The Three-Dollars Problem

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Karthik Sankaran is a senior research fellow in geoeconomics in the Global South program at the Quincy Institute for Responsible Statecraft.

There’s been a lot of ink spilled recently over Trump’s threat of 100 per cent tariffs on any country that would “leave the dollar.” Understandably so!

While Trump didn’t spell out why, dollar centrality in the international monetary and financial system (IMFS to hipsters) gives the US unmatched powers to surveil cross-border financial flows and curtail them, as acknowledged by Treasury Secretary designate Scott Bessent here:

This seems to override the preferences of VP-elect-Vance, who believes the dollar’s centrality has led to unwarranted currency strength and American deindustrialisation. Trump himself also seems to believe this, telling Bloomberg earlier this year that the US has “a big currency problem”.

All this suggests a conflict between two views — one might call them the National Security Dollar and the Trade Dollar. But there’s a third critical global role in play — the Financial Stability Dollar. And here, the tussles between the Trade Dollar and the National Security Dollar could have a big impact on the rest of the world.

The role of the dollar as the leading denomination for cross-border borrowing and invoicing means that when it is too strong (ie, the Trade Dollar faction loses), it tightens financial conditions in large parts of the world.

There are multiple transmission avenues. It hits emerging markets that borrow mostly in dollars by making repayment more expensive, and subjects others with dollar-sensitive investors in their local currency debt markets to capital outflows. A combination of dollar strength and slower global growth can be especially toxic for commodity exporters who borrow in dollars — and there are a lot of them.

Interactions across these three roles could become increasingly problematic. So far, markets have reacted to tariff threats by lifting the dollar. And while such strength might dampen the price signals that favour import substitution, it would also offer a partial offset to the inflationary impact of tariffs (something Bessent welcomed in the interview above).

This trade-off makes sense if the fundamental conception of tariffs is based less on industrial strategy and more on the idea that the withdrawal of market access to the US can be used as a cudgel, including for geopolitical purposes. And this seems like an administration that likes its geoeconomic cudgels.

Online, there’s a widespread belief that tariffs that lead to a weaker renminbi would exacerbate capital flight from China, alongside the occasional hope that this process would hit the Communist regime’s legitimacy. But to push the country into a deeper economic malaise (more than its own policies already have) would cause a lot of collateral damage

China is still the world’s second-largest economy. Any strategy to weaken it would have consequences for countries that compete with its exports and/or are sensitive to Chinese growth and imports. This would include many US allies, with two of the four members of the Quad —Japan and Australia — checking these boxes.

Anything that hits China would hit other emerging markets even harder. They would see their currencies weaken in tandem with the renminbi, but without the degrees of freedom that come from what China has — at least $3tn in official reserve assets and more in other quasi-governmental institutions; a debt stock that is largely in local currency held by onshore investors; an immense manufacturing export sector; and local bond yields at just 2 per cent. Life would be a lot harder for countries without those buffers.

The above would actually be a relatively restrained geoeconomic outcome compared to some more crypto-friendly ideas floating around the blog/podosphere.

One such idea is that the cross-border availability of dollar-based stablecoins could extend the footprint (or dominance) of the dollar by permitting currency substitution (or capital flight) outside the US. This is sometimes presented as an expansion of rule of law/liberty in places that need one or both, and as a private sector version of reserve accumulation that will support demand for US government debt — the natural asset counterpart to the dollar-stablecoin issuer’s liability.

This might well be the case, but while easy currency substitution might be a good thing for individuals in some countries, it can be a very bad thing for the stability of those countries’ banking systems.

Moreover, stablecoins expand not just the footprint of the US, but also the footprint of its financial cycle, and that is determined to a substantial degree by the Fed’s response to key macroeconomic aggregates within a relatively closed economy.

For more than a decade now, many developing countries have grappled with the problem of having their financial cycles determined in Washington even as critical components of their real cycle — commodity demand and prices, for example — are determined in Beijing. A unipolar force driving the global financial cycle alongside multipolar forces driving local real cycles is a bad idea for financial stability, but that seems to be a significant risk here.

There’s an argument for a multipolar global monetary system that avoids exactly such a divergence between real and financial cycles across hubs and spokes. But the only place that has come close is the Eurozone, where a common currency is not just a denomination for trade, but also for capital markets transactions backstopped by a central bank that has after 2012 begun to take its lender-of-last Resort function seriously.

No one else is close to this — certainly not the BRICS — and that’s a bad thing for global financial stability. What would be even worse is if the proponents of the National Security Dollar actually prevent a multipolar monetary order (presumably with another minor hub in the renminbi at some point in the future) from ever happening.

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