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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
**Key Takeaways**
1. **Erosion of Dollar Hegemony:** The weaponisation of the US dollar, once America’s most potent geopolitical tool, is demonstrating diminishing returns, fostering an environment where sanctioned states and even allies seek alternative financial mechanisms, threatening the dollar’s long-term dominance.
2. **Rise of Parallel Financial Systems:** Sanctions are accelerating the development and adoption of non-dollar trade routes, shadow banking networks, and decentralised cryptocurrency payments, creating a fragmented global financial landscape less beholden to traditional US-controlled rails.
3. **Increased Market Volatility & Risk:** This shift introduces new layers of complexity and risk for global financial markets, impacting currency valuations, commodity pricing, trade finance, and central bank reserve management strategies, as geopolitical considerations increasingly override pure economic efficiency.
The writer is a managing director at Frontline Analysts and author of ‘The Unaccountability Machine
There is an old central banker maxim that seems widely applicable to today’s geopolitical situation, especially when viewed through the lens of global financial markets. As recounted in David Kynaston’s history of the Bank of England, it runs: “Wave the big stick if you like, but never use it; it may break in your hand. Better still, try wagging your finger.” For decades, the ‘big stick’ of American foreign policy has been the dollar – its unparalleled role as the global reserve currency, the linchpin of international trade, and the dominant medium for cross-border payments, all underpinned by the SWIFT messaging system. This financial leverage allowed the US to impose its will, with the threat of cutting off access to the dollar system being a potent deterrent.
Among the many consequences of the stand-off in the Strait of Hormuz, it seems that we may look back on this as the week in which one of America’s most powerful geopolitical tools was shown to be a weakened stick. Threatening to limit access to the global dollar system now seems less fearsome, sparking broader market questions about the future of financial hegemony and the stability of the international monetary order.
We saw the first indications that this was the case back in 2022, when Russian banks were sanctioned and disconnected from the Swift messaging system for global bank payments. The immediate market reaction was one of shock and a surge in commodity prices, particularly energy. However, while the initial disruption was severe, the subsequent resilience of the Russian economy surprised many. Even at the time, it was understood that this was likely to be more of an inconvenience than an economic death sentence, but the extent to which Russia has continued to be able to wage war and to sell oil to fund itself must have disappointed supporters of the sanctions. Crucially, this episode forced a rapid acceleration in Russia’s pivot towards non-dollar trade, fostering bilateral currency swap agreements, boosting trade in renminbi with China, and exploring alternative payment infrastructure, thereby directly challenging the dollar’s market share in certain critical sectors. The commodity markets, initially volatile, eventually adapted to new trade routes and payment mechanisms, highlighting the market’s capacity to circumvent traditional financial choke points under duress.
The ineffectiveness of the weaponised dollar in the Gulf has also been telling, providing further evidence of a weakening grip. Iran is one of the most sanctioned places in the world; it is one of a handful of cases where US Treasury sanctions cover an entire country rather than specific entities and people. But not only does this not appear to have prevented it from selling oil while at war with the US, it has not seemed to stop it from charging ransom fees to international shipping seeking to pass through the Strait of Hormuz. This situation has direct market implications, inflating maritime insurance premiums, driving up shipping costs, and introducing an unpredictable risk premium into the pricing of oil and other goods transiting this vital chokepoint.
Some ships have paid as much as $2mn to Iran to ensure safe passage, according to Lloyd’s List Intelligence. And following news of a ceasefire between the US and Iran, an Iranian official has indicated his country will demand that shipping companies pay tolls in cryptocurrency for oil tankers equivalent to $1 per barrel of oil transported. This move is a stark signal to global markets: a direct and audacious bypass of traditional financial systems, demonstrating the practical application of decentralised digital assets in state-level operations. Such demands could further legitimise crypto as an instrument for illicit finance or sanctions evasion, posing significant challenges for financial regulators and compliance departments worldwide, and potentially fragmenting global payment standards.
Part of the problem is that being cut off from the dominant global payments system is only a threat because the dollar economy is so convenient and profitable to deal in. That means that the weapon is most effective against open economies that are integrated into global supply chains, rely heavily on dollar-denominated trade, and access international capital markets. But these are rarely the ones worth threatening with full financial exclusion, as such actions would have severe blowback on global trade and the stability of the dollar system itself.
