dollar’s centrality.5 When US President Richard Nixon suspended the gold convertibility of the US dollar in 1971, some contemporaries viewed the move as a signal of the dollar’s weakness. However, a series of historical forces and events converged to increase the dollar’s centrality in subsequent years. The underlying strength of the US economy, the absence of viable alternative currencies and the emergence of the “petrodollar” system resulted in the US dollar maintaining its core role in the emerging financial order. A linchpin of the system involved a US arrangement with Saudi Arabia in the 1970s to ensure that the global oil trade would be conducted in dollars, which created a perpetual source of dollar demand.6The US dollar became increasingly central to the development of the global financial system in subsequent years, due to structural and institutional factors. Deep and liquid US financial markets, combined with relatively predictable monetary policy, strong legal frameworks and political as well as institutional stability maintained the currency’s appeal for international transactions and reserves. Moreover, the US dollar’s entrenched role in global trade and commodity pricing and its widespread use in international contracts created powerful network effects that resist change. The 1980s and 1990s saw the formation of a truly integrated global financial system through three parallel developments. First, financial deregulation and innovation created interconnected global capital markets. The easing of foreign exchange controls and expansion of derivatives markets enabled unprecedented capital mobility.7 For instance, the estimated outstanding stock of international bonds increased from $260 billion to $1.4 trillion between 1982 and 1990.8 This deregulation coincided with many emerging markets (EMs) shifting from import-substitution strategies to export-led growth, further integrating global finance and trade.9 Technology played a crucial role in enabling this integration. The introduction of real-time gross settlement (RTGS) systems dramatically reduced settlement risk and contributed to more efficient cross-border transactions. Electronic trading platforms and the internet transformed financial markets, enabling faster trading (for example, the US stock market moved from a T+5 to a T+3 settlement cycle in 1995), better price discovery and improved access to information.10 These technological advances significantly reduced the costs of international financial transactions and simultaneously increased their speed and reliability. International arrangements further solidified the institutional framework for global integration. The establishment of the World Trade Organization (WTO) in 1995 created a more unified global trading system that encouraged financial integration. Most of Europe’s largest economies further integrated their markets by adopting the euro as their common accounting currency in 1999. China’s 2001 WTO accession marked another crucial milestone, integrating the world’s then-most populous nation into global markets.11 The 2007 US housing downturn, which triggered the global financial crisis, revealed the risks of integration but ultimately led to stronger international regulatory coordination through new institutions such as the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS). Cumulatively, these trends converged to create dramatic increases in foreign direct investment, which grew from 0.5% of global GDP in 1970 to a high watermark of 5.3% of global GDP in 2007, just prior to the 2008 crisis.12 1.2 Integration of a global system The historic role of the US dollar BOX 1 The Bretton Woods system established the US dollar as the global reserve currency. Growing fragmentation of the global financial system is partly fuelled by countries and companies seeking to mitigate the perceived risks associated with US dollar dependence such as changes in US monetary policy affecting global liquidity and other financial conditions. Nevertheless, the US dollar is likely to maintain its dominance for the foreseeable future, given strong US fundamentals, a lack of credible alternatives and its powerful and entrenched network effects. The euro faces limitations due to the Eurozone’s economic and political fragmentation, while the renminbi is constrained by its controlled capital account and lack of full convertibility. Other currencies suffer from insufficient scale and liquidity. Central banks prefer holding dollar reserves due to the currency’s stability and liquidity, and, accordingly, the dollar maintains a dominant share of global foreign exchange reserves. Global trust in the US economic and financial systems and confidence in the US government’s ability to meet its financial obligations collectively make the scenario of continued dollar dominance the most likely outcome. The strength of the US economy, the absence of viable alternative currencies and the emergence of the ‘petrodollar’ system led to the US dollar maintaining its core role in the emerging financial order. Navigating Global Financial System Fragmentation 11

Navigating Global Financial System Fragmentation 2025