(MENAFN- Asia Times)
In the 1960s, French Finance Minister Valéry Giscard d'Estaing famously said that issuing the globe's undisputed reserve currency gave Washington“exorbitant privilege.” In the last week, Joe Biden has proved d'Estaing understated the case quite significantly.
Among the US president's steps to sanction Vladimir Putin for his brutal is effectively cutting Russia off from much of its currency reserves. Markets were every bit as flummoxed as Putin's central bank, which planned to use that US$630 billion war chest to stabilize what's now a junk-rated economy.
Dylan Grice, a UK hedge fund manager at Calderwood Capital, speaks for many when he says he's“never seen weaponization of money on this scale before.” And then, the kicker:“You only get to play the card once,” Grice warned.“It's a turning point in monetary history: The end of USD hegemony.”
Maybe. But in the meantime, it's a gut punch to Russia.
The Central Bank of Russia (CBR), says economist Gerard DiPippo at the Center for Strategic and International Studies, had amassed giant official reserves amounting to double Russia's goods imports and more than a third of Russia's gross domestic product (GDP).
“Many referred to these ample reserves as 'Fortress Russia,'” says DiPippo. Yet,“the sanctions demolished the walls of that fortress by severely limiting the CBR's ability to transact in major foreign currencies and cutting off Russian banks from and certain transactions.”
Biden's move,“effectively rendered most of the CBR's reserves useless by prohibiting transactions in those currencies,” in DiPippo's estimate.
He continued,“The sanctions will impose enormous costs on Russia's economy, effectively cutting it off from international capital, triggering a currency crisis, a potential banking crisis and its worst financial shock since the debt crisis of 1998.”
The damage is mounting. As of March 2, the Russian ruble had fallen more than 30% against the dollar compared to before the sanctions. On February 28, the CBR scrambled to double its key interest rate to 20% to stabilize exchange rates and imposed capital controls.
Credit rating agencies scrambled to downgrade Moscow to junk levels as default risks soar. Russia's economy has already fallen , trailing South Korea's.
And looking back, its 1998 default on government debt killed the Long-Term Capital Management hedge fund, and nearly triggered a global crisis.
Russia faces US and Western sanctions for its invasion of Ukraine. Photo: iStock Dollar on a knife edge Credit Suisse AG global strategist Zoltan Pozsar notes that wars often lead to major inflection points for currencies.
If central bankers wake up to find that their mountain of currency reserves is not real money – the policymaking equivalent of a crypto trader whose password won't work – is in for a history-turning shock.
How will this shock be interpreted by China – which, along with Japan, is among the two biggest holders of US Treasury debt?
To Biden's boosters, freezing Russian assets was a stroke of realpolitik brilliance. The line on predecessor Donald Trump was that he kept Putin, North Korea's Kim Jong Un and other rivals off-balance. Well, Biden just gave dollar-hoarding authoritarians a masterclass in out-of-the-box methods for keeping your adversaries guessing.
Yet there is a downside. Biden, Pozsar observes, also sent a glaring message that no country can rely on these ginormous cash stashes actually being theirs in times of need.
Going forward, why would you hoard dollars if they could be held beyond your reach when you most need the liquidity? The precedent raises existential questions about the durability of the post-war Bretton Woods system.
When the Ukraine crisis – if it simmers down – Biden's dollar gambit could increase the urgency for a new monetary order, a new reserve asset and a global system infinitely less interconnected via bank accounts and central bank currency reserves.
Until then, China's foreign-exchange holdings may become the globe's most hotly analyzed financial data.
Prime position Yet, for the time being, Russia, and the globe's top dollar holders, are stuck with today's dollar-centric trade universe.
Marc Chandler at Bannockburn Global Forex says,“I don't buy,” the argument Russia can abandon the dollar anytime soon. Moscow, he says,“faces the same problem as always – no clear, compelling alternative.”
The euro is out, he says, because the Europeans“have also sanctioned so that the alternative could not be” the common currency. The yen could offer the same landmines.
Cornell University economist Eswar Prasad acknowledges“speculation is rife that when the dust settles, China, Russia, and others will intensify efforts to unshackle themselves from the dollar-dominated system and reduce their financial vulnerability.”
But, he adds,“The reality is likely to be far less dramatic.”
China holds massive amounts of US dollar-denominated reserves. Photo: Chen jialiang / Imaginechina via AFP
To be sure, Prasad says, some changes already underway as a result of new financial technologies could gather steam.“But,” he adds, the“fundamental structure of global finance, including the status of the major reserve currencies, will not be easily shaken.”
And why not?“That would require deep-rooted reforms that China and Russia have long scorned,” Prasad reckons.
China has been working on those reforms, particularly since 2016 when the yuan was added to the International Monetary Fund's“special drawing rights” .
Yet, President Xi Jinping still refuses to make the yuan fully convertible, boost transparency or make the People's Bank of China central bank independent.
The upshot, says economist Barry Eichengreen at the University of California, Berkeley, is that China may grow fast as a transactional currency, but less so as a safe haven.
Nor are private cryptocurrencies about to replace the dollar. One reason: Russian oligarchs using crypto assets to spirit away their billions might prompt the US, Europe, Japan and others to clamp down hard on blockchain-based tools.
In a recent research note, Citigroup opined the crypto world is more about speculation than protecting state wealth.
Gold is always there. But its recent rally makes the a crowded trade already.
US Treasury securities, on the other hand, Chandler says, offer“yield, liquidity, transparency and security.” In other words – everything crypto-assets and their echocardiogram-like price swings don't.
Then there is the issue of transactions.
Washington, Prasad notes,“has outsize influence over the SWIFT messaging system.” China could expand its , but such networks take time to perfect.
“Could,” Prasad asks,“China and India allow Russia to evade sanctions? The relatively modest financial footprint of those economies and their exposure to secondary sanctions limit the viability of this escape route. But surely the lesson that these countries will take away is the need to reduce their vulnerability to sanctions. That will be feasible in some dimensions but not in others.”
Treasuries: weapon or linkage? There's also a question about whether China is essentially trapped.
For years now, many investors assumed Beijing's $1.1 trillion of US gave it undue leverage over Washington. Economists have long seen China's $3.22 trillion of reserves as a geopolitical strength – the ultimate rainy day fund should China's shadow-banking system blow up.
If China or any other top Asian US debt holders began dumping huge blocks of Treasuries, though, chaos would ensue. Even news that Japan, China, Taiwan, South Korea or others are curtailing new purchases could slam global credit markets.
The US has used finance to maintain its empire. Image: Screengrab / Marketwatch
That surge in global rates could devastate demand for Chinee goods. It creates a sort of “mutually assured destruction” dynamic that could force China to hold its dollars.
So, the long-term implications of Biden's decision to separate Putin from hundreds of billions of dollars of state money is still impossible to guess.
Last week, another French finance minister – the current one, Bruno Le Maire – made headlines of his own calling banning Russia from SWIFT a“financial nuclear weapon.”
Biden's team just went a step further than that. How Putin responds is an open question. What's not in dispute is that the post-war financial system will never be the same.
MENAFN08032022000159011032ID1103809683