Fragmentation of Global Finance

Ahmed Qutub 

(Chongqing, China, Night Skyline, Creative Commons)

De-dollarization has been coined as the large reduction in the use of United States dollars in various aspects of international finance and economics, such as world trade and financial transactions. Over recent years, there has been a strategic shift by alternative global powerhouses away from using the dollar as a method of fragmentation, politicization, and militarization. The fragmentation of global finance has resulted in three significant competing blocs: the dollar-led system, the Chinese yuan-led system, and the digital alternatives. The fragmentation marks a shift in the dollar’s enduring but politicized role.

For over 60 years, the United States dollar has been the global reserve currency, following the Bretton Woods system, pegging the dollar to the gold standard and subsequently other foreign currencies to the dollar. In 1971, under the Nixon Administration, the Bretton Woods system ended following the suspension of the dollar’s convertibility to gold. Within two years, the system fully collapsed as countries shifted away from the fixed exchange rates, allowing currencies to freely float against one another.

The United States has continuously remained the global leader in economic, political, and military power. Through the dollar’s status, the country has enabled itself to maintain said power and privilege over the world, with a strong perception of stability and safety in the currency. Both the ongoing negative events, such as the US tariff policy and political polarization, in addition to the increasing credibility of alternative currencies, have eroded the status of the dollar. This fundamentally marks a shift in the ‘balance of power’, reshaping the global financial markets and economy.

China is facing a dollar dilemma, as there are deep concerns regarding its reliance on dollars in its financial system and the extent of its dollar asset holdings. The dollar connectivity to the Chinese financial system is highly elaborate, with the largest commercial banks being interconnected with the dollar, and a high portion of outstanding external debt being dollar-denominated. As of late 2023, over USD 1.1tn in external dollar-denominated debt was recorded by the Chinese economy, accounting for 84% of the external debt in foreign currencies. This dependency is driving efforts in China of de-dollarization and sanction-proofing, similar to what is occurring in Russia.

Economic sanctions have been intensifying against Russia, drawing concern from China as it realizes the extent of its dependence on dollars in its financial system, in addition to its dollar asset holdings. Were similar sanctions were to be placed on China, the financial system would be exposed.

Despite extensive efforts by Russia in their ‘Fortress Russia Strategy’ to protect their central bank, they still have an estimated USD 300 to USD 350bn in foreign exchange reserve assets, of which USD 65bn are dollar assets, frozen following the Russian invasion in 2022.

The People’s Bank of China Governor announced plans to set up a ‘center for digital yuan internationalization’ in Shanghai with the goal of promoting the trading of yuan foreign exchange futures and by initiating a digital currency. The commodities in the futures markets highlight a step away from a reliance on a single foreign currency, and rather the promotion of the Chinese currency and alternatives around the world.

In recent years, China’s alignment with Saudi Arabia has evolved through banners such as Saudi Arabia’s Vision 2030 and China’s Belt and Road initiative. Beijing is framing its initiative as a broader financial reorientation and changing global order away from the dollar-based system. Additionally, the diplomatic aspects of the partnership have shifted Saudi Arabia and the Gulf towards an alliance with China for future projects and development goals. The strategic diversification away from the dollar and towards yuan-denominated contracts and infrastructure financing has showcased the efforts towards de-dollarization and an attempt to end the US financial hegemony.

The dollar will not be dethroned overnight, yet the drift far from it signals a multipolar financial world. The accelerating trend of de-dollarization poses potential economic and geopolitical challenges for the United States. As alternative systems emerge, the dollar’s dominance in trade, reserves, and investments holds implications far beyond finance in limiting Washington’s influence and leverage through sanctions. An American response beyond monetary policy would require the restoration of confidence in the US governance and the reinforcement of the legitimacy of the dollar-led system. Additionally, deeper alliances with emerging markets would foster Washington’s role in fostering innovation and digital finance.