SWIFT, the U.S. Dollar, and the Global Political Economy of Trade

Decoding the Messaging Network That Enables International Bank Transfers

BY BILL BARCLAY | September/October 2022

This article is from Dollars & Sense: Real World Economics, available at http://www.dollarsandsense.org

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“The dollar is our currency, but your problem.”
—John Connally, U.S. Secretary of Treasury at the Rome meeting of the G-10 in 1971.

If you use international wire transfers to send or receive money, you may have heard of SWIFT, the Society for Worldwide Interbank Financial Telecommunications. But most of us only heard of SWIFT when Russia invaded Ukraine. SWIFT was mobilized as one weapon in the financial sanctions applied to Russia. To understand SWIFT’s role in the sanctions, it is best to begin with the role of the U.S. dollar in the global political economy.

Let’s start at the level of the individual. If you live in the United States and fly abroad, when you deplane at almost any airport in the world, you can change your U.S. dollars into the local currency. The exchange rate may or may not please you, but the market for the dollar is liquid and active wherever you travel. People are happy to have your dollars.

This is certainly a convenience for U.S. residents, but does it mean anything beyond that? Why is the market for converting the dollar into another currency (in the rest of this article, “dollar” will refer to the U.S. dollar) so readily available and, in economists’ terms, why is the dollar so “liquid”?

The dollar occupies a unique place in today’s global financial system, and it is dominant in global trade as well as international investment and asset valuation. In effect, the dollar functions as a global or world currency, just as the U.K. pound sterling did throughout much of the 19th century and the first half of the 20th century.

The interaction between international trade, the U.S. dollar as the world currency —including its role as the dominant reserve currency for central banks —and SWIFT is an important but often overlooked dynamic in assessing the real world of international trade.

International Trade in the Neoliberal Era

In 1970, international trade was only equal to about 25% of total global GDP, the sum of the individual country GDPs around the world. In the next four-plus decades (from 1970–2012), global trade —the movement of goods and services (mostly goods) —grew twice as fast as global GDP. The growth of international trade is a core feature of globalization as it has developed in the past half century. The global exchange of goods and services has been a major factor in offshoring; in the shift of manufacturing from the older manufacturing centers of the United States and Europe to China and the global South; and, more recently, in highlighting the fragility of supply chains. Although the growth rate of global trade has slowed in the past decade, international trade today equals almost 60% of global GDP.

That international trade equals 60% of global GDP does not mean that 60% of global GDP is traded. Consider autos and vehicle parts that alone account for 7.5% of global trade, with another 5% composed of the fossil fuels that supply the energy needs of the internal combustion engine (crude and refined petroleum). China exports auto frames and brake systems to U.S. auto manufacturers and the invoiced value of these exports (imports to the United States) are counted in international trade statistics. After assembly in the United States, cars containing these Chinese-produced parts may then be exported, sometimes back to China, sometimes elsewhere. The total value of the exported vehicles, including the frames and brake systems, is added to the international trade statistics. A single car’s various traded parts, and then the car as a whole, are both included in trade statistics.

The Financial Logistics of International Trade

The transport of these and other goods is an issue of physical logistics, involving container ships, oil tankers, and (sometimes snarled) supply chains. But essential to this movement of actual stuff is a worldwide, parallel system of financial logistics that makes the flow of goods possible. And the core factor in this system of financial logistics is SWIFT.

SWIFT has been a key mechanism in allowing world trade to grow twice as fast as total global economic output over the past half century. And SWIFT has also emerged as a mechanism for weaponizing the dollar as a tool of global diplomacy and power.

So, what is SWIFT, how does it work, and how has SWIFT been used to weaponize the dollar?

SWIFT was founded in 1973 as a Belgian cooperative and became operational in 1977. There were then 239 member financial institutions located in 15 countries. SWIFT does not itself transfer any money. Instead, SWIFT is a messaging service that allows Bank A in country X to communicate with Bank B in country Y to verify and clear the transfer of funds for the bank’s own account or for that of a customer of the bank.

Use of SWIFT has grown even more rapidly than actual trade: 46 million messages in 1979, almost 300 million in 1989, slightly over one billion in 1999, and today over 10 billion. SWIFT’s reach to more than 11,000 financial institutions in almost 200 countries has made global trade low-cost and reliable by connecting buyers and sellers of goods, services, and financial instruments across borders. SWIFT’s governing board is the central banks of the G-10 countries (Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, the United Kingdom, the United States, Switzerland, and Sweden), as well as the European Central Bank, with its lead overseer being the National Bank of Belgium. All have the same voting power, unlike in the World Bank. However, the U.S. Federal Reserve, because of its status as the largest central bank, exercises considerable informal power.

