The End of the Dollar Monopoly?

US dollar to collapse.

“This is the end of the dollar monopoly in the world. Anyone who has dollars can no longer be sure that the US will not steal his money." - Vyacheslav Volodin, Chairman of the Russian Duma, the lower house of parliament.

"Sanctions have fundamentally undermined US credibility in the international monetary system." - Yu Yongding, chief economist, Chinese Academy of Social Sciences.

Nearly 60% of the world's reserves are held in the US dollar, which amounts to USD 13 billion. When the Americans “print” their greenbacks, the cost of that debt falls on everyone holding their reserves in dollars. This is perhaps the greatest comparative advantage that any superpower has ever had over the rest of the stakes in world history. However, nothing is a given forever. Just 20 years ago, the dollar's power was even greater. In 1999, the dollar accounted for 71% of global foreign exchange reserves. But many participants in the system are unhappy with this hegemonic arrangement. China, Russia, and Iran are obvious examples, but this dissatisfaction is increasingly being expressed by other players, yesterday still close allies of the US, such as Saudi Arabia. The Russian-Ukrainian war and the consequent draconian US sanctions imposed on Moscow have further undermined the existing arrangement. In what way? Are we facing a "financial Suez Canal" moment?

Privilège Exorbitant

The dollar's status as the world's reserve currency was sealed in July 1944 at the Bretton Woods Conference. This was in practice the prize that the Americans, taking advantage of Europe's weakness, awarded themselves for victory in the Second World War. This status was later shaken in 1971 when the dollar abandoned the standard of gold, but nevertheless maintained its vital position. In practice, the dollar has dominated global financial markets for 80 years. The famous statement of the French Minister of Finance in the 1960s, Valéry Giscard d'Estaing, called the American financial asset a “privilège exorbitant.”

Therefore, at the time of the Russian attack on Ukraine, it was not the thousands of Javelins and Stingers that constituted the greatest asset in the deck of US retaliatory movements. It was the de facto control of the global financial market. No one doubted that the Americans would make use of this advantage, but the scale of their use surprised literally everyone and certainly caused panic in the Kremlin. We are talking about the largest package of sanctions ever imposed on another country, but it is not North Korea or even Iran, but the world's largest territorial state, heir to the might of the USSR, the current Russian Federation. This photo illustrates the mood in Moscow well. It shows the reaction of Elvira Nabuilna, the head of the Central Bank of Russia, to Vladimir Putin's refusal to accept her resignation from her post, which means that she will have to face a challenge that, in practice, cannot be met.

It would take us a whole episode to list all the sanctions that have been imposed on Russia. Russian banks were cut off from SWIFT, a move which Russian diplomats in the past have called 'tantamount to a declaration of war,' hundreds of Western companies have left Russia, and exports to Russia of many key components are blocked.

However, the blow that hit Russia the hardest, and surprised analysts the most, was the move aimed at the Russian Central Bank to freeze or - to call things by their name - confiscate a large part of Russia's foreign exchange reserves. The exact amount is not known, but it can be assumed that the figure is $200-300 billion, i.e. plus or minus half of Russia's reserves that were valued at $630 billion before the war. On top of this, a number of assets of Russian oligarchs located in the West were confiscated.

Of course, a person who has seen the pictures from Bucha or Mariupol may not be surprised by this move and, what is more, may have welcomed the news. However, leaving aside the moral aspect of these decisions, they set a precedent, a dangerous precedent according to some, which may contribute to the demise of the dollar as the world’s reserve currency and the gradual loss by the Americans of their privilège exorbitant.

"The sanctions have shaken the Earth. They broke the pattern," admits John Smith, a former US Treasury Department official responsible for the sanctions. Hitting a country the size and strength of Russia is an unprecedented event. Financial law professor Mitu Gulati of the University of Virginia admits that if you change the law for Russia, you are effectively changing it for the whole world - forever.

He is joined by Louis-Vincent Gave of Gavekal Research in a conversation with Strategy & Future. I encourage you to listen to the entire interview.

The rule of law. It is often instrumentally exploited by authoritarian leaders and magnates, but it is also the strength of the Western world and has caused capital to flow from all over the world into Western institutions.

