Such is the extent of the sanctions imposed on Russia for its invasion of the Ukraine, especially freezing its assets abroad, that more countries will in theory strive harder to avoid the US dollar. By Justin Pugsley.

What is happening?

Russia’s invasion of Ukraine on February 24, depending on who you believe, could be a pivotal date for the world’s monetary order — the one anchored around the US dollar. Should that order unravel, the consequences would be extremely serious for financial stability, inflation, global trade and prosperity. 

Reg rage anxiety

The status of reserve currencies depends heavily on trust. However, the extent of the West’s actions sent shockwaves through the financial community. 

The harshest was the freezing of the central bank of Russia’s assets held abroad, representing some 60% of its reserves. Other Russian entities, including Russian oligarchs closely associated with Russian president Vladimir Putin, suffered the same fate. 

It is now very difficult for Russian entities to spend even the G7 currencies they hold. And many firms are avoiding Russia for reputational reasons, even if they do not have to. 

Also, there is a high chance that once the war is over there will be bitter legal disputes over using those reserves to pay reparations to Ukraine and compensate foreign creditors.

This, some analysts say, has seriously damaged trust in the dollar, particularly among countries that have at best lukewarm relations with Washington. As the argument goes: the more you use sanctions, the less effective they become as alternatives are eventually found.  

In other words, the world could be accelerating towards a two-tier financial system with China, the world’s leading trading nation, eventually running a breakaway monetary system. It would likely be supported by Russia, the world’s top commodity producer, and no doubt some of the 70 Belt and Road Initiative countries too. It could resemble the old Soviet monetary order and how it interacted with its satellite states.  

Or, as has been rumoured for years, China might launch a gold-backed digital renminbi. The idea is that it would be better than a currency like the dollar that is constantly being debased via quantitative easing. 

Why is it happening? 

The West and its allies, long considered toothless and divided by their enemies, want to show beyond a shadow of a doubt that they will not tolerate certain behaviours. Indirectly, it is a warning shot across China’s bows, not to invade Taiwan for instance. The Ukraine war is basically a multidimensional geopolitical chess game. 

This is not a comfortable environment for global bankers. 

What do the bankers say? 

Bankers were stunned by the speed and comprehensiveness of the sanctions. Though they understand their purpose, they do not welcome this latest, potentially significant reversal in globalisation. It implies dreaded ‘bumpy’ playing fields and market fragmentation. Indeed, many policy ‘hawks’ in Washington would like to take down China next. 

Bankers are also on the front line of this economic war, be it tracking down and freezing assets of sanctioned entities or blocking transactions with them. 

Will it provide the incentives?  

The aim of the sanctions is to make the invasion of Ukraine ruinously expensive for Russia and, if necessary, to cripple its economy and banking system. On that front they’ll probably succeed. 

But there could be unintended consequences for the dollar and the West-centric payment systems such as Swift. 

China will no doubt look to speed up the digitisation of the renminbi, the development of its capital markets and to trade with other countries in its own currency. Already, around half of Sino–Russian trade is in renminbi and there are similar discussions afoot with India and Saudi Arabia. 

For the past 20 years, the US dollar has comprised nearly 80% of foreign exchange (FX) transactions, though its share of FX reserves has fallen over that period from 71% to 62%. A move away from using the dollar would see it fall in value; Treasury yields would rise and inflation will be truly unleashed. 

But it is way too soon to call time on the dollar. The sanctions against Russia are widely supported globally and, even if some trust has been lost in the dollar, what else is there? None of the alternatives tick all the boxes for a reserve currency and none looks likely to emerge soon. Some have cited bitcoin as a candidate — maybe one day, but for now it lacks most of the qualifications to be a reserve currency and is anyway far too volatile.

So, for all its faults, the dollar probably has at least a few more decades left in it as the world’s top reserve currency. 

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