Josh Lipsky on Financial Statecraft, Cross-border Payments, and the Global Status of the Dollar

Josh Lipsky is the senior director of the Atlantic Council’s GeoEconomics Center. Josh joins David on Macro Musings to talk about the tools of financial statecraft, how they have evolved over the years, and their implications for digital currencies moving forward. Specifically, David and Josh also discuss how financial statecraft would be applied to a possible conflict with China, the current state of the cross-border payments system, the future of wholesale CBDC in the US, and much more.

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Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Josh, welcome to the show.

Josh Lipsky: Thanks so much for having me, David. Really pleased to be here.

Beckworth: Great to have you on. I've been following the work that you're doing there on payments, cross-border payments, digital currencies, and of course, financial statecraft. We're going to talk about all of that today, but maybe start us off by talking about your work there, what the Atlantic Council is, what it's doing, and how you got there.

Lipsky: Yes. Happy to do that. I've been at the Atlantic Council for four years. I was at the IMF before that as an advisor and speechwriter to Christine Lagarde, and prior to the IMF, I was at the State Department for about three years. Having been at State and then been at the IMF, I had this realization that, oftentimes, those two institutions are working on similar issues, but they don't speak the same language. At State Department, for example, you might be dealing with the rise of terrorism in a certain region. At the IMF, you might be dealing with hyperinflation in that same country.

Lipsky: But we don't talk a lot about counterterrorism at the IMF, and we don't talk a lot about hyperinflation at the State Department. And so, when I left the IMF, I had this idea that it would be useful in Washington to have a center that was at the intersection of national security, finance, and foreign policy. In Washington, we have the Peterson Institute, the sort of macroeconomic gold standard of work going on. We have the traditional foreign policy think tanks. Atlantic Council is one of them, Council on Foreign Relations [is another], and I wanted to build something that was the intersection of the two.

Lipsky: And that's where the idea of geoeconomics came from, and the center came from, and we've built it out over the last four years. We do a range of work, as you said, on digital currencies, China's economy, economic statecraft, and in the first two years, I always had to explain to everyone what geoeconomics meant, but since Russia's invasion of Ukraine, and especially the G7 sanctions response, I always say that I don't have to explain it anymore. Everyone just intuitively understands what geoeconomics is. We live it. The only other thing I'd say is that geoeconomics is not a new idea. It's an old idea.

Lipsky: We're marking the 80th anniversary of the Bretton Woods Institutions this summer. Those are geoeconomic institutions founded during a war, not after a war. And so, what I think is, in the West, we have to rediscover geoeconomics. It's actually how a lot of countries operate every day. It's how India operates. It's how China operates. A lot of emerging markets operate from a geoeconomic posture. We are rediscovering what geoeconomics means here in the United States.

Beckworth: Maybe the economists are rediscovering geoeconomics. I think that political scientists, like yourself and lawyers, have been on top of it for some time. But I know that in our field, at least, it's something that we are addressing again. We've had some previous guests on the show who've been exploring this topic, and we've had some political scientists as well. We've had Dan McDowell, for example, on dollar dominance, a number of guests. So, very topical, very fascinating, and very important, I think, is the point you're trying to make here. It's national security, it's financial statecraft, all of those wonderful things.

Beckworth: Well, let's look at some financial statecraft issues, and let's start with a case study, a very prominent one, right in front of us today, and that's the Ukraine war. And two parts of that, both the financing of it, but also the sanctions that were applied, in 2022, to Russia, and how we have supported Ukraine through these various mechanisms of financial statecraft. Let me begin first with the financial sanctions. So, if my understanding is correct, Russia had around $600 billion in foreign assets, and we were able to freeze around $300 billion of that. Is that right?

The Russia Sanctions as an Example of Financial Statecraft

Lipsky: Yes, and there's $600 billion in total reserve assets, but about $300 [billion] that were held outside of Russia. That's the amount. It's probably closer, we think, now, to $280 billion that was actually blocked. We say blocked instead of frozen. This is a semantic debate inside of the Atlantic Council. But about 280 blocked, frozen, and the vast majority of that, about $220 [billion] in Europe, in euros, predominantly. That's an important distinction when we talk about how those assets are used, and that is what has put so many constraints in so much G7 negotiation, about what to do with those assets. They're held in Euroclear, a European clearinghouse in Belgium. So, we always think that it's important, when we talk about the assets, to get nuanced, to get detailed. What do we mean? How much is it? Who's holding it? In what kind of currency?

Beckworth: Okay, so, most of it that is held outside of Russia, these reserves, are held in Europe, which, I guess, means that the US has less ability to use financial statecraft directly. It's going to have to go with partners, have a coalition. And something that's interesting to me, Josh, sitting back and looking at this development, is that coming out of Iran, when we dropped the deal with the Europeans, they were livid at us. They were mad. In fact, we imposed, I believe, both primary and secondary sanctions. So, European businesses who'd invested into Iran again, suddenly, they found out that they were on the wrong end of the financial sanctions deal.

Beckworth: So, they were ticked off, and they just tried to develop their own payment system. But then, come forward to 2022, and all of a sudden, we're all on the same page again. Everyone's happy, everyone's singing from the same page of the choir book. So, we've maybe mended some of those hurt feelings from earlier. But still, we depend upon Europe playing its role as well. So, we have the financial sanctions. I'll come back to those in a minute. I want to talk about how effective they've been. Also, [there are] sanctions on banking in Russia. Is that right? And sanctions on oil and import/exports. Is that fair?

Lipsky: Yes. These are some of the most sweeping sanctions ever put on a G20 economy, wide ranging. many banks de-SWIFTed, though not every bank, as we've shown through our work at the Council, on the Global Sanctions Dashboard that my colleague, Kim Donovan, runs. Many banks [are] outside of the SWIFT system now, but it is important to say, especially at the beginning, [there were] wide exceptions for energy. It's very hard to sanction a current account surplus country, that is an energy exporter, and leave out the energy exports loophole in the sanctions. So, we'll talk about the effectiveness of the sanctions, David, but I don't think an economist would have any trouble understanding why they may not have been effective, as many assumed at the beginning, when you have that kind of hole in the sanctions regime.