Gave notes that this was the reason why all the capital surpluses earned by developing economies were reinvested in US treasuries, even though they now offer a negative rate of return. This helped keep local currencies undervalued and protected these economies from a crisis similar to 2008. At the same time, they financed US debt.

Now, according to many experts, the Americans are playing with fire, as not only are they conducting a very profligate fiscal and monetary policy, putting additional trillions of dollars into circulation and burdening the whole world with this debt, but now they are also undermining their credibility among all the countries that are not ‘Western.' And let us remember that these countries still constitute the majority in the world.

Gave is echoed by Gal Luft, director of the Institute for the Analysis of Global Security, "Central banks are beginning to question whether full reliance on the US dollar is a good idea. Until now, 'all eggs were put in one basket, a basket of US securities." Luft warns that such a lack of awareness among US policymakers could end badly for the dollar. "1 in 10 countries in the world are under one form or another of US sanctions, so on the one hand you sanction everybody from left to right, and on the other hand, you want these countries to buy your bonds and finance your debt. That is not a recipe for success."

Death of the Dollar

The death of the Dollar has been predicted many times before, but as Credit Suisse analyst Zoltan Pozsar notes, "Great wars tend to challenge the dominance of existing financial systems and create new ones." This could be the financial Suez Canal.

This move by the Americans has had a domino effect. Russia continues to maintain significant exports of energy resources, most of which are paid for in dollars or euros and these can be blocked at any time now. Therefore, the Kremlin, by cutting itself off from Western currencies, has told the countries that are hostile to it, namely those countries that have imposed sanctions on Moscow, that they expect to be paid for their hydrocarbons in Russian rubles. To countries that the Kremlin considers friendly, such as China and India, the Russians have offered to buy raw materials in their local currencies. This is a key event.

The European Union immediately announced that it had no intention of paying for raw materials in rubles, because the contracts were agreed upon and signed in another currency. Therefore, on 27 April, Moscow for the first time blocked gas supplies to two Member States, Poland and Bulgaria, because they complied with the joint directive. However, as the Financial Times reports, energy companies from Germany, Austria, Hungary, Slovakia, and Italy are planning to comply with the Russian demand which in practice would amount to opening a ruble account in the Russian bank Gazprombank. "This is a breach of sanctions," - European Commission spokesman Eric Mamer said. This is a developing situation, so by the time of publication of this material, it may have already changed.

Equally interesting is the game between countries that Moscow considers friendly or at least neutral. This position was taken after the start of the war by the major economies of Mexico, South Africa, and Brazil. The latter country recently condemned the war in Ukraine, but the South American giant still hasn't changed its approach to sanctions on Russia: "We are against sanctions," says Brazilian Finance Minister Guedes. Even more significant for Moscow is the position of, arguably by now, the world's most populous country - India.

The Russians have offered to sell 15 million barrels of oil to the Indians at a discounted price of up to $35 a barrel, Bloomberg reports. While a barrel of oil is currently hovering around $100. But more importantly, the Russians have proposed that transactions should not be denominated in dollars, but in Indian rupees and that everything should be handled by the Russian SPFS payment system.

The Indians refused, probably in order not to spoil their relations with the Americans whom they still need in order to neutralize the power of their main regional adversary, China. Nevertheless, this situation is a good illustration of the process we are facing.

For China, whose economy depends on incoming hydrocarbons, an isolated Russia presents a tempting opportunity. Not only does Beijing have the chance to buy oil, gas, and other elements that Russia has in abundance at half price, but closer ties on the Moscow-Beijing axis offer a real chance to sink the US dollar. This is a dream the Chinese have had for a long time.

In Beijing, the Russians made the same offer as in Delhi, “We will sell you our oil and gas in Yuan.” China wasted no time contemplating and Russian coal and oil settled in the Chinese Yuan are already reaching the Middle Kingdom.

The chain of cause and effect by no means ends there. Now the Chinese, with an extremely advantageous deal in hand with the Russians, are going to their largest oil supplier, Saudi Arabia.

Saudi Arabia is in talks with China to settle a part of Saudi oil in the Yuan. Talks on denominating Saudi oil in RMB have been going on for some six years, but have accelerated in recent weeks and stem from a whole range of diverging interests between Riyadh and Washington.

