Fragmentation of the Global Monetary and Financial System in the Context of Rising Geopolitical Tensions

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Introduction

The breakdown of financial and economic cooperation between the United States and China (Eichengreen, 2024), the growth of economic sanctions and the use of reserve currencies as a financial weapon (Syropoulos et al., 2024) are the key characteristics of modern global development. Obviously, the origins of the current crisis go back to the desire of the hegemonic country of the world economy to destabilize the processes of global development in such a way as to prevent the growth of the influence of competitors (Sakwa, 2024). At the present stage, the USA is trying to contain its competitors by maintaining American control over the main international monetary and financial institutions, a policy which consistently reduces the efficiency of their functioning (Kuznetsov, 2023).

The current configuration of the US dollar as the central element of the global monetary and financial system (GMFS) has caused instability, uncertainty, inequity and insufficient aggregate demand, which has negatively affected the development of the global economy (Ponsot, 2016). To resolve the balance of payments deficit, developing countries are forced to pursue austerity policies and reduce domestic costs. As a result, the United States ‘import deflation’ by purchasing foreign goods at relatively low prices (Inozemtsev*, 2021, p. 9).

The ongoing geopolitical confrontation has led to a reversal of globalization trends, a return of countries to economic nationalism and a redirection of the international trade and investment flows towards geopolitical allies (Bratersky, 2024). An obvious way to resolve these contradictions is to create a more decentralized multipolar monetary and financial system as a method of defusing international tensions and smoothing out socio-economic imbalances (Balyuk & Balyuk, 2024).

Meanwhile, the experience of the functioning of the single European currency area has proved to be insufficient to use this model for the regionalization of the GMFS. Within the current institutional framework of the European Economic and Monetary Union, the above mentioned problems could hardly be solved without its further worsening. This was evident in the aftermath of the global financial crisis, when the United States provided financial support to European countries. The US dollar loans enabled European banks to prevent insolvency and to recover from the recession (Abbassi et al., 2022; Alogoskoufis, Gravas & Jacque, 2023).

Methodology

Despite the abundance of scientific papers examining the problems of GMFS fragmentation, the academic literature still lacks studies on the institutional aspects of this process. In their publications, the authors mainly focus on examining the trends of GMFS fragmentation in various sectors (McCauley et al., 2019; Arkhipov, 2023; Arnold, 2024) or regions of the world economy,¹ while a comprehensive analysis of the causes of this phenomenon still does not receive due attention.² This paper aims to fill this academic gap to some extent. The author employs historical-logical and systemic approaches to clarify the categories of concepts used and to identify and characterize the main institutional aspects of the fragmentation of the global monetary and financial system, taking into account their implications for the transformation of the global financial architecture.

Global Monetary and Financial System: Essence and Modern Concept

The global monetary and financial system is a set of rules and agreements, mechanisms and institutions that facilitate international trade and investment.³ A robust GMFS is comprised of the following elements: an effective international payment system, a stable global reserve currency configuration, and robust crisis mitigation and resolution mechanisms.⁴

It is important to acknowledge that the current GMFS standard does not fully meet the imperatives of its reliable functioning. The dominant role of the US dollar and US banks in global finance gives the United States an unprecedented level of financial power, the regular abuse of which destabilizes the development of the world economy⁵ by disconnecting individual banks and entire countries from the GMFS through the freezing of official foreign exchange reserves, prohibiting the attraction of international debt and equity financing, impeding investments and transactions with sanctioned countries by introducing secondary sanctions against financial institutions of third countries in all regions of the world.⁶

Since the end of World War II, both intergovernmental organizations and private institutions have been conducive to the US monetary and financial dominance. For 80 years, the International Monetary Fund (IMF) has been the institutional foundation of the modern GMFS. Since its establishment in 1944, it has provided geopolitical cover for the implementation of the US global agenda (Steil, 2013, p. 135). This is evidenced by the fact that the IMF did not play a major role in the world economy until the late 1950s. The US State Department blocked the international settlement system created at the Bretton Woods Conference in order to create the most favorable conditions for the internationalization of the dollar (Steil, 2023, p. 388).