Beckworth: Yes, so, let's talk about that. How effective have the sanctions been, that were introduced in 2022, relative to expectations?

Lipsky: The key statement there, David, is relative to expectations, right? This is so important, because, in the beginning, expectations were set that this was going to cripple the Russian economy. That was never realistic. Sanctions have to work, in complement, with a range of other tools. Many of them take a long time to fully bite, and it was really not realistic to think that you could sanction a country like Russia, leave out energy exports— Gazprombank, for example, [was] left out of the sanctions regime— and think that the economy wouldn't find ways to work around that. We've learned that lesson over and over in the history of sanctions. That doesn't mean they haven't had an effect. 

Lipsky: I look at Russia's GDP growth compared to where we thought they would be pre-invasion. Look at the long-term outruns from the IMF, 10 years out. Look at some of the things that are happening in their markets, how they're having to have really stressed in terms of finding backfills for auto parts, for example. So, it doesn't mean that there's not an effect on the Russian economy, there's not strain on the Russian economy. And China has really stepped in to backfill the needs there, so Russia has to reorient a lot of how it does business. This introduces enormous long-term risks for them, to be overly reliant on one country, China, as opposed to Europe, but it has not crippled the Russian economy. We should just be very upfront and straightforward about that. So, has it hurt the Russian economy? Yes. But relative to expectations, it did less than what many thought at the beginning.

Beckworth: Well, it sounds like you were, at least, more sanguine about these effects early on than the rest of us. Is that right?

Lipsky: I mean, I can go back to my statements in the first week, and I'm sure that I, like many people, thought this is— "Wow, the Russian economy is on the precipice here." And by the way, Nabiullina, the [Russian] Central Bank governor, took a series of steps in the early days which stabilized the Russian economy, capital controls and other measures. So, I think that we can all do a lot of reflection of how we reacted in the first couple weeks, and take a step back, and take a deep breath and assess things as they are. One thing that I would say is important is that macroeconomists, lawyers, and national security professors have to be in the room together when these sanctions packages are designed.

Lipsky: I've written about this. A lot of times, these packages are built, and then the macroeconomists come in later and say things like, "What about substitution effects?” and, “Look at how they would work around these supply chains." I think one lesson that the administration, and the G7 more broadly, has learned in this process is that if you are going to try to sanction effectively, you've got to put the economist in the room with those designing the packages in a way you haven't before, and you also have to think about this, not just in the Russia scenario, but if you ever got into a future conflict in the Taiwan Strait, [and] if you were dealing with sanctions on China. We've done studies on this at the Atlantic Council. You really have to rethink the way you structure your sanctions and build a government apparatus to sanction another country. I think there's some lessons learned in this whole process for everyone.

Beckworth: Okay, let's talk now about the financing of the war, at least the external financing being sent to Ukraine. In the US, we recently passed the REPO Act. But I think, more importantly, is this G7 agreement to provide a $50 billion loan, and it would be financed— or at least the interest rate would be covered by interest earned on the blocked assets of Russia.

Lipsky: Exactly.

Beckworth: Can you walk us through that, and what does it mean?

The Financing of the Russia-Ukraine War

Lipsky: Well, it's incredibly innovative financial statecraft, and I think that the administration deserves credit here. Daleep Singh, Deputy National Security Advisor, is the leader of this idea, and has brought the G7 around on it. But let's just take a step back and think about what's happened to these assets over the past two years. First, they were blocked. Two years ago, it was a Saturday morning. Earlier that week, the G7 was saying that they weren't going to block the assets. It was announced on a Saturday.

Lipsky: And just to give you a sense of how quickly it came together, the Japanese didn't sign on to the G7 blocking of the assets, only because it was overnight in Japan, and it was only the next morning when they signed on to the G7 statement. So, I always just remind people of how quickly this idea came together. To sanction the foreign exchange reserves, at this level of a country, had never been done before. I don't think Putin expected it. I think that this is why he diversified into euros between 2014 and 2022. It surprised him, and it changed the way that a lot of countries think about the euro-dollar dynamic. So, that was the blocking two years ago.

Lipsky: Now, of course, immediately when they were blocked, the question started to be raised, "Well, what are you going to do with them? They're just sitting there. It's a huge chunk of money. Ukraine has growing and growing reconstruction and financing needs. Can you use this money?" And for the first year, I think that that conversation was on a low simmer. War was ongoing. There was funding going into Ukraine from the Americans and the Europeans, and it wasn't a top priority. Then, we ran into dysfunction in Congress, here in the US, and an inability to pass new aid to Ukraine.

Lipsky: Then, the conversation really picked up speed in the US. "Well, hold on. If we can't pass the supplemental aid package for Ukraine, why can't we tap these assets?" Of course, as we talked about before, the assets are primarily in Europe, held in euros. It's not something that the US can just do unilaterally. Then, when we ended up passing the aid in Congress, the conversation shifted a little. It went from, what about instead of confiscating the assets, which the Europeans and others, in my opinion, rightly raise a lot of concerns about— what that would mean for rule of law, what that would mean for the global role of the euro— what if we use the interest being earned on those assets, which didn't touch as many legal and geopolitical and financial red lines as confiscating the base assets would?

Lipsky: So, originally, about seven months ago, the G7 agreed to use one year of interest on the assets. These assets are, by the way, parked in the ECB, in overnight lending. That's how they're earning interest. So, they're doing okay, and they're getting a good amount of interest off the $220 [billion] base, $4 to $5 billion, potentially, annually. And that was the first agreement, to get one year. But $4 to $5 billion was only meeting a small fraction of Ukraine's financing needs. Enter the new idea. Pull forward 20 years of future interest earnings. Now, we're talking about close to $50 billion, and give it to Ukraine. Now, there's all kinds of financial complexities around this. Who backstops it? Who's actually distributing the money? Who gets paid back if there's a negotiated peace settlement here and the assets are unblocked? So, a lot of questions raised here, but this is the idea. I think that it's incredibly creative, and it looks like it's going to bring Ukraine $50 billion by the end of this year, which is over half of their budget expenditures in 2023. So, [it’s] a significant amount of money.

