The US-Israel war on Iran has brought discussion of de-dollarisation into the mainstream Western press. For instance, a recent headline of Financial Times read “Iran War has exposed the Weakness of the Dollar”; The Guardian noted that “The US-Israel war on Iran is accelerating de-dollarization”; while The Telegraph warned that “Trump’s war in Iran threatens to topple the dollar”.

Such concerns were also raised in 2022 when Western sanctions cut Russia off from the SWIFT payment system, froze more than $300 billion of its assets, and the then US President, Joe Biden, threatened to “reduce the ruble to rubble” and cut Russia’s economy to half its size. However, they were more muted then, and the war on Iran constitutes not just a quantitative acceleration of de-dollarisation but adds a qualitatively new danger to the dollar’s dominance.

Volatile and crisis-prone as the dollar system has been since its inception, it has, in recent decades, hobbled productive capacities around the world and boosted inequality to unprecedented levels. (In the case of India, inequality now exceeds levels higher than under the British Raj as the country deepened its engagement with the dollar system by continuous relaxation of capital controls.) Although these ills and the dangers of the “weaponisation” of the dollar system boosted efforts to create alternatives to it, they were going nowhere very fast. The war on Iran seems, however, to be pulling the rug out from under the dollar’s feet, and not simply because of its demand for payments in yuan, which has given rise to all sorts of Chinese whispers (no pun intended) about the new “petroyuan”.

Constructive de-dollarisation

The establishment of the New Development Bank (formerly the BRICS Development Bank) had already set in train the trend towards creating elements of an alternative international monetary and financial system. It was spurred by the announcement of sanctions against Russia. Although such measures had been used before—against Venezuela, Iran, and Afghanistan, for instance—their use against a major country, a nuclear superpower, and a permanent member of the UN Security Council made the world sit up and take notice.

Countries began trading in each other’s currencies, with Russia’s burgeoning trade with China after 2014, particularly after 2022, roviding a significant boost to this trend, and India’s rupee-ruble trade with Russia also adding to it. Governments set up new digital payment systems either jointly with other central banks, as in Project mBridge, or individually, such as India’s own UPI, the Russian Mir, or China’s UnionPay. Many non-G7 currencies also began to experience internationalisation.

These processes had limits, however: the share of non-G7 currencies in total international payments remained low even compared with that of the renminbi, which is now the fourth most used currency in the world but accounts for only about 2.5 per cent of global payments. Worse, these initiatives seemed to plateau and slow down in what should have been a youthfully vigorous phase.

With the most to gain from de-dollarisation as the most sanctioned country in the world, Russia, during its presidency of the BRICS grouping at Kazan, commissioned a rather extensive report titled Improvement of the International Monetary and Financial System. It identified an impressive list of the dollar system’s faults, seeing it as characterised by “frequent crises, persistent trade and current account imbalances, elevated and rising public debt levels, and destabilising volatility of capital flows and exchange rates” and pointing out that it “primarily serves [the] interests of AEs [Advanced Economies]”. Nonetheless, the Kazan summit failed to advance de-dollarisation significantly.

The reason, it would seem, lies in the investment of the ruling elites of most societies—including India and most other BRICS countries—in the dollar system as a place for parking, and multiplying, their wealth by participating in the vast opportunities for speculation in asset markets and for predatory lending offered by the dollar-denominated international financial system. Even China, which is different in this respect, is home to large companies that rely on dollar liquidity.

However, de-dollarisation has never been confined to this constructive aspect of building alternatives. The dollar system’s internal contradictions have long been maturing. The war on Iran appears to be dramatically accelerating de-dollarisation by exacerbating these internal contradictions to the point where alternatives will become an imperative, not just a choice.

