May 17, 2018 / 2:50 PM / 3 months ago

REFILE-FACTBOX-Iran sanctions risk highlights dollar's hegemony in world markets

(Corrects spelling to linchpin in paragraph six)

By Tom Finn

LONDON, May 17 (Reuters) - From global finance and merchandise trade to investment, the dollar’s supremacy in the world economy is being underscored by the U.S. decision to reimpose sanctions on Iran and all those doing business with it.

President Donald Trump this month pulled out of a nuclear accord with Iran, sparking consternation among European companies which now risk punitive U.S. measures if they continue business dealings with Tehran..

Oil firm Total, insurer Allianz and shipping company Maersk are among European names signalling an exit from Iran.

European leaders are meeting in Bulgaria to try to salvage the Iran deal but many remain frank about the prospects for operating beyond the reach of U.S. law.

British foreign minister Boris Johnson, for instance, said governments had to be realistic about “the electrified rail, the live wire of American extra-territoriality and how (it) can serve as a deterrent to business”.

The linchpin of U.S. financial might is of course the dollar, which pervades nearly all aspects of global commerce.

“No company or bank is going to go deal with Iran knowing they will face U.S. sanctions,” said Peter Kinsella, head of FX and debt strategy at the Commonwealth Bank of Australia.

“The U.S. would cut off your dollar funding and that would be a nightmare as the U.S. has the deepest and more liquid currency,” he said.

The dollar has defied years of efforts by foreign governments to end their reliance on it. This is what may complicate international efforts to preserve Iranian business links.

Here are four of the key ways in which the dollar is used in the global economy:

CENTRAL BANK RESERVE HOLDINGS

Over 60 percent of the world’s $11 trillion currency reserves — used by governments to settle international claims and intervene in foreign exchange markets — are held in dollars.

The greenback’s share amounts to $6.3 trillion, the International Monetary Fund (IMF) said in March, with the euro, the next largest, totalling $1.6 trillion or 20 percent.

True, the dollar’s share was at a four-year low after a prolonged weak spell that bred concern about its standing as the premier reserve currency.

Yet years of hype about the Chinese yuan’s growing popularity among central banks has not translated into its share in global reserves amounting to much more than 1 percent, the IMF said.

Dollar reserves are held largely in U.S. Treasury bonds, and while data shows foreign creditors cooling on U.S. debt, big reserve managers in Beijing, Tokyo or Seoul have few viable alternatives to the immensely large and liquid $21 trillion Treasury market.

INTERNATIONAL PAYMENTS, INVOICING The dollar remains the dominant vehicle for foreign exchange transactions, being on one side of 88 percent of all trades in 2016, according to The Bank for International Settlements (BIS).

Contributing to its role in foreign exchange transactions is its widespread use in the invoicing of international trade.

In 2014, 51.9 percent of international trade by value and 49.4 percent of international trade by volume of transactions were invoiced in U.S. dollars, even when a U.S. counterparty was not part of the transaction, the BIS said.

European Union statistics office Eurostat said over half of all goods imports were invoiced in dollars in 2016, as was 85.5 percent of petroleum and petroleum products. The euro share was 13.7 percent.

As a result, BIS data shows that in 2016 the dollar comprised 90 percent of the $3 trillion-a-day market for FX swaps and forwards, derivatives used by companies to hedge currency risks.

“It’s very hard to escape the interaction with the U.S. financial sector,” said Claire Dissaux, head of global economics and strategy at Millennium Global Investments. “If you are a French carmaker you would have dealings with U.S. banks and dollar funding.”

In 2015, a U.S. court fined BNP Paribas $8.9 billion for moving money through the U.S. financial system for Sudanese, Iranian and Cuban entities subject to U.S. sanctions.

COMMODITY PRICING

Internationally traded commodities such as oil and gold are typically denominated in U.S. dollars, as are benchmark futures such as Brent crude oil. Analysts estimate over 80 percent of traded oil is priced in the greenback.

China, pushing to denominate imports in other currencies, has launched yuan crude futures which could eventually become a global price benchmark alongside Brent and WTI crude.

But a pre-requisite would be liberalising China’s capital account to allow free movement of money. Gulf oil producers peg their currencies to the dollar and would face foreign exchange risks by invoicing sales in other currencies.

CROSS BORDER INVESTMENTS

At the end of the second quarter of 2017, $13.950 trillion, or close to half, of all cross-border claims were denominated in U.S. dollars, Eurostat said.

The United States is the biggest recipient and source of foreign direct investment (FDI), with inflow and outflow of $391 billion and $300 billion respectively in 2016, United Nations data shows.

U.S.-based investors accounted for more than a quarter of flows to emerging market debt, 42 percent to emerging equities and a tenth of all FDI to the developing world, according to the Institute of International Finance. (Additional reporting and editing by Sujata Rao Editing by Catherine Evans)

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