Beckworth: So, you bring up the issue of the legal precedents that one would create from just seizing, confiscating, and distributing the assets. So, help me understand this. You're the lawyer here. I'm this American who says, "Go ahead. Take it. Seize it."

Lipsky: Yes, which a lot of people say.

Beckworth: The Russians are the bad guys, right? They're the bad guys. They're at war. Did we care about the Nazis in Germany?

Lipsky: Larry Summers, Bob Zoellick, Phil Zelikow, they all said the same.

Beckworth: Yes. It's good to have thoughtful, careful, cautious people like you to rein in the cowboys here on the policy frontier. So, walk us through why it was important to be delicate with that issue.

The Delicacy of Legal Precedents and the REPO Act

Lipsky: Okay, well, this is my perspective. First of all, we all want the same thing, those of us debating this. We want to give Ukraine the money it needs, one, to fight the war, and two, to rebuild its country. So, I think it's just important to start from that framework. The question is how to do it. And so, there are those who say, "Just take the assets and give them to Ukraine." There are others, and I count myself among them, who say, "Wait a second, we are not in direct military conflict with Russia. Under international law and under our own law in the United States, before the REPO Act was passed, we don't actually have the legal authority to confiscate these assets."

Lipsky: Now, the REPO Act did change that, or at least gave the administration authority for the assets held in the United States. So, that overcame the US legal hurdle to it. But there's a broader geopolitical hurdle. I was in India a few months ago. If you talk to countries and how they have reacted to the G7 sanctions, and think about the difference between blocking and confiscating, it is significant. I know that there are many people who say, "What's the difference? You've already blocked them. Seizing them is no different." I think that the rest of the world will take a much different signal if we were to seize those assets.

Lipsky: They would say, "The dollar is no longer a safe harbor. The euro is no longer a safe harbor.” And it would accelerate— and we can talk about this when we get into the alternative payment conversation— their research and their ability and their interest in working around the Western-based international financial system. So, if there was a way to get Ukraine the money it needed without triggering all of those repercussions, that, to me, seemed like the right avenue to go down. And I think that's where we've gotten to here, with the plan, the $50 billion plan, which, by the way, doesn't preclude seizing the assets down the road. You're taking the future interest. The assets are still there.

Beckworth: Okay, so, we want to preserve institutions, and, also, I'm guessing, the recovery, after the war, once it's over. Given that we're not in direct conflict, it's just a quicker, smoother environment for international countries in order to keep the system intact as long as possible.

Lipsky: I do agree with that. I do think it's important to keep the assets as leverage, in negotiation. It's something Russia wants back, so I think it's an important element to have out there when you negotiate. I also think it's one thing to say, "Let's confiscate the assets and give it to Ukraine." I am the believer that— let's say that the Europeans, tomorrow, agreed to that. It would be incredibly complicated to actually liquidate those from Euroclear [and] get them to Ukraine. So, if the goal is to get Ukraine money fast, I think we needed to come up with alternatives, and that's what, I believe, we've actually done here.

Beckworth: Okay. Well, it's good to have people like you in D.C., holding the reins, keeping us American cowboys in check.

Lipsky: No, there's a good debate. Everyone comes at it with good faith. We have debates at the Atlantic Council, with colleagues here, and I understand where the confiscation argument comes from. So, I think that we found a good solution for now, but this debate is not over, I think, is the bottom line.

Beckworth: Sure, sure. Okay, fair enough. Let's touch briefly on the REPO Act that we've mentioned already. Tell us about that.

Lipsky: Yes. Well, the REPO Act was basically-- It's been misinterpreted a little as, now, the US will seize the assets that they have, which are not a huge amount, I think, maybe 7% total of Russia's foreign exchange reserves that are in dollars held at the New York Fed. It just gives the administration the ability to do it, and I think that's what's important to say. And the purpose of the REPO Act, therefore, was to tell the Europeans, "We could now do this if we want,” but Treasury was very clear, even [with] passage of the REPO Act, that they didn't want to do this unless it was coordinated across the G7. So, I think that the REPO Act served an important usefulness when it came to the US going back to the G7, and saying, "Let's come up with a solution, so we don't have to pull this lever Congress has now given us." That's how I think about the REPO Act.

Beckworth: Okay, so, that's Ukraine, and we want to move, maybe, onto a more general discussion of financial statecraft. But before we do, I'm just going to throw this out there. Something that I think about, at least, is the amount of money we have sent, the US has sent, I should say. I think it totals $175 billion, and in my view, again, maybe I sound like a hawk here, but to me, that is money well spent. I had Brian Riedl on the podcast, and he's a big budget guy, typically works with Republicans.

Beckworth: He made the case that, look, if that $175 billion— it was a little less when he came on the show— but that $100 plus billion is maybe the best spent part of the defense budget we have over the next 10 years if it really undermines Putin's ability to create havoc in the world, but I'll leave it at that. I do want to say, though, that there is a reasonable argument to be made for the money that was spent funding Ukraine. So, let's move to financial statecraft, and my understanding is that what some call the weaponization of sanctions— which, there's more to it than that, I understand, but that seems to be the hot topic. That really took off after 9/11. Is that right?

Breaking Down the Tools of Financial Statecraft

Lipsky: Yes. You're right, and I think that one way to think about financial statecraft and economic statecraft is the evolution of these tools over the last 20-plus years. So, you're right. Starting at 9/11 is a good point. Of course, sanctions preexisted 9/11. We've just been in Cuba for 60 years-plus now. It's not a new tool, but [it has] certainly accelerated post 9/11, with the creation of Terrorism and Financial Intelligence inside Treasury right after September 11th. The whole idea with sanctions after 9/11 was to complement what was going on in the military space.

