American sanctions on Russia’s currency reserves could gradually prompt many countries to bypass the US currency.
On February 28, the United States and its European allies froze the assets of the Russian Central Bank following the Russian military intervention in Ukraine. Half of the Central Bank’s assets held in the form of foreign exchange reserves and gold (US $300 billion) have been blocked by the West.
By weaponizing the dollar to preserve its global economic and geopolitical position, the United States risks jeopardizing its greatest power: its control over the world’s reserve currency and capital market system. Zhang Yanling, former executive vice-president of Bank of China, said the sanctions would “cause the US to lose its credibility and undermine the dollar’s hegemony in the long run”.
The Russian response was not long in coming. A few weeks later, Vladimir Putin signed a decree stipulating that “unfriendly countries” will have to pay for Russian gas in rubles from April 1. This announcement caused the price of natural gas to rise and the ruble to strengthen against the dollar.
Ray Dalio, founder of the US $140bn US hedge fund Bridgewater Associates, believes that the conflict between Russia and the West is the first battle in the long war for control of the world order. According to him: “When this first round comes to an end, most people will probably misconstrue it as the end of the fight, but it will only be the beginning.”
The end of the US dollar has been predicted countless times and the inertia of a reserve currency that dominates international transactions should not be underestimated. So why should this time be any different?
In theory, a currency can be held in the form of debt or money and must fulfill two essential functions: a store of value and a medium of exchange.
In practice, the US dollar has ceased to be a store of value since its purchasing power began declining faster than its bond yield. And for countries that are not geopolitically aligned with Washington, the weaponization of the greenback prevents it from being a reliable medium of exchange.
Vyacheslav Volodin, speaker of the Russian Duma lower house of parliament, recently said: “Anyone who keeps money in dollars today can no longer be sure that the US will not steal their money.” Countries such as China, Russia, India and Saudi Arabia, are already reducing the share of dollars used in trade, financial transactions or central bank reserves.
Published in a recent note, Zoltan Pozsar, Former Federal Reserve and U.S. Treasury Department official stated “We are witnessing the birth of Bretton Woods III – a new world (monetary) order, centered around commodity-based currencies in the East, that will likely weaken the Eurodollar system and also contribute to inflationary forces in the West.”
“Demand for commodity reserves will be higher, which will naturally replace demand for FX reserves,” Mr Pozsar said. “Demand for dollars will be lower too, as more trade will be done in other currencies.”
This analysis is consistent with the new monetary paradigm presented last month by IMF’s first Deputy Managing Director, Gita Gopinath, according to which we could see the emergence in the coming years of small currency blocs based on trade between separate groups of countries.