outside an Anglo-American-centric world and such options could well include cryptocurrencies.

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By Patrick Tan, CEO & General Counsel of Novum Alpha

Novum Alpha is the quantitative digital asset trading arm of the Novum Group, a vertically integrated group of blockchain development and digital asset companies. For more information about Novum Alpha and its products, please go to https://novumalpha.com/ or email: ask@novum.global

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