Lipsky: So, we were going after Al-Qaeda, we were going after them militarily, and we wanted, at the same time, understandably, to choke off the financial flows. And that's where a lot of the new sanctions tools and the financial sanctions we see got developed. Now, fast forward 10 years to the Iran negotiations. Sanctions are used in a different way there. Sanctions are used to put pressure on Iran to come to the negotiating table, but military force from the US is not ruled out. That's in the background as a potential issue if we do not reach a resolution on the nuclear development, and that brought Iran to the negotiating table.

Lipsky: We can have a separate debate on whether it was a good agreement or not a good agreement, the JCPOA, but sanctions played a role there, but military threat, use of force, was in the background. Now, go to 2022, Russia-Ukraine. Direct military engagement from the US is off the table, explicitly. The administration's been clear about that, and financial sanctions and economic statecraft become the leading tool of the response. So, just think about that evolution. From 9/11, the complementary tool to military, Iran, the sort of side-by-side, you have the threat, but you're using sanctions. Now, to Russia, we're going heavy on the financial statecraft— de-SWIFTing, export controls, freezing, blocking the foreign exchange reserves— but we're not using direct military force, and I think that helps give you a sense of what's happened to these tools and how they've evolved over the last two decades.

Beckworth: Do you think that's a good development? On one hand, it seems great that we're not actually engaging in physical violent hacks.

Lipsky: Of course.

Beckworth: On the other hand, some say that we're maybe using these tools too much. Where do you think the answer lies?

Lipsky: I do think it's fair to say that there's an over-reliance on the tools, because if you do not have to risk American blood directly, and then you go to these tools, and they seem very useful— but, again, as I said at the beginning, they can't achieve everything they're sometimes asked to achieve, and they have to be used in complement with other tools of American foreign policy, American national security, and that's sometimes lost. We think that the tools can do more than they can, and so, they are useful, they are effective, but they cannot do it alone, and I think that's the lesson we're learning.

Beckworth: Alright, let's look forward to a possible conflict with China. What do you think would happen, then, with the use of financial statecraft?

Applying Financial Statecraft to a Possible China Conflict

Lipsky: Well, we've done a study on this. We'll share it with your listeners. We modeled out what would happen if we were in a crisis in the Taiwan Strait, and we're talking about short of direct full military engagement. So, this is not the People's Liberation Army directly taking Taiwan, but some sort of gray zone activity, escalation, blockade, quarantine, and the G7 decides that we don't want to respond militarily yet, but we want some financial sanctions/statecraft response. In that scenario, I think it's important for everyone to understand that the immediate market reactions, before the sanctions are even implemented, could be extraordinarily dramatic. You could see a 10%, 15% drawdown in global markets within a 48-hour period.

Beckworth: Wow.

Lipsky: Because remember, people don't know how bad this is going to get. They don't understand. Are the Chinese taking Taiwan? Will the US respond militarily? So, in the uncertainty of that moment, just the strain on the global economy, liquidity, banks, you can imagine the ripple effects of the dominoes of what could happen in a short period. Then, the question is, would the G7 respond in sanctions? And we estimated that they would, and I'll just put some numbers out there to think about. If we were to sanction the big four commercial banks in China— and I'm not talking [about] the PBOC, I'm talking [about] the big four, so not the central bank— It would put, at risk, in the global economy, immediately, about $3 trillion. That's the size of the UK's entire economy, okay?

Beckworth: It’s huge. Yes.

Lipsky: So, just to put that in perspective, what we're talking about, in terms of numbers. Then, you say to yourself, "Well, if the markets are already reacting one way, are we really going to do that? Are we really going to, basically, send the global economy into a depression or worse?" So, you move on to individual sanctions. We're going to sanction party members. We're going to sanction military leaders. We're going to sanction their families. And I think that we would do that, but that's not going to serve any deterrent effect. That would be priced in from the beginning, as soon as they started escalating.

Lipsky: The third dimension to consider, and, I think, the most likely to pursue, are export controls. Are there targeted sectors of the Chinese economy where there's asymmetric vulnerabilities? Meaning, they are overly reliant on the West for inputs, but we are not overly reliant on them. There, you can look at aerospace and civil aviation and engines and how Chinese aircraft work, where they really rely on Western imports— Boeing and Rolls-Royce, et cetera— where I think it's far more likely we'd pursue that kind of route, and let's all hope we never get to that situation. I think that's important to say, but it's far more likely that we'd get there, which would have an impact on everyone, economically, but far less than financial sanctions to the banks. So, that's a little bit of how I think and how our study broke down the potential sanctions impact in a Taiwan crisis.

Beckworth: Okay, we'll provide a link to that in our show notes for the listeners, but this challenge that you bring up in these various scenarios, that it would be difficult to apply these sanctions, really, in force, like we did against Russia, just because of the interconnectedness of the Chinese and US economy— I guess, China and the global economy— It really speaks to the arguments that have been made in the past for globalization, for, why is trade good? One argument is that, well, the more interconnected you are, the harder it is to fight each other without harming oneself. And I think this really speaks to that. It's very costly to go to war with a country that you're so closely integrated with. We run big current account deficits, they run big current account surpluses.

Lipsky: Yes. That's right.

Beckworth: Just breaking that link would be so incredibly painful for both parties.

Lipsky: Agreed.

Beckworth: It's interesting to hear your analysis underscore that point.

Lipsky: Yes, and we did the analysis just to put numbers around a conversation that we heard was happening in Washington. People said, "Oh, we'd sanction China, Taiwan crisis." So, my mind immediately, David, went to, "Well, do we know what that means? Let's put some numbers around it to have a debate." You could argue about our methodology, and there's a lot of gray area here, but one thing that I think was effective vis-à-vis Russia was the unity between the G7, specifically the US and Europe. It's not clear to me that you would have that kind of unity if we came to a crisis in the Taiwan Strait, and that's a very different calculation for the Europeans than is Russia. So, I think that's important to think about in this situation.

Beckworth: That's a great point. We may not have the unity, the multilateral effort that we now have against Russia. I wonder, on the other hand, though, did China look at the unified effort and say, "Oh my goodness, we should think twice before trying to take Taiwan"?

