Trade distortion and protectionism

The convergence of political risk, economic coercion, and de-dollarization

Nicholas Mulder

Published 03 June 2025

The use of economic coercion has increased in frequency in the last decade. Yet the scale and force of recent US measures has come as a particularly strong shock, for it had been widely assumed that American hegemony since the middle of the 20th century had an overall effect of enhancing global growth and reducing political risk. This assumption is not historically accurate.

The global economy is undergoing an enormous transformation and its future shape is in doubt. One of the major sources of political risk is the growing use of coercion in the realm of trade, finance, and investment. Such policies have been increasing in frequency in the last decade, such as Chinese embargoes and export controls, Russia’s severance of energy flows, and the growth of European Union and G7 financial sanctions.

From the moment that the United States came to wield global hegemony in the 1940s, it has used geoeconomic instruments to pursue its foreign policy goals. During the Second World War, the US Treasury froze roughly two-thirds of all foreign capital in the country, much of which belonged to European nations occupied by the Nazis. In the Cold War, it used export controls and sanctions to contain the Soviet Union and imposed an embargo against Communist China that lasted from 1950 until the normalization of relations with Beijing in 1979.

Like many other trading powers in history, US administrations have not been averse to using economic leverage to motivate and subjugate their allies. From promoting decolonization to rebalancing expenditures, virtually every postwar American president has imposed powerful economic sanctions, or threatened to, on adversaries and allies alike to influence strategic outcomes in the US national interest. These moves had real consequences for the development of the world economy and financial markets. Above all, they stimulated a search among asset-holding governments and firms for new safe havens.

Yet here the global monetary regime of the Bretton Woods system imposed an important restriction on the emergence of competitors to the US dollar. This was the fact that the widespread adoption of capital controls limited the convertibility of most rich economies’ currencies. One of the only strong currencies that was gold-backed and fully convertible, the Swiss franc, suffered from the fact that the small size of the Swiss economy limited its availability; there were simply never enough Swiss francs in the world to satiate global demand for reserves.

One of the first major effects of the Bretton Woods gold-dollar standard was thus to stimulate the growth of offshore markets: places where dollars could be used beyond the reach of the arm of the American state. The immunity from potential asset freezing conferred by the market’s opacity was an explicit part of its appeal. The economist Ronald McKinnon observed in the 1970s that "the layering of financial intermediaries makes the assets of any one country more difficult to expropriate… the United States might freeze Soviet dollar deposits in New York but would have little control over indirect dollar claims channelled through the Bahamas."

But the US also developed new tools to counter the growing power of surplus economies that were accumulating claims on dollar assets. During the 1973 and 1979 oil shocks the West grasped the leverage that Organization of the Petroleum Exporting Countries (OPEC) possessed. Tensions were alleviated as these commodity exporters began to recycle their petrodollar earnings by investing in global fixed income. Fears of being held hostage by Arab oil exporters motivated US Congress to preserve extensive powers to freeze and seize foreign assets in the United States and under US jurisdiction under a new economic coercion bill, the International Emergency Economic Powers Act (IEEPA).

To preserve investor confidence at a time of rising budget deficits and inflation, however, US policymakers had to accept limits on their ability to interfere with foreign property and assets. As a result, between 1977 and 2025, the use of IEEPA remained confined to financial sanctions against governments adversarial to the United States, nuclear proliferators, and various non-state actors and militant groups. But its powers were not deployed to interfere directly with global trade.

The most significant geopolitical event to shape diversification out of the dollar, however, was the Carter administration’s decision in November 1979 to freeze US$12 billion in Iranian dollar reserves worldwide, taken as an emergency measure during the Iranian embassy hostage crisis. The financial world was taken by surprise when it found out that the measure extended to dollar deposits everywhere in the world. The freeze immobilized not just Iranian government funds directly under US jurisdiction, but also all funds "which are or come within the possession or control of persons subject to the jurisdiction of the United States." The offshore global dollar system, previously considered a citadel beyond the reach of US economic coercion, was now exposed as highly exposed to extraterritorial measures from Washington.

The result was a genuine move by a significant set of foreign official holders and investors out of dollar reserves, which deserves to be called the "First De-dollarization" of the 20th century. In 1976, the dollar still constituted 77% of global foreign exchange reserves. But by 1980 this share had fallen to 67%, while the Deutschmark’s portion had grown from 8% to 15% and the yen had increased from 2% to 4.3% of global foreign exchange reserves. In the same period the Swiss franc also doubled its share, while the real gold price quintupled from US$200 per ounce to nearly US$1,000 per ounce. By the end of 1980, just US$15 billion of the US$140 billion in oil exporters’ deposits were held in New York.

