It’s odd that no one is questioning the assertion that the dollar’s selling price is overdue, even as it trades at a premium against the euro, yuan, ruble, etc. For example, the dollar is trading at 0.93 euros, well above its five-year low of 0.82 euros in January 2020. This was before the US imposed shock-and-awe sanctions on Russia and led the asset freeze (EU banks actually hold far more assets than US banks). As explained below, a new Financial Times column explains that other data shows the dollar’s position remains strong.
We have repeatedly stated that the importance of the dollar is destined to decline over time as the US economy becomes a smaller share of world GDP, but it took two world wars for the US to replace the pound as the dominant international currency, and that was because the US actively weakened Britain through the way it supported its military.
Moreover, many anti-globalists (including some officials in the BRICS countries) embarrass themselves by trying to create a new currency out of thin air, like Athena emerging from Zeus’s forehead. However, since World War II, only two meaningful currencies have been created: the euro and the SDR. The SDR is not a freely tradable currency, is not used in trade transactions, and is not something that private investors can invest in. It took three years of planning and eight years of execution for the euro to launch smoothly. And this was much easier than launching a new currency, since existing national currencies were converted into the euro and all participants had to follow the same legal system. One of the myriad problems is that it is unlikely that a new currency would be implemented without the participants agreeing on which legal system to apply. Even though one of the aims of the new multipolar system is to support greater national autonomy, recognizing the jurisdiction of a court system other than one’s own for trade disputes would be tantamount to ceding sovereignty.
But those seeking to escape the punitive use of the dollar do not need to create a new monetary system to escape the abuses of U.S. sanctions. Trade transactions account for only 1% to 3% of all dollar transactions outside the U.S.; the rest is for investment purposes.
These dollar rejects need to be able to conduct trade transactions outside of the dollar system, which has been possible before, as shown by China using the yuan to buy Russian oil in 2015. This is particularly cumbersome and is now done mainly for very large trade transactions.
It is worth noting that what Foreign Minister Sergey Lavrov said at the BRICS Finance Ministers’ Meeting on June 10 is entirely consistent with having the goal of facilitating bilateral trade outside the dollar system, rather than creating a new currency. RT says:
Lavrov said the BRICS countries are “actively working to implement the decisions of last year’s Johannesburg summit, in particular improving the international monetary and financial system and creating a settlement platform in national currencies for mutual trade.”
He also said that the government also aims to harmonize frameworks for exchanges among BRICS countries, which have recently undergone an unprecedented process of expansion.
“Harmonization of the framework” obviously does not mean the establishment of a new legal system, but rather to bring legal conditions and procedures closer to one another among the BRICS countries.
To put it more bluntly, those promoting the “new BRICS currency” cryptocurrency, and the journalists who support them, are undermining their own plans.
What about the investment side? The US has a significant advantage through the current administration and will likely remain the cleanest shirt in the laundry for some time to come.
1. Liquidity. This is a scale advantage that is hard to reverse. It includes a significant depth of hedging instruments and strategies for professional traders. The SEC’s public securities regime, with its extensive disclosure requirements and regulations to curb insider trading and front-running, remains best in class despite significant problems due to its age (including not cracking down on HFTs, who are essentially predatory by adding liquidity when they don’t need it and drying it up when they do).
2. Established and credible institutional procedures for settlement and liquidation, including dispute resolution, including the existence of well-established legal precedents.
3. A broader range of investable assets. The United States has an advantage here because it has moved much of its bank lending into the capital markets (or, more accurately, banks may still originate transactions and securitize them). In contrast, most other major economies have much larger banks and smaller bond markets relative to GDP.
Many other items could be added to this list, but this should be enough to illustrate the point.
Thus, the conditions described in the Financial Times article: The dollar pessimists are all wrongwhich shouldn’t be surprising at all.
The share of dollar-denominated reserves held by global central banks has been declining in recent decades. According to IMF data, in 2016 dollars made up more than 65% of official reserves. By the end of 2023, that share had fallen to 58.4%. At the beginning of 2016, China’s yuan-denominated reserves were zero. Between the end of that year and 2023, yuan-denominated reserves jumped to 188%. This sounds huge, but it still represents only 2.3% of the total.