Lipsky: Well, I don't know. It's a good question. I think, certainly, Putin did not believe that the US and Europe would be as aligned as they've been on sanctions, which, again, as I said, is why he diversified into euros, in my opinion, from 2014 to 2022. What Xi thinks watching it, I don't know, but my guess is that they do not think that the Europeans and the Americans would be as aligned when it came to China as they are with Europe, because Europe is existential. Russia's invasion of Ukraine is existential to the Europeans, where Taiwan may not feel that way, but I think it may have given them pause, because if they didn't think it would happen with Russia, you can't know for sure what would happen in a crisis scenario.

Beckworth: Well, as you said, let's hope we don't come to this place where we have to actually consider these questions in reality. Let's hope this is just an exercise in speculation.

Lipsky: I always say that it's important to say that about this study. This is not a study about how to sanction China, or a study that says you can't sanction China. It's just trying to understand that if we were to get to that place, we have to know what we're talking about, because you cannot do things ad hoc with the second largest economy in the world, like we did with Russia.

Beckworth: Right. Well, maybe we can take some comfort from Xi Jinping's recent statement that the US is forcing China into conflict. It almost signaled that he doesn't want to get pushed into some kind of costly engagement with the US. Alright, let’s transition to cross-border payments. We've talked about financial statecraft and the tools, and closely related to that is cross-border payments. In fact, we've been touching on this quite a bit. And you had a recent op-ed with, I believe, one of your colleagues, and the title of the op-ed is, *The Geopolitical Imperative to Upgrade the Dollar.* So, we need to upgrade the dollar. And I want to read just a few parts from your intro, then let you run with this. But you say, "The ongoing debate about the health of the dollar is often framed in binary terms. Either its status as a global reserve currency is rapidly eroding, owing to geopolitics and the US fiscal pressures, or it remains the unrivaled dominant currency with no competition in sight. The reality is much more complicated." Okay, so why is it much more complicated than those two binary outcomes?

Cross-border Payments and the Global Status of the US Dollar

Lipsky: Well, here, we come back to where we started, David, the difference between how national security professionals and macroeconomists think about issues. So, a macroeconomist will look at indicators of dollar strength; foreign exchange reserve holdings, trade invoices, currency settlements. We look at this in our dollar dominance monitor, and they will say, "You know what, the dollar is healthy. We don't see any significant changes over the past few years. We see it as the dominant currency. There's nothing that rivals it in terms of the currency that other countries want to hold. 80% of all cross-border payments touch dollars. So, there's no issue here."

Lipsky: Now, a national security professional will look at the dollar and say, "Hold on a second. Countries are building alternative financial plumbing around the dollar." And this is what we study at the GeoEconomics Center. That might not erode your macroeconomist view of the dollar, but it erodes my ability, as a national security professional, to implement sanctions. And so, here is really a distinction where we talk past each other in Washington. The dollar can be both healthy and weak at the same time, and what I think is happening is that we're looking at the wrong indicators.

Lipsky: We are looking at what I believe are lagging indicators, and that's what I just listed, the trade invoicing and the currency settlement, versus what I believe, now, are leading indicators, and that's the alternative financial plumbing; these pipes that are getting built between commercial banks around the world, that don't need dollars to settle. And once the water turns on in those pipes— that's the money— then, the lagging indicators might start to shift. So, we try to pay a lot of attention to the leading indicators and say, "We, in the US, need to pay attention to these upgrades that are happening in financial payments and settlement."

Beckworth: So, you list, as an example, the Chinese Cross-border Interbank Payment System. It's relatively new, right? It's not--

Lipsky: It’s about ten years old, nine years old, yes.

Beckworth: Okay, so, it's being built up is what your point is, right? And, I guess, to put some context, how big is it? Where are we on its journey?

Lipsky: Yes, it's a good question. So, it's about 8% or 9% of the banks that are in SWIFT, right? So, if you have 11,000 banks in SWIFT, you're only a little over 1,000 here in CIPS. On the other hand, it's doubled in size in the past two years. So, you can look at it in terms of its relative growth, or you can look at it [in terms of] macro, compared to SWIFT. But the thing that CIPS does, the Chinese Interbank Payment System, is that it's settlement and messaging combined, and that's different than SWIFT, which is only messaging. In our system, in the system that most banks around the world use, you message in one platform, SWIFT, and you settle in another, usually CHIPS, [which is] US based. CIPS combines both.

Lipsky: Now, does anyone believe that if we were building a system from scratch in the West, that we wouldn't build a system that combined both? SWIFT is 50 years old, and at the time, that technology made sense, to separate out the messaging and settlement. It doesn't make sense anymore. China has built a system that actually makes a lot more sense and provides some efficiencies. Now, the question is, if you're a bank that's on CIPS, say in Bangladesh or in Thailand, and you're doing business with China, you want to be on both. You want to be connected to CIPS, and you want to be connected to SWIFT.

Lipsky: And a lot of the CIPS transactions still need SWIFT, because CIPS has such a limited banking network. When those banks want to reach other banks, they still have to connect through SWIFT, but the important thing about CIPS is that the Chinese are spending a lot of money, they're investing a lot of time, they're building out the network, countries want to be part of it, and none of it touches dollars in the Western financial system.

Beckworth: That's interesting. You talk about that, having one system, both the communication and the actual transfer of the funds, where we have two, SWIFT and CHIPS. And it's kind of like the apps that they have in China, right? I understand that these apps are like one-stop shopping, everything [is] on that. Now, of course, there's also concerns, because the state can track you on those apps. But those apps are— when they came out, they were light years ahead of what we had in the US, in terms of personal banking, payment, connection to social media, all in one. So, we have a [slew] of previous guests on that topic, but it's interesting that the Chinese are doing this in this other area, too, this international payment system.

