The unprecedented raft of sanctions hammering Russia showcases the power the US dollar wields over the international financial system.
Finance and geopolitics are often considered a toxic mix. Nearly two weeks in, Russia’s war in Ukraine is taking that mix to new levels of both toxicity and consequence.
On February 24, the US, the EU and other allies imposed an array of punitive sanctions – from freezing the assets of the Russian central bank, to barring several Russian banks from using the SWIFT payment system.
Restrictions were also placed on goods and services that Russian institutions and firms can purchase from the US, while several major brands, including Apple, General Motors and Ikea, have either closed offices or exited the Russian market.
Then there’s the slow burn sanctions on Moscow’s access to key technologies, in particular global chip supplies. US groups like Intel and Nvidia have cut Russia off, while the world’s largest chipmaker, Taiwan Semiconductor Manufacturing Company, has pledged to halt exports.
The scope of sanctions has demonstrated the web of transnational interdependencies that constitute the fabric of every contemporary society, said Mikhail Sebastian, a London-based political risk analyst.
“Four decades since the fall of the Iron Curtain have been defined by the globalisation and financialisation of the world economy, one result of which is that costs can now be imposed on unfavoured nations through the financial system,” Sebastian told TRT World.
“Restricting its access to SWIFT and freezing central bank assets are an effort to impose costs on the Russian economy via inflation and bank runs.”
Those costs have been borne instantly. The rouble has tanked by 30 percent, hitting a new record low. Reports suggest ATMs have already been emptied of foreign currencies, with desperate Russians lining up to withdraw whatever cash they can.
The decision to freeze Russia’s dollar assets was the first to be levelled upon a G20 member state – putting it on par with Iran, North Korea and Venezuela.
And despite the years spent building a $600 billion mountain of foreign reserves with the intention of sanction-proofing itself, Russia learnt it had the opposite effect.
“All of those stockpiled dollars, euros and pounds exist only on spreadsheets at their respective central banks. They are not bearer assets, they are digital IOUs,” said Sebastian.
Now those central banks are now refusing to make good on them. “Russia thought they had billions of foreign reserves. Now, they don’t.”
The move also undermines the assumption that global banking is a neutral and rules-based system. As economic historian Adam Tooze argued: “To do this [reserves freeze] to a fellow central bank involves breaking the assumption of sovereign equality and the common interest upholding the rights to property.”
When it’s all said and done, the rug pull of Russia’s reserves could end up having unpredictable knock-on effects. What happens to a delicately balanced monetary system when hundreds of billions in collateral is abruptly frozen?
Sebastian thinks such an escalation is likely forcing central banks, oligarchs, and even normal investors to rethink their assumptions around the nature of money. He believes the use-case for decentralised digital assets like cryptocurrencies will get a stronger look too.
“After the dramatic events that have taken place over the last week, plenty will be thinking hard about self-custodying their assets.”
While weaponised finance might be a less deadly way to fight wars, Sebastian notes that the stakes in today’s interconnected world can be much higher and more immediate than they were during the Cold War.
The decision by European nations to import Russian natural gas – Germany alone relies on Russia for 40 percent of its energy imports – was driven by the hope that commercial ties would intertwine Russian interests with Europe’s, raising the stakes in the event of any potential conflict.
The stakes are so high that freezing Russia’s central bank assets is referred to metaphorically as “the nuclear option,” Sebastian said.
Nicholas Mulder appropriately then reminds us in his premier on the history of sanctions, that while the appeal of economic sanctions is that they are seen as an alternative to war, they paradoxically function as a weapon of mass destruction.
Dawn of a post-dollar future?
Some experts believe that Western sanctions are likely to push Russia away from the Western-led economic order and closer economically to China – and potentially sow the seeds for a post-dollar future.
“For an economy such as Russia that still relies on a great deal on export revenues and on international trade more broadly, losing access to global finance is clearly a painful blow,” said Eswar Prasad, a professor of economics and trade policy at Cornell University.
“The restrictions on Russia’s access from the Western-dominated global financial system will undoubtedly drive it into a deeper embrace with China, in terms of both trade and financial dependence.”
Prasad said this could include “creating channels for payments using their currencies and avoiding the dollar, and also by creating mutually compatible payment messaging systems that can bypass SWIFT.”
While the renminbi and China’s own Cross-border Interbank System (CIPS) might be of interest to Russia at the moment, Beijing will want to manage ties with Moscow without damaging its relationships with the West or threatening its own access to the global financial system.
“China, if it were to seek to evade the sanctions, or somehow dividing the sanctions, they would be vulnerable,” State Department counsellor Derek Chollet said last week.
Meanwhile, those like market guru Zoltan Pozar believe the war has pushed the US dollar to a critical inflection point.
Speaking on Bloomberg’s Odd Lots podcast, the Credit Suisse strategist said with Russia losing access to its foreign currency reserves, a message has been sent to nations that they can’t count on reserve stockpiles to be theirs in the event of a political conflagration. A similar scenario played out recently when the Biden administration seized Afghanistan’s cash assets and prevented the Taliban from accessing $7 billion in central bank funds.
“Never seen weaponization of money on this scale before…you only get to play the card once. China will make it a priority to need no USD before going for Taiwan,” Dylan Grice, a hedge fund manager based in the UK, tweeted. “It’s a turning point in monetary history: The end of USD hegemony & the acceleration towards a bipolar monetary order”.
Since the gold standard was jettisoned for the dollar as the world reserve currency in the 1970s, the greenback has been the foundation of international finance. Half of all international trade today is done in dollars, and half of all global bonds and loans must be paid back in dollars. Nearly 90 percent of all currency trades involve the dollar.
A big part of what underpins the dollar as the currency used to clear transactions is that it’s held by all central banks, and they all agree to it being the final currency used to clear international payments.
But if central banks decide that it’s not safe anymore to hold dollars, might we see a return to assets like gold?
“It’s not clear that anyone other than the United States has both the ability and the will to ‘manufacture’ safe assets and sell them to foreigners as the bedrock of a global financial system,” said Bloomberg strategist Cameron Crise.
Author and political economy commentator Grace Blakeley echoed Pozar’s view that by deploying all-out financial warfare, America’s adversaries will be incentivised to pursue a parallel system to allow them to transact and trade with one another.
Hedging on a clear alternative to the dollar remains speculative, however. The long play is that as US dominance of the world economy wanes and China rises, the renminbi would be positioned to take over as the world reserve currency.
The dollar imbues the US with exorbitant privilege, from complete freedom of monetary policy that it can print its own money and effectively finance unlimited amounts of spending. And Washington is unlikely to give that up without a fight.
“It’s hard to see how that transition happens without a military confrontation between the US and China,” Blakeley said on the Bad Faith podcast.
“If China finds itself in the position of allying with Russia against the rest of the world, what you have first before the move to a new unitary system is the emergence of a bipolar world order again, like the one we had during the Cold War.”
Only then, Blakeley argues, can the mechanisms of an alternative international financial system start coming together.