Erik Weijers, 9 months ago

A new crack in the trust in the dollar

The developments set in motion by the war in Ukraine are causing a landslide in the global financial system. The fact that the Russian Central Bank can no longer monetize its dollars on the international market is a sanction that could have enormous global consequences. The effect is the loss of confidence in the validity of the dollar as a currency for saving. Guess which financial technology could benefit from this development?Hint: it's a technology that enables trustless payments.

Governments are not the only ones who have recently realized that money in a bank account is only accessible if you meet standards that others set. In February 2022, the Canadian government froze bank accounts of people who supported the trucker protests: unprecedented for a Western democracy. Without due process, people could no longer access their money. It was one of those instants when "Bitcoin fixes this" didn't sound so far-fetched (although Bitcoin is by no means a panacea when it comes to circumventing sanctions).

A new monetary era

Back to the grim world stage. An analyst at Credit Suisse argues that the war in Ukraine marks the transition to a new monetary order, in which the dollar is no longer the global norm. This Zoltan Pozsar calls what we are experiencing now a new iteration of the Bretton Woods system. The Bretton Wood agreement was the result of negotiations between the Allies at the end of World War II. It created a new and stable monetary system that revolved around the dollar. But the hardness and reliability that the dollar had in the early years of this system has gradually crumbled - and a new crack emerged due to recent developments.

A brief history of Bretton Woods. In the first version of this monetary system, central banks of many countries established dollar reserves. They were given the promise that their dollars would be covered by gold stored in the US. After 1971, the amount of dollars in circulation had become too large and Nixon decoupled the dollar from gold. This default was the first major crack in the system. It was glued by making the dollar the currency in which oil was priced and international trade was conducted. This in exchange for protection by the U.S. military of oil producing states and major international trade routes. In the decades that followed, U.S. government bonds became an increasingly common means for both individuals and countries to invest their savings. After all, the US government was the richest and most powerful on earth: surely it would be creditworthy?

That last assumption has now been shattered. If countries can no longer rely on being able to cash in on their dollars or U.S. government bonds, why should they invest their hard-earned money in them? This shock must have been felt by all governments worldwide - especially, of course, those that are on tense terms with the US. Although this is not the first time a country has faced financial sanctions from the US, the impact of this new sanction is unprecedented. As in 1971, it involves a default: a failure to meet an obligation.

Many potential buyers of US government bonds will now be pondering: I might put my savings in something else next time. And that's not limited to saving in the United States bonds. Author Luke Gromen: "The Fed and the European Central Bank (ECB) have discredited sovereign debt as an FX reserve, completely."

Alternatives to the dollar

The dollar is no longer backed by gold, as mentioned above, but since 1971 by the "full faith and credit" of the United States. A new crack has appeared in this trust. All this does not alter the fact that the dollar has risen in value in recent weeks. In times of crisis, people reflexively reach for fixed values. But with time, countries will increasingly look for alternatives. This trend had been going on for some time, by the way. Since 2014, the percentage of foreign-owned U.S. government bonds has already declined.

What are alternatives? China, as an alternative for U.S. government bonds, is increasingly buying up foreign property and commodities. The Russian Central Bank has been eagerly buying gold for years. The aforementioned Zoltan Pozsar looks ahead: "When this crisis (and war) are over, the dollar should be much weaker and ... the renminbi much stronger, backed by a basket of commodities. From the Bretton Woods era backed by gold ... to Bretton Woods 3 backed by ... gold and other commodities."

Covered by commodities, gold and... Bitcoin? That is likely still too much to ask from China or Russia. But all over the world the penny has dropped. Pozsar: "Bitcoin (if it still exists [after the war]) will probably benefit from all of this."

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