If talk of the internal contradictions comes as a surprise to many, it is for two interrelated reasons. First, in the mainstream press, the dollar’s decline tends to be attributed to contingent circumstances. While the Biden administration’s weaponisation of the dollar against Russia was mentioned in the past, today it is the Donald Trump administration’s actions that top the list. These include Trump’s preference for a weaker dollar; his attacks on the independence of the Federal Reserve and on the Chairman of its Board, Jerome Powell, personally; his further weakening of the US’ fiscal position; his tariff disruptions of the world economy; and his generally unpredictable and chaotic policies and U-turns, which are set to make more and more countries turn away from close economic ties that need nothing more than predictability and reliability. However, the problems of the dollar system go much deeper.

Secondly, thanks largely to the efforts of American scholars, the world has come to believe that there is something natural about the currency of the world’s most powerful country providing the world with its money. This task was once performed by the British pound sterling, we are told, and as the US replaced the UK as the global “hegemon”, the mantle fell on the dollar’s shoulders. But little could be further from the truth.

The pound sterling could not have functioned as the world’s money had it not been for Britain’s empire, with British India constituting its largest and most lucrative chunk, the jewel in its imperial crown. The empire, or more specifically, its non-settler colonies, furnished surpluses in a variety of ways, and Britain then exported these as the famous “capital exports” through which it provided the world with liquidity. It is less widely appreciated that these capital exports went chiefly to continental Europe, the US, and Britain’s settler colonies. It is no wonder, then, that the period of the sterling system was the period during which all these parts of the world industrialised most rapidly. Essentially, Europe and its offshoots industrialised in good part on the back of Britain’s non-settler colonies.

The dollar did not have the luxury of a surplus-providing empire and could only provide the world with liquidity by running current account deficits, essentially issuing IOUs in return for the world’s goods and services. This method of liquidity provision was subject, however, to the Triffin Dilemma: the higher the deficits, the less attractive the dollar and the greater the downward pressure on it. No wonder then, that early on, the US’ creditors began demanding gold instead of dollars. Having run out of gold to back the dollar by about 1961, and having tried every expedient to nevertheless keep the show on the road in the following decade, the US government had to break the link with gold in 1971.

A bumpy 1970s followed, with a significant fracturing of the world economy. Even with the quadrupling of oil prices giving oil-importing countries four times as many reasons to hold dollars, followed by a further doubling, the dollar, now dubbed the “petrodollar” dropped in value to the point of hitting $800/oz around 1980, a level only surpassed in real terms at the end of the recent huge surge in the gold price.

Meanwhile, oil-exporting countries were persuaded to deposit their surpluses in dollars in Western financial institutions in a move widely regarded as a shining example of self-serving Machiavellian diplomacy on Henry Kissinger’s part. However, this sent them on a lending spree that began to finance a spurt of heavy industrialisation in many developing countries, not something the US authorities were pleased about. These difficulties were resolved by the Volcker interest rate shock of 1979–82.

It famously placed borrower developing countries in receivership, in the form of the infamous IMF and World Bank Structural Adjustment Programmes that imposed economic regression on them for a decade and, in some cases, two. The developing world’s pain was not, however, the dollar’s gain. Its world role could only rest on interest rates that remained historically high even after coming down from their Volcker Shock highs. And even with them, the dollar sank to new lows around 1990.

The ‘everything bubble’

Only in the late 1990s and early 2000s did the current phase emerge, where the dollar is sustained by the influx of private money into the dollar-denominated financial system in the expectation of making huge profits through its predatory lending and its asset bubbles. This is the real foundation of the dollar’s world role today, not the reserve accumulation by foreign governments to which dollar-boosters usually point.

This influx has been systematically attracted by the Federal Reserve’s commitment to encouraging asset bubbles and refusing to even detect, let alone control, them, and to maintaining high asset prices with liquidity infusions. This began when Alan Greenspan first made his “Greenspan put” after the 1987 stock market crash and continued with the “Federal Reserve put”.

As each such bubble has burst, it has required adjustments that have made the system weaker and more volatile. After the dot-com bubble burst, the Federal Reserve opted for a longer-term easy money policy to keep the housing bubble that was already inflating so that its “wealth-effects” would now fuel upper-class consumption as those of the stock market bubble had done. With the investment boom that the stock market bubble had generated now exhausted, this sort of consumption was the only motor powering what anaemic growth the US economy could manage in the 2000s.