First, the Saudis expect Washington's support for their war and intervention in Yemen. Riyadh is concerned about a potential unfreezing of US-Iran relations and a potential new deal.

Second, the Saudis are surely watching in horror as draconian sanctions strangle Russia. Saudi Arabia is far from a democratic state. Biden himself remains of the view that after the killing of journalist Jamal Khashoggi, who criticized the Saudi government, Saudi Arabia should be treated as a pariah and that the Saudi regime carries little value for its people. Biden also withheld military aid to the Saudi coalition in Yemen.

Third, there is pressure from China, Riyadh's biggest customer, which may demand the sale of oil denominated in Yuan, since it is already buying it that way from Russia. Saudi Arabia has previously changed its patron from the British to the Americans. Will the Chinese be the new Saudi patron?

All the more likely, because the dynamics of Saudi oil exports have changed dramatically in the last 30 years. In the 1990s, the Americans imported as much as 2 million barrels of oil a day from Saudi Arabia, but in the meantime the US has become an energy superpower, mostly covering its own needs. Today, therefore, these imports have dropped to 500,000 barrels a day. Meanwhile, the opposite trend is happening vis a vis China, which is approaching the peak of US imports. In December 2021, the Chinese were buying nearly 1.8 million barrels of oil a day from Riyadh, a bit more than from Moscow. The trade dimension is extremely important here and may herald some new strategic choices. In addition, China is helping the Saudis build ballistic missiles and bin Salman's dream projects, such as the futuristic city of Neom.

It was not without reason, therefore, that de facto Saudi leader Mohammed Bin Salman refused to talk to Joe Biden who was seeking support for an international coalition to isolate Russia which Saudi Arabia and the UAE would help by increasing oil production. At the same time, however, bin Salman found time to talk to Russian President Vladimir Putin.

Finally, the Saudis may be hoping that greater cooperation with Beijing may help them discourage the Chinese from working closely with their biggest enemy - Iran.

A Premature Funeral?

Will the current moment turn out to be one of many overshoots that history will verify as a premature burial of the dollar? This contrasting view also has its supporters. The lack of viable alternatives is how their arguments can be summarised. Apart from Europe and Japan, which stand shoulder to shoulder with the US, there are simply not enough liquid financial resources in other currencies to meet the demand to dump the dollar.

"We have a very accommodative monetary policy, we are very open with our markets, things are easily convertible and we are safe as an economy. Until those things change, the rest of it ain’t changing. If we’re acting with all of our partners and allies in this, where else are you going to go? There’s no place else that has anything approaching the level of liquidity and access that the US market has. It doesn’t exist anywhere,” says Brian O'Toole, a sanctions expert at the Atlantic Council and a former senior official at the US Treasury.

The dollar will not suddenly fall, its dominance continues to be overwhelming. In 2019, it was used in 88% of international transactions, compared to 4% recorded in yuan. A yuan that China wants to internationalize, yet the exchange rate of the same yuan continues to be strongly controlled by Beijing. And… it can’t be both ways at the same time.

Perhaps the truth lies somewhere in the middle. Robert Manning, of the Scowcroft Centre for Strategy and Security in Washington says that, “the dollar is unlikely to be dislodged in this decade,” but adds, “looking out to 2035-2040, the dollar is likely to be challenged by the RMB and euro, and we may see a more fragmented international financial system.”

But in the age of blockchain technology, the rise of cryptocurrencies, and central bank digital currencies, will a reserve currency still be needed?

Larry Fink, CEO of BlackRock, the world's largest investment group with $10 trillion in assets under management, said in his annual letter to shareholders that "the Russian invasion of Ukraine has brought to an end the globalization we have experienced over the past three decades.” One result, he said, could be the wider use of digital currencies - an area in which the Chinese authorities have made considerable preparations.

Washington applied draconian sanctions against the Moscow regime after its aggression against Ukraine. After the images from Bucha, Irpen, and Mariupol, no one doubts that morally this was the right thing to do. But in doing so it potentially "could have thrown the baby out with the bathwater," in effect undermining its global dominance and the current world order. Time will tell whether the dollar will survive the next crisis, but there are many indications that this will be the greatest challenge yet posed to the US’ “privilège exorbitant.”

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