SWIFT and the Dollar

But just as it is not just cars that are traded across borders but particular kinds of cars —Fords, Hondas, etc. —it is not just “money” that is transferred as a result of SWIFT messages but particular currencies.

What currency is being transferred as a result of SWIFT messages? Overwhelmingly dollars, with euros a distant second. Only the Japanese yen, the third-ranked currency among the dozens of other currencies that can be handled by SWIFT, accounted for as much as 5% of total currency movements linked to global trade.

The United States accounts for less than 10% of global trade, and our trade-to-GDP ratio is about 25%, less than half the overall global ratio of 60%; that is, the value of goods and services that the United States trades is equal to about one-quarter of its GDP. Despite this, goods and services moved in global trade are primarily priced in dollars, over 70% globally and over 80% if intra-European trade, where the euro dominates, is excluded.

Currencies are usually considered to have three functions: as a store of value, a unit of account, and a medium of exchange. As a store of value, a currency serves to hold (and measure) wealth. As a unit of account, a currency measures how much a good or service is worth in market terms. And, as a medium of exchange, a currency can be used to settle cross-border payments and financial transactions. Goods and services traded across borders use the dollar as the medium of exchange because the dollar functions as the world currency, a role held by the U.K. pound from the mid-1800s until World War II when it was displaced by the dollar.

The dollar dominates on all three of these dimensions. That dominance is a pillar of U.S. financial power, including the power to bring financial pressure on other countries via sanctions and limiting access to international trade, all the while financing our trade and budget deficits. How do SWIFT and the dollar interact in a manner that helps sustain U.S. global financial power? After all, SWIFT messaging can be done in many different currencies —there are more than 200 countries represented among SWIFT members. But, because world trade is conducted primarily in dollars, most SWIFT messaging involves movements of the dollar.

And this is where SWIFT, the dollar’s world currency role, and the power of the dollar meet; it is also the source of the potential financial weapon represented by SWIFT. “Potential,” because until the 2022 Russian invasion of Ukraine, SWIFT had been used to sanction a nation only once: Iran in 2012 over the possibility that it would develop nuclear weapon capabilities. The United States has applied sanctions in various other situations, including against the Taliban in Afghanistan and against Venezuela’s left-wing government, but these have not included bans on access to SWIFT. Banning a financial institution from SWIFT means banning that institution from participating in the almost-universal financial settlement process for international trade. The institution can no longer use SWIFT to authorize payments to or receive payments from any of the other 11,000 financial institutions that are SWIFT participants.

Now, if world trade pricing were distributed across many currencies —perhaps in proportion to their global trade share —there would be other avenues, more costly and less efficient but extant, that a SWIFT-banned institution might use to move currencies to pay for goods and services imported or to receive for goods and services exported (“pays and collects,” in the jargon of international trade). But the dominance of the dollar as a medium of exchange means that it is the most liquid market for international currency trading. Consider a Mexican vehicle parts manufacturer selling to Volvo in Sweden. It is usually less costly for the Mexican company to price the trade in dollars and, if necessary, later convert to pesos than to price the goods in kronor and then try to convert kronor to pesos. From the Volvo perspective the same logic holds. Transaction costs between the krona and the dollar and the peso and the dollar are much lower than between the peso and the krona.

The dominance of the dollar does not end with the medium of exchange function. The dollar is also the dominant store of value in central banks: About 60% of central bank reserves are in dollar-denominated securities, mostly U.S. treasury issuances. Freezing these assets simply reinforces the impact of sanctions.

The Future of SWIFT and the Dollar?

Until Iranian financial institutions were excluded from SWIFT in 2012, the system had never been used as a weapon of financial warfare. The 2022 banning of Russian financial institutions from SWIFT in response to the invasion of Ukraine has raised questions about the possible future use of SWIFT as a weapon of financial warfare. If SWIFT becomes a financial weapon rather than simply a worldwide settlement mechanism, will some countries seek an alternative to SWIFT? And what is the likelihood that such an alternative would succeed?

Similarly, some have asked whether the weaponization of the dollar via SWIFT will push international trade to move away from dollar pricing. Such a shift would lessen the power of the dollar as the world currency and undercut a lever of U.S. power.

While the power of the dollar and the centrality of SWIFT to intentional trade are connected, the answers to these two different questions are not necessarily linked.

Both China and Russia have developed alternative financial messaging systems. In 2014, Russia created the System for Transfer of Financial Messages (SPFS), and in 2015 China created the Cross-Border Interbank Payment System (CIPS). In the latter case it was part of China’s ongoing effort to internationalize the yuan. Neither system has been able to gain much traction. The Russian economy is smaller than that of Italy, and Russia accounts for less than 2% of international trade. There are very few countries that want to replace the dollar with the ruble.