The IMF’s current role as a lender of last resort is becoming less and less noticeable. Despite a threefold increase in capital and debt financing after the global financial crisis, over the next 15 years, on average, about 80% of the Fund’s available financial resources remained unclaimed.⁷ The reason for the ‘idleness’ of IMF credit resources is related to their high cost, the rigidity of the debt servicing schedule and the impossibility of its extension (Navoy, 2022, pp. 33–34). The IMF reform carried out in 2010–2015 proved ineffective in addressing the existing problems.⁸

Another aspect of the institutional dysfunction of the GMFS is its offshore nature, which has led to the loss of control of central banks over the growth of the money supply on a global scale (Shaxson, 2018, p. 97). For example, in Russia, the share of cash of the Central Bank and non-cash money of commercial banks ranges from 16 to 84%,⁹ in the UK from 3 to 97% (Bjerg, 2023, p. 190). In conducting settlements through the global interbank communications system SWIFT, only money of commercial banks is used, not central banks.

The largest and most liquid offshore segment of the GMFS is the global foreign exchange market, where the US dollar and US banks have an advantage.¹⁰ In particular, interbank foreign exchange daily turnover was 7.5 trillion USD in April 2022, with USD share 88 and 70% settlements carried out through Continuous Linked Settlement — the currency conversion system, which is serviced by the US clearing bank CLS Bank.¹¹

Bloc Confrontation as a Sign of GMFS Fragmentation

The biggest winners from the functioning of the offshore GMFS were corporations of developed countries. Thus, over the three decades from 1990 to 2020, the assets of foreign affiliates of multinational companies increased by 21 times (5.5 times faster than the growth of global GDP).¹² In 2003, in the ranking of the 500 largest companies in the world by revenue, 197 companies were of US origin, the rest of the G7 countries accounted for another 217 companies, and only 18 companies belonged to the BRIC countries, of which only 11 were Chinese.¹³ However, after the transformation of the PRC into a major ‘global manufacturer,’ the corporate balance of power also began to shift in favor of China. By 2023, the number of Chinese enterprises among the 500 largest companies in the world had increased to 135, compared to 136 US enterprises.¹⁴

According to US business circles, the expansion of Chinese capital is incompatible with the doctrine of market fundamentalism, since most Chinese global corporations, including banks, are state-owned and rely on government direct support. From the point of view of official Washington, multilateral institutions such as the World Trade Organization (WTO) are no longer able to defend the market paradigm and protect US interests in the global economic arena, since they allow unfair competition from China (Zagashvili, 2019, p. 8). Such arguments serve as a reason for the U.S. to continue blocking the activities of the main WTO institutions — the negotiating committees, the General Council, and the Appellate Body for the settlement of disputes (Drabek, 2024).

To cover the significant negative trade balance with China, the U.S. is forced to regularly increase the size of its national debt by selling their treasury securities to China. In addition, US manufacturers are becoming increasingly dependent on global supply chains involving Chinese companies.¹⁵

However, China’s share of US imports of goods and services declined from 22% in 2018 to 14% in 2023 due to the aggressive introduction of US trade restrictions.¹⁶ It is noteworthy that after leaving the US markets, the presence of Chinese companies in the supply chains of Southeast Asian countries is becoming increasingly pronounced. In particular, owing to this expansion exports of Cambodia and Vietnam to the U.S. have been steadily increasing.¹⁷ Since the start of the armed conflict in Ukraine, trade flows and the number of announced investment projects between US- and China-centered geopolitical blocs have decreased by 12 and 20% respectively compared to trade and investment between countries within the same bloc.¹⁸ Against the backdrop of negative inter-bloc dynamics, there has been an increase in trade and investment flows — China’s exports and the US’s imports, respectively — with third countries, primarily Mexico, Canada, Vietnam, Taiwan, and India. The implication is that the U.S. and China remain linked to each other indirectly through these third countries (Eichengreen, 2024). The relocation of Chinese production and investment to Asian countries gives the United States grounds to introduce secondary trade restrictions on these countries as well.

