One can logically and legitimately ask oneself whether the US dollar will retain the flagship status it has always enjoyed or whether it will be, or could be, dethroned. As we emerge from a major and unprecedented health crisis and enter a phase of war in Europe, we must take stock. A post-dollar race may be underway. Let's think about what could happen. The cards could be reshuffled, according to some specialists. We have also entered a new period of uncertainty, high volatility, and extreme geopolitical and economic tension, to make matters worse. The situation is, as they say, to be continued...
The FX markets and financial markets in general react strongly to geopolitical events and, after a while, they forget what caused the trouble in the first place and ‘go back to normal’. This time may be different as the situation is unique in the modern Western economy. War, for example, at a scale that could well threaten the global financial system. There are interlinkages in the financial market pipes that could generate unexpected and violent shocks or chain reactions. The size of the Russian GDP (US$1.48tr. in 2020) is small compared with that of the UK, US$2.70tr., and the US’s $20.94tr. during the same period. And yet, the shock waves are disproportionately great, maybe because of importance of Russian gas, wheat, and precious metals. Financial war, a consequence of the physical war, will create unpredictable aftershocks and collateral damages for years. We should be prepared because Russia will not be the sole victim.
The invasion of Ukraine by the Russian armed forces is perhaps a major turning point in economic (and obviously political) history. Have we reached a crossroads and a breaking point – or at least a major change? That is highly likely and does give cause for concern. And the consequences that could follow will be lasting, perhaps eternal or at least profound.
Are we not entering a bipolar FX world, with the Dollar God and his dolphin the Renminbi? The war and the consequential sanctions applied to Russia could have an unexpected impact. The decoupling of the West from the East, with the latter represented by Russia, has been underway for a long time. Since the annexation of Crimea in 2014, many Western banks have reduced their exposure to those in Russia.
The same is true of the Russian private sector, many have also withdrawn from its exposure. The sanctions will accelerate the decoupling and the repercussions will be felt for a long time. But the change has its roots in Russia's increased dependence on China, which will only grow. The Chinese will rush to buy cheaper Russian oil and gas, which is now not so attractive to the markets in Europe and the US. But China needs Russia’s precious metals, commodities, oil and gas, and arms, and considers the country as a key part of a new Chinese-led order, a factor the Kremlin is well aware of.
The problem comes from the fact Russia knows perfectly well that it can count on China in difficult situations and can lean on it for political and economic support, although certainly not military, that would be far too risky.
We do not think China will break sanctions to support Russia. However, China could give access to its own financial market and financial institutions. China has even recently announced a friendship with “no limits”[1], whatever that means in practice. China may help as European markets are now closed to Russia. For example, since 2019, Russia can settle all their trades in their respective currencies, rather than the US dollar. This is what Putin asked European nations to do when paying for gas.
The war in Ukraine will catalyse this further. It is also why China will try to develop and build a post-dollarised world. In this new order, Russia could settle all transactions in renminbi, with a dependency on its financial protector.
To get to this point, China will have to ‘de-dollarise’ the global economy. As far the USD remaining the world’s reserve currency, well, this will be complicated. How can this ‘de-dollarisation’ be achieved when the USD is so liquid, open, and transparent? In any case, the current situation will help China to increase its share of the global FX market, with its growing renminbi. Still, this share may remain limited, yet significantly increased. The USD makes up three-fifths of global foreign exchange reserves [2]. However, China is patient, smart, and has accumulated gold and other reserve currencies in a bid to try to force this rebalancing as much as possible. Persistence is virtuous.
China also cultivates a trustworthy and transparent image in its quest to bring in investments from abroad, not only from US, and to attract internal and domestic investments in its capital markets. Rather than being ideologically driven, China is economically driven and motivated. The financial markets and FX could be also a huge battlefield; one where China could form a coalition with Russia or Iran, for example. The battlefield could be like a huge chessboard where each nation tries to rebalance its currency weight.
If the USD could be described as a movie, it would be the 2003 American fantasy comedy Bruce Almighty. But for how much longer? We always talk about the ‘greenback’ This currency is so dominant that, like a weed it will always spring back.
Russia has been aware of the dominance of the USD for decades and has been preparing to tackle its strength and spread since first incursion in Crimea in March 2014. Russia wanted to rely less on the USD to minimise the impact of any US-led sanctions and move trading power eastward. Russia has succeeded in reducing its exports in denominated USD to half of its total exports. Even with such a decrease, Russia remains highly dependent on American currency, because of the volume of goods exported from China to Russia, all paid for in USD. Which country won’t be pleased to reduce it linkage to the USD?
De-dollarisation is clearly a Russian objective but it remains chimeric. Shifting the focus from the dollar is easier said than done. Is the euro (EUR) an alternative solution? Using EUR would decrease Russia’s exposure to US sanctions but would not shield the Russian economy from any EU sanctions. The USD is used in a great majority of international transactions because of its attributes as a high-quality currency (high liquidity, not too volatile, offering a global acceptance). It is more than a cultural habit or tradition in trading. Some people claim that the CBDCs (central bank digital currencies) could be a way to bypass USD domination.
The current geopolitical situation creates additional uncertainties and volatility of commodity and FX markets, making our lives even more complicated. In such tough times, hedging FX risks efficiently is necessary. This requires revamping processes and IT solutions to complement TMSs’ weaknesses and the often-forgotten pre-trade phase. Currency management automation (CMA) solutions enable businesses to save money, reduce P&L impacts by better aligning policies to processes and by hedging earlier. Volatility could stay for a while, according to specialists. And I am also afraid that we will not see (not even when we have all retired) the day the USD is replaced as the dominant global reserve currency.
The Russian invasion of Ukraine may certainly be a sign of changes in the world economy and current order, with a dominant USD. Nevertheless, even if it rebalances the weight of each force, it won’t completely remove the USD’s sovereignty. We should never say never… although maybe never in our lifetime, at least.
François Masquelier, Chair of ATEL, Luxembourg 2022
* Disclaimer: This article was prepared by François Masquelier in his personal capacity. The opinion expressed in this article are the author’s own and do not necessarily reflect the view of the European Association of Corporate Treasurers (EACT).
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