But a recent blog from the New York Fed argues that the apparent shift away from the dollar isn’t due to a global cooling in its favor. Rather, the shift is attributable to a small number of countries, including Switzerland, whose long-running efforts to keep the franc in check nearly a decade ago led to a large accumulation of euros. “Indeed, an increase in the share of the U.S. dollar between 2015 and 2021 characterized 31 of the 55 countries for which we have estimates,” New York Fed economists wrote in late May. “A decline in dollar preference in a small number of countries, including China, India, Russia, and Turkey, and a large increase in Swiss-held foreign exchange reserves explain most of the decline in the dollar’s share of foreign exchange reserves.”
Meanwhile, central banks around the world are apparently increasing their purchases of gold to avoid sanctions risks, since gold is not controlled by any national authority. But as the New York Fed stresses, even after the rapid accumulation of gold in 2022 and 2023, the precious metal will still only account for 10% of total global reserves. Talk of a falling share of the dollar and an expanding role for gold “inappropriately generalizes the actions of a small number of countries,” the Fed said.
To be fair, gold holdings are set to rise further: A survey of foreign-exchange reserve managers by the think tank Official Monetary and Financial Institutions Forum found that they are keen to add to their holdings of the metal despite record gold prices helping to tame global inflation (gold is often seen as a hedge).
But demand for dollars remains extremely strong. The survey doesn’t cover every country, but it does cover 73 central banks with a combined holdings of $5.4 trillion. Of those, 18% plan to increase, not decrease, their dollar allocations, OMFIF said, tempted by rising interest rates and a strong U.S. economy. The next most popular currency is the euro, suggesting that reserve managers want to hang on to bigger, more liquid currencies.
Now, with the US determined to continue its bad behaviour, it is natural that concerns about the dollar will continue, especially among countries that are geopolitically important and not firmly established as a world hegemon. But what acts as a sort of brake are the efforts of financiers to thwart the monstrously foolish plan to seize Russian assets. This may be a sacrifice too far for the EU, since, as noted above, the frozen Russian assets are far more denominated in euros than dollars, exposing eurozone institutions to further backlash. Euroclear in particular is concerned about being sued in jurisdictions such as Hong Kong, where it operates. Hong Kong courts will be more receptive to Russia’s argument that there is no legal basis for the expropriation than the Western world as a whole.
To be clear, the US remains the pressure point in the current G7, but protracted negotiations are generally a sign of serious disagreements. From Al Jazeera:
U.S. officials are trying to rope in European allies to propose how interest on frozen Russian assets could be used to help war-torn Ukraine at a Group of Seven summit later this week, but talks are still ongoing as the meeting in southern Italy starts on Thursday.
Diplomatic sources told Al Jazeera that some European countries are still not fully convinced by the US-led proposal.
Rome wasn’t built in a day, and the same is true for the new monetary regime. However, the usual transition path, where the renminbi gradually replaces the dollar due to China’s economic power, is unlikely to happen even in 10 years’ time, due to obstacles such as China’s economic model’s persistent and large trade surpluses (which prevent the renminbi from accumulating meaningfully outside China) and Chinese currency controls. Therefore, the most likely next regime at this point is the fragmentation of multiple major currencies used for trade and investment, rather than a dominant currency. At the margin, this will hinder trade, as importers and exporters will be forced to handle more currencies, increasing their risks and forcing them to operate in a more financialized way (as is evident in the rise of treasuries as profit centers in almost every major multinational corporation).
So this remains an open area, please stay tuned.
Updated 5:45 AM EDT: As this post was published, the Pink Papers announced some sort of deal for the frozen Russian assets. It is still very opaque. The key point is that they are only using the proceeds of the frozen assets, not the principal. For reasons, Euroclear believes it has a much stronger right to the proceeds than the principal. Although this update describes the deal in dollar terms, let us remind you again that it is the Europeans, rather than the US, who are at risk in this scheme. From the Financial Times:
G7 negotiators reached an agreement to use profits from frozen Russian state assets to help Ukraine, in a bid to shore up support for the country amid a string of domestic political difficulties.
G7 officials have agreed to a plan to provide Ukraine with “around $50 billion,” backed by future profits from Russian assets, two people involved in the talks told the Financial Times. The financial aid is set to be the centerpiece of the G7’s annual summit in the southern Italian region of Puglia.
The agreement did not specify details of the loan plan, such as who would bear the ultimate risk for lending to Ukraine or how the funds would be distributed.