China, on the other hand, is the largest manufacturing and trading nation and the second largest economy, and therefore is better positioned to challenge the centrality of SWIFT to the global trading system. But China’s goal with CIPS has been largely to increase the visibility of the RMB. And, although CIPS has banks from 103 countries participating, most are indirect participants with only 76 actual bank members, almost all branches of Chinese banks.

With more than 11,000 members from over 200 countries, SWIFT has a huge “network effect”; this means that the value of SWIFT is significantly increased by the very large number of users of the system, making transactions cheaper and available across a wide range of participants. SWIFT’s network-effect advantages are very hard to overcome in the near or likely even the intermediate future.

What about the world currency role of the dollar? Could another currency come to dominate the SWIFT messaging network and become the favored pricing currency for international trade?

The question of a competitor for the dollar has been raised more than once in the past two decades, as it was earlier when the link between the dollar and gold was severed in the early 1970s. In the immediate aftermath of the Great Financial Crisis of 2007–2008, there were some predictions that the euro would replace the dollar, perhaps as soon as the 2020s, but, outside of intra-European trade, that has not happened. Or maybe the RMB will come to dominate the world currency market? After all, it is likely that the Chinese economy will become the world’s largest in the foreseeable future.

However, economic size has not been the determinant of world currency status. The United States became the largest economy in the 1890s, but the U.K. pound remained the world currency until World War II. More importantly, the dollar dominates the foreign currency trading market, and almost 80% of publicly traded debt is dollar denominated, a percentage that has actually increased in this century. Further, China, to date, has been reluctant to take the steps that would make the yuan a true competitor to the dollar. To do so would require a significant reduction in capital controls and a huge expansion of China’s domestic financial markets.

It is certainly the case that there are —today mostly potential —replacements for the dollar as the world currency. The two leading candidates are the RMB and the euro. China has been diversifying its foreign exchange reserve holdings, but the bulk continue to be dollar-based assets. The European Union continues to seek a larger role for the euro beyond dominating intra-European trade and may actually emerge as the primary contender at some point in the future.

Another Scenario: A Multi-Polar Currency World?

From the foregoing, it appears that the dollar’s role as a medium of exchange and a unit of account have not diminished over the past two decades. To paraphrase Mark Twain, reports of the dollar’s demise appear much exaggerated. But, what about the dollar as a store of value?

A good index on the dollar’s status as a store of value is the reserves held by central banks around the world. Since 2000, total central bank reserves have increased almost sevenfold, rising to almost $13 trillion in 2021. During the same period, the share of dollar-denominated assets in total central bank reserves dropped from 70% to a little under 60%. The amount of dollar-denominated reserve holdings have increased over the past two decades, but at a slower rate than total central bank reserve holdings. Central bankers were, to some extent, diversifying out of dollars, likely seeking higher returns on their reserve holdings (as noted below). But little of that decline represented a shift to the currencies of the three other members of the big four: euros, pounds, and yen reserve shares did not increase. So, what happened?

In part, the answer lies in some reporting issues with the Currency Composition of Official Foreign Exchange Reserves (COFER), a database run by the International Monetary Fund (IMF). At the beginning of the 2000s, over 20% of total central bank reserves were classified as “unallocated,” that is, not assigned to any currency. Today that number has declined to about 6%. The dollar’s share of total central bank reserves, allocated and unallocated, is about the same today as it was in 2000. There was a short period after the Great Financial Crisis of 2007–2008 when the dollar share declined while the euro share increased, probably feeding the “euro may replace the dollar” narrative. However, the dollar share is now actually up significantly from the levels immediately after the Great Financial Crisis, and the euro has lost ground.

There have been some interesting but limited shifts in the composition of central bank reserves. First, the RMB share has increased from less than 1% in 2017 to a little over 2% today; however, one-third of those increased RMB-denominated reserves are held by the Russian central bank. But the most striking shift is out of the big four currencies —the dollar, euro, pound, and yen —and into “nontraditional” currencies, including the Canadian and Australian dollars and Swiss francs.

Central banks are, after all, mostly run by bankers. And bankers seek to increase returns on their holdings. For much of the past two decades (at least since the Great Financial Crisis), yields on the debt of the big four currencies has been low. Central bankers have looked to add returns by acquiring reserves in the form of other currencies and, to a lesser extent, commodities, especially gold.

It is difficult to assess definitively what this means for the future of the dollar as the world’s currency. But we may be moving, albeit slowly, toward a more multicurrency world, at least in terms of the dollar as a store of value.

However, for the foreseeable future, it appears that John Connally’s dictum will remain true. Fifty years down the road? Who knows.

Bill Barclay is a resident of Ventura County, Calif., and a member of the Chicago Political Economy Group.

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