For decades the dollar has dominated world markets to the point of becoming
what Wall Street Journal columnist, Andy Kessler, considers the backbone of the
Horizontal Empire of the capitalist US economy. However, Russia's invasion of Ukraine and the
resulting sanctions that Western democracies have imposed on Vladimir Putin's regime may
have opened a breach in the dollar's dominance: The United States, the United Kingdom and European
institutions have frozen a substantial portion of the $630 billion equivalent that make up the
reserves of the Central Bank of Russia. We are talking about hundreds of billions
of dollars that overnight have ceased to be controlled by Moscow.
("No one who predicted what sanctions the West might impose could have predicted this.
It was simply a robbery. Sergey Lavrov, Russian Foreign Minister)
And that is not all. Encouraged by the US federal government itself, companies such
as Visa, Mastercard, American Express and the financial services of companies like Google and
Apple have stopped operating in Russia. Washington has also banned several Russian
banks, including Sberbank, the country's largest bank, from operating with dollars.
The ultimate goal? To disconnect Russia from the global financial system as punishment for
the heinous storm of fire and destruction that this country has unleashed on Ukraine.
But, VisualPolitik fans, there might be a slight drawback:
("If you change the rules for Russia, you are changing the rules for the whole world.
Once these rules change, they change international finance forever." Mitt Gulati,
Professor of Financial Law at the University of Virginia)
The problem is that all these measures raise some questions:
Can countries like China be confident that they will not suffer the same fate? If so,
won't they take steps to become independent from the power of the dollar? Could this
pose a serious threat to the global dominance of Uncle Sam's currency?
Well, in this new video made in collaboration with our friends at Value School, we are going
to answer all these questions. So, let's get on with it.
(THE INFLUENCE OF THE DOLLAR) Since the Bretton Woods agreements
in July 1944, the dollar has been the world's reserve currency. In the 1960s,
former French President Valéry Giscard called it "the exorbitant privilege" of the United States.
The fundamental idea of Bretton Woods was that the dollar was pegged to gold
while all other currencies were pegged to the dollar itself.
A scenario that changed completely in 1971 when Richard Nixon abandoned the gold standard,
suspending completely and forever the convertibility of the US currency.
Despite this, the new virtual dollars have continued to form
the backbone of the modern banking system. A system that is no longer backed by any
precious metal but primarily by confidence in the US market economy, in the ability of the
US government to meet its commitments and the power of its formidable war machine.
This explains why the dollar is still by far the most widely used currency in international trade,
financial transactions and central bank reserves. In other words, with such a background,
who can dare to question the hegemony and solvency of the greenback?
Well, VisualPolitik community, this has basically been the prevailing thinking
over the last decades. And it also explains why almost 60% of the $12.8 trillion that make up
all the world's foreign exchange reserves are denominated precisely in dollars. Just look at it.
Without digging too deep, the People's Republic of China itself safeguards in its reserves more
than $1 trillion dollars in US government debt and, in total, its assets denominated in this
currency could be close to $2 trillion dollars. This makes it, by the way, the largest foreign
creditor of the United States of America. The importance of the dollar is so great
that evidence tells us that when countries deplete their dollar reserves, they face painful financial
collapses. This is precisely what happened to South Korea, Thailand and Russia itself
during the crisis of the late 1990s. But let's not get sidetracked.
The fact is that since 2014, both China and particularly
Russia have been trying to progressively reduce their exposure to the dollar. To date,
they have only partially succeeded in doing so. This is because the Chinese government considers
the dollar's current position as one of the bulwarks of US power,
so it has publicly confirmed that it intends to make the Yuan play a much
more important role in the global financial system in the long term.
Well, now the Russian invasion of Ukraine and the sanctions imposed against the Russian government,
especially in terms of freezing the country's foreign reserves, could accelerate these plans.
This, at least, is the risk that many experts and analysts have indicated. And indeed, at the
end of March 2022, the former executive vice president of the Bank of China, Zhang Yanling,
publicly advocated that China should support the rest of the world in getting rid of the dominance
of the dollar. While also being blunt about the consequences of the Ukraine war. Check it out.
("Sanctions will make the US lose its credibility and undermine the dollar's
long-term hegemony. Zhang Yanling) Because, of course, it's not just
about China. Many autocrats, tyrants and populist leaders around the world would
be delighted with this change of position. So the question is: Will Russia's expulsion
from the global financial system spell the beginning of the end of the dollar as the
international reserve currency? Will Russia and China agree to adopt the Yuan or pivot to
cryptocurrencies turning the sanctions against Russia into a kind of historic turning point?
