The U.S. dollar is the world’s reserve currency. Being a “reserve currency” means that it is the top currency held in reserve by central banks around the world (a topic to be discussed later). Reserve status also means that the dollar is the dominant currency used in international transactions. As an American, you are likely already aware of this arrangement.
The dollar’s current state in 2026 is largely the result of two historic events – the Bretton Woods Conference in 1944 and the advent of the “petrodollar” in the 1970s. Bretton Woods marked the ascension of the dollar over the British pound as the world’s reserve currency. The advent of the petrodollar cemented the dollar as the primary currency used in international trade. Both of these topics will be handled separately in the future.
The focus of today’s article is to discuss some of the financial “plumbing” that makes transactions in the dollar possible. Why is this important? Part of the reason the dollar is currently the world’s reserve currency is because global finance is built around it, making its use the most cost-effective choice. On the other hand, the present system makes switching to another currency a more expensive choice. In other words, there is an inertia within the present financial system that works to keep the dollar as the world’s reserve currency.
Here we will discuss two institutions that are sources of that inertia.
International Transactions
The globalized nature of supply chains today means that large amounts of high-value transactions are international. By international, this means that the two companies doing the transaction are from two different countries and bank with individual banks within their respective countries. As hinted at above, perhaps no industry is a better example of these types of transactions than the oil industry.
Take the example of Saudi Aramco, based in Saudi Arabia, which sells a cargo of crude oil to the Indian refining company Reliance. When the oil cargo lands at Reliance’s refinery in India, Reliance will then begin the process of paying Aramco in dollars (this practice is known as the Petrodollar). The mechanics of the payment process can be broken down into 2 parts:
- The initial messaging between the respective banks
- The actual clearing of the wired payment
SWIFT
In the first step of the international payment process, Reliance’s bank will communicate to Aramco’s bank via the Society for Worldwide Interbank Financial Telecommunication – better known as SWIFT. SWIFT is a messaging network of financial institutions that was created in 1973 and is located in Brussels, Belgium. This communication is a coordinating set of messages that shares the necessary preliminary details of the payment to follow – amount to be paid, account numbers, etc. These messages pass between the two banks via the interconnected SWIFT network of correspondent financial institutions. It is important to note that SWIFT does not facilitate payments; rather, it only passes messages that precede the payment.
Now, you may wonder why an institution like SWIFT is needed to pass messages between banks. There are two reasons. First, SWIFT is a large, interconnected network of thousands of financial institutions. This enables any two banks that have access to the network to instantly communicate with each other through SWIFT in an automatic and secure fashion. While it may be difficult to appreciate, this results in enormous cost savings because of the amount of work that would otherwise be needed for transactions of this size.
The second advantage of SWIFT is that it enables banks that are not technically a part of the network to still be able to use SWIFT. This occurs via correspondent banks, which gives even more banks around the world access to the advantages of SWIFT.
Going back to the example transaction between Aramco and Reliance, the messaging flow is as follows:
- Reliance’s bank sends a message to Aramco’s bank via a SWIFT correspondent bank.
- That message goes through another correspondent bank to Saudi Aramco’s bank.
- Saudi Aramco’s bank communicates back, and the two banks come to an agreement.
Interestingly, you may remember back in 2022 when Russian banks were banned from using SWIFT. Why was this ban so significant at the time? The answer lies in the high costs involved to manually coordinate thousands of large oil transactions in a secure way. A fully laden cargo of crude oil could cost between $100-200 million, and ensuring that the payment is processed correctly and securely is very important to the business of the banks. This is the service that SWIFT provides. As a result, while it is true that banks could still communicate directly with each other to avoid SWIFT entirely, this is an enormous burden which is why exclusion from SWIFT matters.
U.S. Dollar Clearing via CHIPS
Once communications between the sending and receiving banks have been established, the second step in the payment process is to actually wire and clear the payment. As with the messaging step, payment clearing is also done through a network of correspondent banks.
Large dollar transactions of the type we are discussing here are ultimately cleared via the Clearing House Interbank Payments System (known as CHIPS) in New York City. As of this writing, there were 43 participant banks that were actual members of CHIPS. The participant banks consist either of U.S. banks or the U.S. branches of foreign banks. China, the UAE, Japan, and many other countries have banks that are members of CHIPS. In other words, you do not have to be a U.S. bank in order to be a member of CHIPS.
In this oil transaction example, it is very possible that neither Aramco nor Reliance hold an account with a CHIPS member bank directly. Instead, their respective banks likely hold an account with a CHIPS member.
Because CHIPS is a U.S. entity and is located in New York City, it is subject to all U.S. law including sanctions. Because of this, the U.S. government can apply sanctions limiting the conditions for use of CHIPS. It does this by prohibiting the correspondent banks from clearing transactions of sanctioned entities. This prohibition is then cascaded further down the chain. Because banks stand to lose too much business if they do not have access to CHIPS, the correspondent banks are the ones that end up physically policing the sanctioned entities.
Now, you may wonder how U.S. sanctions can be applied to SWIFT on a country like Russia. CHIPS is in New York, whereas SWIFT is located in Belgium and is not a U.S. entity. The answer is that SWIFT could resist the U.S. government but often chooses not to because of how much SWIFT messaging traffic deals with dollar transactions. Rather than face potential U.S. sanctions itself, SWIFT often goes along with the U.S. mandates as in the Russian case (and Iran).
An Interesting Aside on Offshore Dollar Clearing
There is one interesting nuance regarding dollar payment clearing. One of the key elements of the dollar is that it is widely held in banks around the world. This fact makes it possible to clear dollar transactions, like the oil deal above, outside of the United States. And, while most dollar transactions will still end up funneling through CHIPS, offshore liquidity in “Eurodollar” markets is one of the key elements of the dollar being the world’s reserve currency.
In Short
The dollar affords the United States a significant geopolitical advantage because of the control the U.S. government can exert over dollar transactions. Most large international transactions – such as oil trades – are first coordinated via the SWIFT messaging system and then cleared through CHIPS. Exclusion from either system (or both in the recent case of Russia) results in an enormous burden on the sanctioned entities which can effectively prevent it from transacting with the rest of the world.
U.S. adversaries have taken note of the tremendous advantage the U.S. enjoys from this arrangement. Unsurprisingly, as a result, both countries such as China and Russia and larger organizations such as BRICS are actively developing alternatives to the SWIFT/CHIPS setup. However, this has proven very difficult to do on account of how entrenched the dollar is in global finance.
Additional Resources
The Clearing House – CHIPS
https://www.theclearinghouse.org/payment-systems/CHIPS
Barry Eichengreen article in Center for Strategic Studies
https://www.csis.org/analysis/sanctions-swift-and-chinas-cross-border-interbank-payments-system
Federal Reserve Fedwire System
https://www.investopedia.com/terms/f/fedwire.asp
https://www.frbservices.org/financial-services/wires
SWIFT