With the Glass-Steagall Act repealed in 1999, US commercial banks got into the act and generated mountains of toxic securities that were bought by institutional investors, chiefly from both sides of the North Atlantic. When the housing and credit bubbles burst in 2008, the Federal Reserve not only doubled down on easy money but added quantitative easing (QE) to it while explicitly supporting particular financial institutions on the justification that they were “too big to fail”, while leaving ordinary mortgage debtors to suffer loss of homes and jobs.

In response to the pandemic-related financial panic in 2020, the Federal Reserve took the opportunity to extend QE to the purchase not just of government debt but all sorts of assets to keep their prices up and to extend loans, for the first time, to non-financial institutions. This monetary policy and financial largesse were able to generate today’s “everything bubble”, notwithstanding all the talk after 2008 of financial reform to prevent such asset bubbles.

Catastrophic de-dollarisation

Soon, however, rising inflation put the Federal Reserve in a quandary. It was the reluctance to face it that inclined Powell and many other monetary policymakers to consider inflation “transitory” in 2022. It made any sort of soft landing impossible. Contrary to the economist Milton Friedman’s famous dictum that “inflation is always and everywhere a monetary phenomenon”, inflation arises from supply failing to meet demand, either because supply is constrained or demand has increased. Such mismatches are particularly inflationary when they affect labour and primary commodities since they are primary to all production and inelastic in their supply. In the current inflation, both demand and supply sides have been at work.

The non-Western world has bifurcated into two: the few that have managed sustained development, pre-eminently China, of course, which has added to the demand for inputs; and the vast majority of others where, thanks to a combination of environmental and economic stress—neither unrelated to the neoliberal financialised economy on which the dollar system rests—the production of primary commodities is declining.

With inflation rising, if the Federal Reserve tightens monetary policy now, it risks deflating the “everything bubble” and throwing the dollar system into crisis. If it does not, inflation threatens the dollar’s value.

This problem was bad enough before the war on Iran; now it has become acute. Several things are coming together at once. Inflation, already ticked up by Trump’s tariffs, is going up further, raising fears, as a Financial Times story put it, of “higher inflation becoming ‘embedded’ across the US economy—and that households and businesses would begin to price in permanently stronger price pressures”. The dollar’s “haven” status seems to be fading as the war on Iran has not boosted the dollar as much as might be expected.

The US treasury market, despite the support it receives from the Federal Reserve, is groaning under rising US public debt. The expectation that somehow investment in AI will help improve the US fiscal position with a miraculous spurt in growth and productivity is just waiting to be thwarted. Finally, the systemically important investors in dollar-denominated assets may soon be diverting their funds elsewhere. Members of the Gulf Cooperation Council, for instance, may find a greater call for their funds closer home in post-war reconstruction. European countries and Japan, all oil importers, may also find themselves with less idle cash to invest.

Whether the dollar’s demise comes with the “bang” of a financial crash or the “whimper” of inflation, what will replace it is not the currency of another country. John Maynard Keynes well understood that what made the sterling system work—colonial surpluses—was not available to the dollar. He had gone to Bretton Woods with a set of proposals that involved a multilaterally agreed currency that was not the national currency of any single country and that would function alongside national currencies that would continue in use for everyday transactions of individuals, states, or businesses only to settle imbalances among central banks amid capital controls.

Barring such an agreement, even among a limited set of countries with strong trading relationships, we can expect to see a multi-currency future with limited internationalisation of national currencies. Given that the volatile internationalisation of the dollar has required an enormous inflation of purely financial activity—about 28 times the world trade—the limited internationalisation of national currencies, to the extent possible, may suffice for the purposes of a productive economy. The difficulties will arise with settling imbalances. If this were to give rise to a trend toward balanced trade, though, with most countries developing their capacities to export enough to finance their imports, that will be no bad thing. 

Radhika Desai is a professor of political studies, University of Manitoba, visiting professor, Department of International Development, London School of Economics, and convenor, International Manifesto Group.

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