Lipsky: Yes, and one way to think about this, David, is that de-dollarization, or wanting to work around the dollar, is nothing new. It's existed for as long as the dollar has been the world's reserve currency, but I think that financial technology is finally catching up with the demand, and that's what's different than, say, five years ago, if we were having this conversation. There are new tools, fintech tools, that allow countries to work around the dollar cheaper than it would have been for them in the past. It doesn't mean there's not huge hurdles to overcome. Liquidity is one of them, right? The renminbi is not going to provide what you need in a cross-border commercial banking environment. So, I don't mean to say that any of this is happening overnight, but the interest is there, and the technology is developing rapidly.

Beckworth: Okay, so, the absolute level of CIPS is low, but its growth rate is just really rapid, and that's the concern.

Lipsky: Yes. That's right, and CIPS is not the only program. We can talk about the others, but it's one of the most significant.

Beckworth: So, you also talk about other projects being developed, beyond CIPS. You've talked about Project mBridge, China, Hong Kong, Thailand, UAE, Saudi Arabia, and work that goes along with the BIS. Maybe talk about those developments, too.

Breaking Down the Development and Geopolitical Importance of mBridge

Lipsky: Yes. mBridge is a very significant project, and it's worth spending a minute on it. So, what is mBridge? First of all, the Bank for International Settlements runs a series of central bank digital currency projects, both retail, how you and I would buy a cup of coffee with a central bank digital currency, and wholesale, which is what mBridge is, which is how commercial banks transfer money to each other. When we say wholesale central bank digital currency, all we're really saying is that using distributed ledger— using advanced technology to settle cross-border compared to the way we do it, which can rapidly speed up settlement times.

Lipsky: They can settle cross-border between these banks within a matter of minutes, as opposed to days. A lot of cross-border bank settlements can take T+1, as we say in this industry, so, a day or two days. So, it can rapidly reduce settlement times, and it can make these transactions across border, and importantly, they don't need the dollar. Because if you don't have the settlement lag time, and you're not worried about the stability of the transaction and the transaction settling, [then] suddenly, maybe, your need for dollars is lessened. There's still liquidity issues, which we can talk about, [but] mBridge is the most significant and advanced of these wholesale central bank digital currency projects.

Lipsky: It's founding members [are] the People's Bank of China, Hong Kong Monetary Authority, Thailand, UAE, and just two weeks ago, as you said, Saudi Arabia joined. And that got some attention back in the US, because here, you have the world's largest commodity exporter, oil exporter, now joining a cross-border payment platform with China, and you can easily see how this could help fulfill some rhetoric that's been [going on] in the past few years, about invoicing oil exports, for example, in renminbi instead of dollars. And so, this is why mBridge has gotten attention. Could it be a platform to accelerate ambitions to do cross-border settlement outside the dollar?

Beckworth: So, would mBridge compete with CIPS? It seems like they're doing similar things. I know they're different, but would they be different markets or the same market?

Lipsky: mBridge is just in the pilot phase, and CIPS is nine years on, and so, you can certainly see a world where what mBridge is doing is not dissimilar from what CIPS is doing, but I think that the Chinese are far from having to confront that challenge, because they're just starting to onboard other countries and other commercial banks. But I do think that because of the reach of mBridge, and the technology behind mBridge, it's one of these advances that could become the platform that everyone gravitates to, and maybe a CIPS network gets transferred into it.

Lipsky: There's all kinds of challenges that would be thought about, but I don't think that they're immediate concerns. But just to put the scale of interest on this for your listeners, in the People's Bank of China, 300 people are dedicated to work on digital currency issues. So, this is larger than the staff of most central banks. So, I think it just gives you a sense of where they think the future is [and] where they're investing resources. We do not put any of that kind of interest and money and resources into these issues in the US. We have a perception, in the US, that things are basically fine. The dollar's fine, the cross-border payment mechanisms are fine. Everyone uses them. We don't have to worry about these potential rivals coming. I, personally, think that that's not the right posture, but we think about it a little differently right now.

Beckworth: So, going back to mBridge, what technology is it using? Some kind of distributed ledger, tokenization? 

Lipsky: Yes. It's tokenization, it's distributed ledger. It's settled on this platform where basically all of the parties can see the transactions at the same time. So, that's why it's called a central bank digital currency. It's important to understand [that] commercial banks have master accounts, just like we do here in the US, with their central bank. They send the money cross-border. All we're really talking about in CBDC is a faster way to do it, because of the use of distributed ledger technology. That's very different than a retail CBDC conversation, which is a direct liability of the central bank, like paper cash. So, I think that wholesale and CBDC deserve separate channels of debate and conversation.

Beckworth: Yes, so, you bring up a good topic that's been brought up on the show many times before, and I think that there are fears and concerns, probably more about retail CBDCs [and] privacy issues. Can we really trust Uncle Sam, even though they have good intentions at some point? There's Operation Choke Point. Look at those Canadian truckers whose bank accounts were frozen. There is this concern, if we go down that path, but what you're suggesting, if I understand you correctly, is this wholesale angle. Merely a cross-border payment advantage, or innovation, to further enhance dollar dominance.

The Future and Importance of Wholesale CBDC in the US

Lipsky: Yes. Put aside the retail debate and the privacy debate, which is a legitimate one to have. There are no privacy concerns in wholesale CBDC. The commercial banks are already working with the Fed through master accounts, as are commercial banks and their central banks in every country. All we're talking about is a faster way to settle that transaction. But the word CBDC has gotten so tied up in the privacy debate that sometimes people say wholesale CBDC. So, I just think it's— from a dollar dominance [perspective], from an international payments [perspective], we need to think a lot about wholesale and cross-border settlement. It's incredibly important.

Lipsky: And to the Fed's credit, they are now engaged in their own project called Project Agorá, with the European Central Bank, the Bank of England, the Bank of Japan, and a few others. And I think this is the right way to go, because if the dollar, the euro, the pound, and the yen coordinate, I don't think there's any country in the world that can afford to be outside that system, but we can't just sit back on our current technology. We have to be willing to innovate.

Beckworth: So, help me understand how wholesale CBDC for the Fed would be different than from what it has with reserves. Reserves are already digital, right? People have Fed master accounts, even other central banks have Fed master accounts, right?

Lipsky: Yes.

Beckworth: So, I guess, help me understand, how would this be a step forward, or any different than what we already have?