By 1986, even a US-allied country like Saudi Arabia that was deeply invested in the petrodollar recycling system held less than one-third of its reserves in dollars. Four years later, at the end of the Cold War, the dollar's share of global foreign exchange reserves had fallen to just 48%; still a plurality among global currencies, but no longer a majority. In the 14 years from 1976 to 1990, the dollar’s share of global reserves decreased by more than one-third. An observer of the international financial system at the end of the Cold War could thus be forgiven for expecting that the US dollar was on the way out, destined to follow the fate of the British pound sterling that had come before it.

But such early predictions of the dollar’s demise proved wrong. Two factors have obscured the First De-dollarization. The first was the fact that it was more a financial than a commercial phenomenon: de-dollarization took place in reserve holding but not in trade invoicing, which continued to take place in the greenback on a large and growing scale. The second reason is the fact that the post-1979 flight from dollar reserve-holding was reversed in just as much time as it had taken to occur. If the 1980s had seen the First De-dollarization, the 1990s were thus the period of Great Re-dollarization.

But in the last decade, especially in the wake of the growing US use of tariffs and sanctions in the late 2010s, the future of the dollar has returned to the forefront of global attention. Widespread concerns over de-dollarization date to 2022, when the G7 imposed wide-ranging sanctions against Russia over its invasion of Ukraine. Ever since, the risk that the overuse of sanctions will erode dollar hegemony has been a frequent topic of public debate among policy experts and academic specialists. Many analysts have dismissed this possibility, noting that there are few feasible alternatives available, and that investment in the US comes at minimal political risk.

Non-Western countries, especially large Asian economies, have been diversifying out of dollar assets for some time now. There are clear and explicit geopolitical reasons for this. The 2022 Russian freeze opened a new risk vector for central banks with large foreign reserves, whose diversification has since helped to drive a major rally in the price of gold from US$1,800 in February 2022 to US$3,400 by May 2025. On the eve of Trump’s second inauguration, economists were already observing a "sharp decline in foreign official demand for US Treasuries and a likely shift towards gold, which is less vulnerable to sanctions and asset freezes." Recent US policy has considerably accelerated an already existing trend that was modest but nonetheless noticeable.

Nothing in US policy since then has reassured foreign investors who had until that point plowed massive amounts of money into Treasuries as a risk-free proposition. To the contrary, by the second week of April 2025, Trump’s "Liberation Day" tariff spree caused such financial volatility and economic uncertainty that otherwise patient holders of long-dated US Treasuries began to sell their holdings. De-dollarization has now begun to spread from foreign official holders of Treasuries – who hold about 13%, or US$3.9 trillion, of the total US$28.6 trillion Treasury stockpile – to institutional investors such as pension funds across Asia and Europe.

US policy is now driving once-staunch allies towards de-dollarization of their reserves and trade settlement and giving investors good reason to diversify out of US assets to reduce their exposure to the political risks of asset-freezing and debt default. The risk of future coercion will drive generalized diversification even by parties that do not want to resort to coercion. Once the US Treasury market becomes a venue for a standoff between US asset freezing and foreign fire sales of US debt, portfolio managers will begin to preemptively reduce their exposure in order to avoid taking future losses.

In the late 1980s, US commentators were concerned that Japan’s rapid economic rise could put Tokyo in a position to deploy a fire sale of US Treasuries to harm the United States. By early May 2025, the Japanese government for the first time explicitly announced its willingness to use its US$1.1 trillion Treasury stockpile as a pressure instrument in trade negotiations with the US. Although this was quickly walked back, the fact it was even raised shows how quickly the coercive mindset can take over the world economy. The US’ twin deficits, long regarded as a source of the country’s economic strength, may now reemerge as sources of fragility in a world of expanding economic coercion.

Contemporary debates about de-dollarization often lack specificity and historical perspective. The starting point of realistic analysis should be that episodes of currency diversification come in different shapes and sizes. Most predictors and critics of the dollar demise thesis are still engaged in debating an implausible form of extreme de-dollarization. In this scenario, the move out of the dollar occurs quickly, and it is assumed that reserve holders will gravitate towards one or a few new liquid assets or currencies that will assume all the roles that the dollar currently plays.

Today, this specific form of de-dollarization is unlikely to come to pass. Yet the process of de-dollarization in response to political risk is nonetheless real. It is simply taking a different form than before. Today’s de-dollarization is driven by a large number of countries and is flowing into many kinds of alternative assets: traditional haven currencies; non-traditional reserve currencies; foreign fixed-income assets; gold; crypto-currencies; and even real assets such as land. The broad nature of the Second De-dollarization suggests that it less likely to be reversed, presaging a monetary history of the 21st century that will be written quite differently from its predecessor.

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