Monetary Systems: A Historical Perspective

Monetary systems have been known to change approximately every 30–40 years over the past century. Prior to 1914, the global monetary system was based on the classical gold standard. Then, in 1944, a new system emerged at Bretton Woods. This system established the dollar as the global reserve currency, linked to gold at $35 per ounce. However, in 1971, President Nixon ended the direct convertibility of the dollar to gold, marking the first time the monetary system had no gold backing.

Time for a Change

The current monetary system is over 50 years old, suggesting that the world is long overdue for a change. There have been ongoing efforts by various nations to dethrone the U.S. dollar as the leading global reserve currency and the main medium of exchange. However, such processes don't happen overnight; they happen slowly and incrementally over decades.

Sanctions and the Dollar

The process of dethroning the dollar is accelerating in ways that were unforeseen before the Russian invasion of Ukraine in February 2022. In response to the invasion, the U.S. initiated a highly aggressive sanctions regime to punish Russia. The first round of financial targets included obvious attacks such as freezing the U.S. dollar accounts of Russian banks and oligarchs. The second round went a step further by freezing the dollar accounts of the Central Bank of Russia itself, an unprecedented move except in the case of rogue states such as Iran, North Korea, and Syria.

Impact of Sanctions

The sanctions extended beyond finance and banking to include bans on Russian exports, freezing Russia out of insurance markets, and bans on critical exports to Russia. Major U.S. and other Western companies were pressured to shut down operations in Russia, and many complied. However, a large part of the world refused to join the U.S./EU/NATO financial sanctions. They didn't necessarily support Russia's invasion, but they didn't want U.S. sanctions to disrupt their trading relationships with Russia either.

Global Response

Countries like India and China, the biggest buyers of the oil that Russia might otherwise have sold to Europe, continued their trade relations with Russia. China itself is selling automobiles, semiconductors, and machinery to Russia. Meanwhile, Turkey has greatly expanded its exports to Russia, while Iran is selling weapons to Russia. The more other economies trade with Russia, the less any of them will need U.S. dollars as a medium of exchange.

Decline of the Dollar

The U.S. sanctions have not only failed, but they've also contributed to the long-term decline of the dollar as the world's leading payment currency. They're driving countries away from using dollars in international transactions for fear that they could become the next target of U.S. displeasure.

Future of the Dollar

Efforts to establish a dollar alternative will see major advances made at the BRICS leaders’ summit in Kazan, Russian Federation. The process will unfold over time, and the dollar won’t be displaced in the immediate future. But the trend away from the dollar is definitely underway. The building de-dollarization movement represents a global sea change, which will only accelerate in the coming years.

Bottom Line

The decline of the dollar's role as the leading global reserve currency is not something that will happen overnight. However, the unprecedented dollar sanctions against Russia have hastened the process. After 80 years under the Bretton Woods arrangements, 53 years since Nixon closed the gold window, and 50 years since the petrodollar agreement with Saudi Arabia, the reign of King Dollar as the world’s leading payment currency is coming to an end. This gradual yet inevitable change may surprise investors if it happens sooner rather than later. It's reminiscent of a quote from Ernest Hemingway’s 1926 novel The Sun Also Rises, where a character describes going bankrupt in "two ways... Gradually and then suddenly." The dollar could lose its reserve status in much the same way - gradually, then suddenly. What are your thoughts on this matter? Feel free to share this article with your friends and discuss it. You can also sign up for the Daily Briefing, which is everyday at 6pm.