Well, wait a minute, because things could be much more complicated
than we might think at first glance. (THE UNASSAILABLE STRENGTH OF THE DOLLAR)
Losing reserve currency status, even partially, would be a severe blow to the US economy.
In the worst-case scenario, the depreciation of the dollar, which would lead to a massive
sale of greenbacks, would cause inflation to soar to levels never before seen in the US.
The purchasing power of households and businesses would likely suffer a severe
correction and capital outflows could wreak havoc on their financial markets.
("Wars also challenge the dominance of currencies and support the emergence
of new monetary systems". Zoltan Pozsar, analyst at Credit Suisse)
But is this scenario really feasible? Well, the truth is that it seems unlikely,
almost impossible today. Why? Well, because we have to take into account the
three great advantages, the three great strengths that Uncle Sam's bills have.
Outside Europe, Japan and, above all, the United States, there are simply not enough
liquid financial assets to meet the enormous demand that would displace the dollar.
What’s more, virtually all countries with major international currencies, with the exception of
China, have supported sanctions against Russia, so we would basically be in the same boat.
And in the case of the Yuan, well, we have to take into account that China's
capital market is not an open market, that this currency does not have free convertibility and
that the degree of legal certainty is nowhere near equivalent to that of the United States.
So, for the time being, and at least in the near future: it is not a reserve currency.
Next, we have to keep in mind that investing in other minor currencies could entail significant
financial and also political risk. The case of Russia is a good example. Chinese owned rubles
saw their value depreciate by 40%, only to rebound later due to the imposition of
huge controls that limited the use of this currency.
And last but not least, what on earth can you do with these currencies? Of course,
their restrictions do not allow you to use them to buy assets and products all over the world. And
that is not going to change anytime soon. On the other hand, there is the matter of
cryptocurrencies, but today they do not seem anywhere near ready for this mission.
And governments such as the Chinese government are not exactly fond of
these types of independent assets. (24 Sep, 2021: China outlaws all
cryptocurrency transactions. BBC) The second major reason
The United States seems to be doing better than its European peers, the Chinese economy
and even the other major Asian economies. Precisely for this reason, the FED seems to
be betting on taking the lead among the major central banks in tightening monetary policy.
In contrast, China's Central Bank seems to be willing to follow the opposite path in an
attempt to fuel its, lately, ailing economy. Of course, relatively higher rates would
strengthen the dollar's position over the next few years. And yes, we are talking about something
conjunctural, but it could help to turn the page on the effect of sanctions on Russia.
However, what is much less cyclical is the third major strength of the dollar:
it is backed by a much better-oiled economy and a younger demographic.
Let's not forget that all the latest technological revolutions have had their epicenter in the
United States: from the digital economy to biotechnology and medical research. Other
important sectors for this country could also do very well in the coming years.
I am talking for example about oil, gas and defense.
(U.S. exported record amounts of liquefied natural gas in 2021. EIA)
(U.S. LNG exporters emerge as big winners of Europe natgas crisis. Reuters)
(Japan plans record defense spending in 2022 with 10th straight annual increase. Reuters)
(Germany to set up €100bn fund to boost its military strength. Chancellor Olaf Scholz
says urgency of Ukraine crisis has forced decision to increase defense spending. The Guardian)
Well, the fact is that, so far, the only structural element that seems to damage
the relative position of the dollar is the strong public deficit that controls
the federal government's accounts. Conclusion: everything points to the
fact that sanctions against Russia will not endanger the role of the dollar,
at least not immediately and not even in the medium term. Of course,
this does not prevent the United States from taking care to improve its competitive position.
For example, by reducing the public deficit or helping to attract more foreign talent.
Especially if we take into account that, for years, international organizations such as
the IMF have been warning that the dollar is gradually losing some of its influence
in the world. This is what the IMF itself has called "the creeping erosion of the dollar".
A process that has caused the percentage of foreign reserves nominated in this
division to drop from 71% at the end of the 1990s, to 59% today.
But, be that as it may, let me repeat that everything points to the fact that the
dollar’s dominance still has many years to go. And now some questions for you: Do you think
that one day independent cryptocurrencies will become the backbone of the international financial
system? What future do you foresee for the dollar? Will the Yuan be able to become a currency capable
of competing for world leadership? Leave us your answers below. And if
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