Lipsky: It's the tokenization of the reserves. And so, therefore, it potentially allows for faster settlement cross-border and some efficiencies and different ways that other banks could participate. But it doesn't change the relationship between commercial banks and their master accounts with the Fed. I just think of it as a technological upgrade to the existing relationship, which is why it's different than a retail CBDC.

Beckworth: So, since you are a national security guy, as well as a finance expert, are there any concerns that if the US did go to this wholesale CBDC approach— that's on the distributed ledger, that's tokenized— that it would make it harder to implement its financial sanctions?

Lipsky: I think that the risk is inaction, meaning that there's more risk if we don't do anything. These alternative systems, where the Fed is not involved, get built up, they become pretty efficient, more countries use them, and even if they don't displace the dollar as the world's reserve currency— which I don't think is happening anytime soon— those systems could still be used to do illicit finance, to do activities that those countries don't want OFAC and Treasury to know about. So, from my [perspective], I don't see a risk of sanctions if the Fed gets involved. I think that would help, because if the Fed is involved, then the US and the US banking system is involved, and that helps make sure that sanctions can continue to be effective. If we aren't involved, I do worry about what grows up in the absence of US leadership.

Beckworth: So, you think that, to maintain our current ability to impose these primary and secondary sanctions on banks and actors around the world, we need to proceed with wholesale CBDC and other distributed ledger, tokenized approaches to cross-border payments?

Lipsky: The way I would say it is that, to maintain US leadership in the international financial system, to maintain the way that we use the dollar to advance national security goals, the Fed has to work with other G7 central banks— the European Central Bank, the Bank of England, et cetera— to ensure that all of our cross-border payments mechanisms use the most advanced technology available, and bring other countries into that network.

Beckworth: Okay, so, when the BIS talks about CBDC, it's also thinking primarily in terms of wholesale CBDC, not retail, correct?

Lipsky: It does both. The BIS does both. They do a lot of retail projects. One way to think about the BIS is that they're responsive to the demands of their members, which are about 50 central banks around the world. There are some central banks who want to work with the BIS on retail, some that want to work on wholesale, some that want to work on both. You can see all of it. We have a CBDC tracker, so you can track all of the different projects there, but the BIS does both.

Beckworth: Yes. I guess the issue I see with this approach is that CBDC, the term, has been so tainted, politically, at least in the US, that maybe having a different word for wholesale CBDC might be useful.

Lipsky: Yes. I'm all for that, by the way. I know that the terminology doesn't matter. I just want to get to the right end goal here, if that's what helps everyone. I do think that it was probably a mistake, years ago, to lump these two together, because they are very different, as we talked about.

Beckworth: Right, and I understand people who call for retail CBDC, Fed accounts. Morgan Ricks is a friend of the show. He's a big advocate of Fed accounts. But I also understand the concerns of privacy and all of those issues as well. I just think the reality on the ground is that Republicans in Congress— and after our most recent presidential debate, a Republican in the White House— it seems like CBDC might be dead on arrival, if that's how you frame it, but maybe there's another way to package this. In any event, let's move from wholesale CBDCs to private sector attempts. Are there crossovers? Are they distinct efforts, when you think of things like Bitcoin or other private attempts to create distributed ledger efforts?

Private Sector Alternatives to CBDCs

Lipsky: I think that the most relevant one to talk about is probably dollar-backed stablecoins. Because if you're thinking of CBDC, a digital version of a dollar, a lot of companies would say, "Well, we already have one. It's a dollar-backed stablecoin." And I think that 98% or 99% of pegged stablecoins, those that are anchored to fiat, are pegged to the dollar. And so, the question is, is that a digital dollar? And we could debate that, if it is or isn't. If you can redeem it at one-to-one, it has a certain attractiveness around the world.

Lipsky: Tim Massad, who was former chair of the CFTC, wrote a great paper on this, basically comparing dollar-backed stablecoins to the rise of Eurodollars, post-World War II, in the '50s and '60s. I mean, it’s basically a creation of dollars outside of the Fed's purview, which is one way to think about the rise of dollar-backed stablecoins all over the world. Now, I think what we have to be wary of, and what a lot of countries are concerned about, is what they would call digital dollarization of their economies.

Lipsky: Dollarization is nothing new in emerging markets— [it’s] a long-term phenomenon— but this digital dollarization, the access to dollar-backed stablecoins, potentially accelerate, because you can imagine, in a range of countries, how citizens would flock to that kind of asset, even outside of a financial crisis in that country, let alone during a financial crisis. So, I think that dollar-backed stablecoins are probably the best asset to think about, in the private sector space, competing with CBDCs.

Beckworth: Okay, so, where do you see this conversation going? [When] we get past the election, do you see the US moving forward, whether being pushed or pulled, or is there interest, momentum to move forward on this topic?

Where is the CBDC Conversation Headed?

Lipsky: Here's where I think we're going after the election. One way or the other, the dollar and the dollar-based infrastructure has to be upgraded. It should start with SWIFT, in my opinion. SWIFT has already put forward plans, internally, to upgrade their systems. The G10 central banks, so the G7 plus Switzerland and a few others, oversee SWIFT. They should support those plans, and I do think that you're going to see a lot of energy behind that after the election. Let's upgrade this infrastructure that exists, and use the best technology available, so we make sure that the Western-based payment systems are fit for purpose in the future.

Lipsky: Then, I think you're going to see more effort, on the US side, on wholesale CBDC. I think that most folks at the Fed understand that this cross-border payment issue is important. We're not going to, probably, do as much, no matter what, on the retail side. I think that's pretty clear. But we should recognize that the Europeans are about to roll out a digital euro. That's a retail CBDC in the Eurozone. The Bank of England has said that they're going to have one by the end of the decade, as has the Bank of Japan. So, we could easily live in a world, in 2030, where there's a digital euro, a digital yen, a digital pound, and not a Fed digital dollar. Now, we may be fine with that, but I think that's where we're headed, at least in the near term.