Meanwhile, the main arena of rivalry between US and Chinese corporations is unfolding in the high-tech sector, an area that until recently was almost completely monopolized by American business. In 2022, key American players — Intel and AMD — controlled 70.77 and 19.84% of the global microprocessor market, respectively.¹⁹ The share of the American company Nvidia in the global graphics processor market was 88%,²⁰ and in the Chinese market it reached 95%.²¹ For a long time, no country could challenge the US dominance in the development of software for automated electronic design. Thus, at present, American platforms such as Amazon Web Services, Microsoft Azure and Google Cloud own 66% of the global cloud computing market.²²

The need for China to overcome its dependence on the United States in the high-tech sector was defined in the government strategy “Made in China 2025,” which set ambitious goals for China to become a leader in the production of the most advanced semiconductors and in the field of next-generation artificial intelligence by 2030. Beijing has already overtaken Washington in terms of investment in the development of quantum technologies and cloud computing and has taken first place in the world in the number of supercomputers (173 systems compared with 127 in the U.S.).²³

Since late 2022, the United States has been deploying a targeted strategy to curb China’s advances in critical technologies. To limit China’s access to advanced semiconductor technology the United States, with the support of Japan and the Netherlands, has implemented an unprecedented export control regime.²⁴ Further restrictions on American direct investment in China’s artificial intelligence industries, quantum and advanced semiconductor technologies took place by the Joseph Biden administration in August 2023.²⁵

The reorientation of China’s trade and investment flows to Asia and, more broadly, to Eurasia may mean a more active yuanization of supply chains in the future, especially given the further development of transnational financial infrastructure involving Chinese banks and high-tech companies. The promotion of the digital yuan as a reserve currency in the long term has the potential to weaken the peg of China’s foreign trade to the US dollar and settlements via SWIFT.²⁶ Consequently, the ongoing bloc confrontation between the U.S. and China potentially increases the risk of GMFS fragmentation.

De-dollarization of International Reserves

The US dollar has historically held an unparalleled position within the global monetary and financial hierarchy. The US national currency has dominated all spheres of international collaboration — development finance, reserve asset accumulation, global public and corporate borrowing and international invoicing. The dominant status of the US dollar in international relations is based on a global systemic infrastructure that requires emerging economies to transact in US dollars (Kuehnlenz, Orsi & Kaltenbrunner, 2023). Meanwhile, over the past two decades, the dollar’s share of central bank foreign exchange reserves has gradually declined, from 78.4% in 2000 to 57.39% in the third quarter of 2024.²⁷ The main drivers of this change have been investments in non-traditional reserve currencies such as the Canadian, Singaporean and Australian dollars, the South Korean won and the Chinese yuan.²⁸ While investments in non-traditional currencies are made to generate returns, the Big Four currencies are used as liquidity to finance interventionsin foreign exchange markets, debt servicing and repayment and current deficits. The share of official reserves in non-traditional currencies is at least 5% in 46 countries. The most active ‘diversifying countries’ include Russia, China, Malaysia, Indonesia, Poland, the Czech Republic, Singapore, the United Kingdom, Switzerland, India, and Brazil (Arslanalp, Eichengreen & Simpson-Bell, 2022).

The weakening role of the US dollar as a reserve asset is most clearly manifested in the decline in Chinese investments in US Treasury bonds, the main reserve asset of the People’s Bank of China. In October 2024, China’s investments in US government debt obligations decreased to USD 760 billion from USD 1,034 billion in January 2022.²⁹ The decrease in the Chinese regulator’s demand for US securities is due to the intensification of the US-Chinese trade and investment confrontation, as well as the freezing of Russian foreign exchange reserves, as an indicator of the unreliability of investments in American assets, which can be transformed into an instrument of sanctions pressure on the investor country (Petrov, 2024, p. 18).

It is noteworthy that the freezing of the seventh largest official foreign exchange reserves of Russia — the world’s fourth largest economy by gross domestic product based on purchasing power parity (GDP, PPP) — returns the world to the original logic of the creation of the IMF, as a mechanism for settlements between countries in their own currencies. Evidence of this is the increasingly active use of the ruble and the yuan in international settlements. Thus, in March 2024, the share of the ruble in foreign trade settlements between Russia and Europe reached 58.5%.³⁰ In servicing Russian-Chinese trade, the share of the ruble and the yuan exceeded 90%.³¹

A further indicator of declining confidence in the US dollar as a reserve asset is the growing demand for monetary gold.³² Consequently, the de-dollarization of international reserves is a significant factor in the fragmentation of the GMFS. Meanwhile, the main impulses in this regard may come from the ambitions of central banks to introduce digital currencies into the sphere of international settlements.