Sanctioned states, on the other hand, tend to get used to making do and mending, and finding people who are prepared to deal with them. These economies, often already somewhat isolated, have developed resilience and workarounds over years. Iran is able to sell at least some of its oil in return for renminbi largely because most of its imports come from China, forming a self-contained, non-dollar trade loop. There is also a network of banks and shadow financial companies, according to research by the Atlantic Council, which are prepared to take the risk of US extraterritorial enforcement, and to launder payments in dollars. Such counterparties, often operating outside major financial centres, are less worried about their access to New York dollar clearing and are willing to absorb the higher risk premium for lucrative transactions. This proliferation of shadow financial networks adds opacity and systemic risk to the global financial landscape.
But these workarounds may be barely necessary in a world in which it is possible for anonymous money to be sent over the internet. The US does not control the flow of payments made in bitcoin or stablecoins — cryptocurrencies pegged to real-world assets such as the dollar — transmitted over decentralised networks. While the intrusive compliance of US money laundering rules continues to cause inconvenience for US allies, countries at odds with America have an entirely separate and barely regulated parallel crypto-dollar to use, just like criminals and other bad actors. The growing market capitalisation and liquidity of these digital assets mean they are becoming increasingly viable alternatives for significant transactions, posing a fundamental challenge to the traditional banking system and the efficacy of financial sanctions. This trend compels central banks worldwide to accelerate their exploration of Central Bank Digital Currencies (CBDCs) as a defensive measure and a means to maintain monetary sovereignty.
As Gulf states of all kinds have understood since the founding of Opec, it is not a good idea to give the users of your product an incentive to find alternatives. In financial market terms, this means that making access to the dollar system too punitive or unreliable will inevitably lead to a diversification of global reserves and trade currencies, gradually eroding the dollar’s commanding market position.
This was all very predictable. In fact, Henry Farrell, one of the political scientists who coined the phrase “weaponised interdependence”, predicted it in a paper earlier this year that I co-authored. Having been a source of global stability for so long, the dollar system has evolved to be a source of instability as it has become more weaponised. As we stated: “As the US ratchets up pressure, other countries will look to escape dollar power, likely provoking the US to double down in response”. This feedback loop creates systemic risk, increasing market volatility and uncertainty for investors navigating an increasingly fragmented global financial architecture.
This is not without impact as the isolation of North Korea from the mainstream global financial system has shown. And as our paper noted, targeted sanctions on individuals appear to have been more effective than general sanctions on countries. “Bad actors” shunned from the dollar banking system still have to turn to inferior alternatives like crypto payments technologies, but this effectiveness diminishes when entire nations build parallel ecosystems. This distinction is crucial for markets: targeted sanctions aim to disrupt specific illicit flows, while broad country-level sanctions risk fragmenting the entire global payment infrastructure.
But far from being a geopolitical weapon for the US, global finance is arguably a force multiplier for its enemies when overused. As Kynaston’s central bankers knew, it is much better to threaten dire consequences than to put yourself in a situation where you have to actually use the big stick. It may break, and in breaking, it risks not only its immediate efficacy but also its long-term credibility and market dominance, ushering in an era of greater financial instability and multi-polar currency systems.
**Market Impact**
The diminishing efficacy of dollar weaponisation carries profound implications for global financial markets. Expect increased volatility in currency markets as central banks and international businesses diversify away from sole dollar reliance, leading to potential shifts in exchange rate dynamics and the pricing of dollar-denominated assets. Commodity markets, particularly energy, will likely see continued fragmentation and price discrepancies as new, non-dollar payment rails and trading routes become more established. Investors should brace for higher compliance costs in cross-border transactions as financial institutions grapple with complex, multi-currency sanctions regimes and the rise of shadow banking networks. Furthermore, the burgeoning use of cryptocurrencies by state actors could spur an accelerated push for regulated digital assets and CBDCs, reshaping the future of global payments and challenging the traditional banking sector’s dominance. The long-term trajectory points towards a more multipolar financial world, where the dollar, while still significant, faces growing competition, potentially impacting the demand for US Treasury bonds and the overall cost of capital for the United States.