Beckworth: You also mention FedNow, which is a real-time payment system that the Fed established recently. Of course, the banks have their own version of the real-time payment system that they set up as well. [There’s an] interesting history there, [of] how those two things emerged together.

Lipsky: Yes, that's right.

Beckworth: And I've had some guests on who say that, because there's two of them and because you need economies of scale to make these things cost-efficient, that they may end up both being not as good as they otherwise would be if there were just one real-time payment system in the US. But do you see a role for one of these systems, maybe both of these systems, to play in this future world?

Lipsky: Yes. FedNow will play a role going forward. The Fed's invested in it. I think that both of the systems are going to run in parallel, at least in the near term. And anything that happens with wholesale CBDC is really primarily conceived of now in the international space, where FedNow is in the domestic space. So, it's important to say that both can exist together. I do think, though, that technology moves very quickly in payments. The Fed has been involved in payments technology, working with the private sector, since its founding. You can go back to the 1920s and 1930s, and check settlement, and all of the history of the Fed, and their involvement with that.

Lipsky: But there's a risk of us being overly invested in what I call “Blu-ray technology, while DVD is being developed.” Meaning that it moves so fast, that if you spend five years building the FedNow system, but the rest of the world is building distributed ledger payment systems, you've got to make sure that you're putting your money in the best technology. And I think that's a risk, because we move slowly in the US. Obviously, we need appropriation from Congress, but we can't be behind the curve on these financial innovations. I think that's the main thing that I'm trying to convey, and the rest of the world is moving very quickly, and I'm not sure that we always appreciate that back here in the US.

Beckworth: Yes. Well, this, again, takes me back to the role that the private sector may play. Maybe if the government has a hard time staying up to the edge of the frontier of cutting technology, maybe stablecoins [will] lead the way, [and] incentivize the Fed to follow. I don't know. Think of Custodia's case right now, against the Fed, in obtaining a master account. Let's say they do get one, and they do innovate, and maybe [get] some stablecoin— I don't know where the story goes, but you could see some path forward where the Fed works hand-in-hand with some of these private firms.

Lipsky: You can, and I think what's really important here is just that the Fed sends a signal that this is a priority. It doesn't mean that they have to do it all, but I think that the private sector would key off that. If Chair Powell or other senior leaders at the Fed said, "We think that cross-border payments are critical. We think that improving domestic payments infrastructure is critical. There's a range of technologies and options to do it, but this will help maintain the dollar as the world's reserve currency." I think you'd see a galvanizing effect across commercial banks to say, "We need to invest in this." Many are, but many more would. You also need regulatory clarity, right? Stablecoins are a great example of that. We have no legislation passed on stablecoins— not likely to get any in this Congress, maybe in the next one— and that is not just for our benefit, domestically, but to the rest of the world, that, as we talked about, is asking questions about our dollar-backed stablecoins and what it means for their economy. 

Beckworth: So, Josh, we are actually getting near the, I believe, 80th anniversary of Bretton Woods, and I understand that your team is working on some projects surrounding that development.

Closing Thoughts: The 80th Anniversary of Bretton Woods and the Future of Dollar Dominance

Lipsky: Yes, we are. This is an important anniversary, I think. And as I talked about in the beginning, we've been reminded, in the US, of what geoeconomics means in the intersection of financial and national security and foreign policy. And that's what the creation of the IMF and the World Bank were really about, at their founding. And so, for July 1st, which is the marking of the opening of the Bretton Woods Conference, we'll bring together senior IMF, World Bank, US, and UK officials to talk about the history of the founding of the institutions. Then, later in the month, in Rio, on the sidelines of the G20 finance ministers meeting down there, we're going to do events marking the conclusion of the Bretton Woods Conference.

Lipsky: There, we're going to bring in a range of emerging market voices. I think it's really interesting that, in the last four years, Indonesia hosted the G20, then India hosted the G20, now Brazil, next year South Africa, and many people haven't focused on this yet, but guess who hosts after South Africa? [In] 2026, [it’s] the United States. And so, the G20 is coming back to the US after four major emerging markets have hosted it, and I think that we have to think, in the United States, what does multilateral international economic coordination mean in this new era? And that's the work that we're doing at the Atlantic Council, to help re-envision, re-imagine, [and] rejuvenate international economic coordination for the next 20 years of the Bretton Woods Institutions. So, if we get to the 100th anniversary, I think that they're going to look a lot different than they do today.

Beckworth: Yes. It sounds like you have a very fun and fascinating job there, working on these issues, hosting these events. I will mention that I recently visited the Bretton Woods Hotel in New Hampshire, and I was able to see some of the rooms. They still have them marked off, and they used to have, actually, I was told, on the doors of each of the hotel rooms, who stayed in each room, but those name tags got ripped off, and they were stolen, so they don't have them anymore, but a very interesting hotel. It's huge, filled with history. I really enjoyed my time there. I was at a conference.

Beckworth: Let's close, Josh, by just circling back to the issues we've been on, and that is the issue of dollar dominance going forward. Will we be able to maintain it? Of course, your argument, your concern is that we need to innovate [and] maintain a very cutting-edge, technology-driven frontier of dollar financial assets. So, you brought up a number of issues that we need to be mindful of, what's happening with CIPS and some of these other competing systems. What metrics should we be following to be aware of what's happening in this debate?

Lipsky: The real way to think about this is less about how countries hold foreign exchange reserves and how much are in dollars— which is how we're traditionally measuring this— versus how money is being settled. I think that this is really where the future is, and do we see any decrease in the dollar being used as a form of cross-border settlement? We don't yet, but if that starts to change, to me, this will raise some more alarm bells that the alternative financial plumbing is starting to have some effect. And I think that even if it doesn't change the big numbers— if it doesn't decrease by five percent— we need to understand not just the macro level, but if it's changing marginally, is it being changed because we think that illicit finance and sanctions evasion are happening through that? That's harder to track, but I think it's important that we look at both.

Beckworth: Okay. With that, our time is up. Our guest today has been Josh Lipsky. Josh, thank you so much for coming on the program.

Lipsky: Thanks so much for having me, David.