According to some forecasts (Kravchenko, 2024), the dollar will retain its dominant position in the GMFS until at least 2060. However, the dynamics of changes in the positions of other currencies in the global monetary and financial hierarchy will obviously depend entirely on the success of the world’s majority countries in creating systemic alternatives to the US dollar as international liquidity. Ultimately, it is precisely such alternatives that can protect emerging market and developing countries from the risks of destabilization of the global financial environment, thereby ensuring the conditions for catch-up development.

Risks of Digital Fragmentation of GMFS

The use of innovative technologies in international payments does not necessarily imply a radical breakdown of the current international reserve system. Nevertheless, an increasing number of sovereign states are exploring the possibility of issuing their own digital financial assets in order to reduce exchange rate and sanctions risks by unifying standards, technologies, legal and regulatory frameworks for international payments. As of July 2024, 134 countries and monetary unions, representing 98% of the world’s GDP, were exploring the possibility of creating a central bank digital currency (CBDC).³³ In addition to national digital currencies, preparations are underway to launch CBDCs for international settlements on a multi-platform basis. With the help of multi-CBDC platforms, international payments between participating jurisdictions can be carried out using national currencies, ensuring the implementation of the concept of multiple reserve assets.

At the same time, the introduction of a CBDC is not sufficient to resolve the asymmetries in the current GMFS. The key role of the US dollar is determined by its dominance in the settlement of international financial obligations, the invoicing of international trade and the conduct of financial market transactions. Deep trust in US financial market institutions and regulation are main preconditions for the steady international demand for the US dollar. Another factor is the ability and willingness of the US Federal Reserve to act as a global lender of last resort. Thus, a de-dollarized global financial infrastructure requires a three-dimensional approach that simultaneously addresses the issue in the areas of payments infrastructure, international trade, and financial markets (Kuehnlenz, Orsi & Kaltenbrunner, 2023).

Meanwhile, the growing interest of the majority of countries in introducing their own digital currencies requires global regulation of digital currency and financial relations, which increases the risks of digital fragmentation of the GMFS (Maslov& Shvandar, 2023; Krylova, 2024). Thefact is that, according to the established historical tradition, Washington has a negative attitude towards supporting any initiatives to introduce global rules for regulating the international currency and financial sphere that are not controlled by the United States.³⁴ Therefore, it is possible that in the process of digital adaptation of the GMFS, the clash of geopolitical interests in the near future may shift to the sphere of legal regulation of international financial settlements and transactions in financial markets using digital financial assets.

Conclusion

The modern GMFS is subject to the risks of fragmentation, which are associated with its growing institutional dysfunctionality, due to the contradiction between the national origin and international use of the US dollar, structural shifts in the world economy related to the transition to a new technological basis, a change in the balance of power between the world’s economic and financial centers and the formation of a new political and economic model of the world order that contradicts with the geopolitical interests and strategies of the leading developed countries of the West.

The preservation of the US control over the international payment and settlement infrastructure and institutions of the global financial market is largely due to the desire of the United States to maintain its dominant position in the new technological order and to prevent China and other emerging economic and financial centers from setting the rules for the redistribution of global financial resources.

The possibility of expanding the access of the majority of countries to international liquidity is being considered through the introduction of digital currencies of central banks and their subsequent use for international settlements, including through digital multiplatforms. At the same time, the US ambitions to maintain unilateral control over the GMFS create risks of its subsequent fragmentation.

Today, sovereign states are increasing protectionist measures for reasons of national security and in order to protect their economies from the negative consequences of the geopolitical confrontation between the world’s largest economies. If the policy of isolationism spreads to the digital sphere as a result of increased competition between high-tech companies, this could have a negative impact on international cooperation in the joint development of strategic technologies.

_{* V.L. Inozemtsev entered into the register of foreign agents of the Ministry of Justice of the Russian Federation (Order of the Russian Ministry of Justice dated 05/26/2023).}

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About the authors

Aleksei V. Kuznetsov

Author for correspondence.
Email: kuznetsov0572@mail.ru
ORCID iD: 0000-0003-3669-0667
SPIN-code: 3219-0542

Dr. of Sc. (Economics), Senior Researcher, Professor, Chair of World Economy and World Finance

References