The imposition of sanctions on Russia by the “West” has alerted certain governments in the emerging market universe to the risk that the holding of US dollar assets leaves them vulnerable if they upset the US administration. The seizure of foreign exchange reserves and the ejection from the SWIFT payments system were particularly painful. This has fuelled some fanciful talk of de-dollarisation and a shift towards the offering from Beijing.
Brazil’s President Luiz Inácio Lula da Silva asked on a visit to China in mid-April why all countries had to transact their trade in the dollar and who had decided in 1944 that the dollar would effectively replace the gold standard. He told an event in Shanghai at the New Development Bank, known as the BRICs bank and part of the Chinese offering in our view, that he asked himself the question every night. The answer can be provided by TINA (there is no alternative).
There may be an alternative at some point but far into the future because the data do not lie. China’s share of the global trade in goods is roughly 15 percent while the renminbi share of the trade financing market currently stands at 4.5 percent: that second ratio has increased from 2.0 percent over the past year because the Russian response to international sanctions has been to purchase Chinese goods with renminbi, rather than part of a broader trend. Turning to another measure, the foreign-exchange reserves of central banks are held 60 percent in the dollar in aggregate and just 3 percent in the renminbi.
We may all have criticisms of the US but most of us would prefer that the world financial order is based on US institutions (and the dollar) rather than any alternative such as the Chinese offering
At the margins we can identify some challenges to the dollar’s position as the effective reserve currency. India is paying in rupees for its imports of Russian crude oil. The BRICs summit in South Africa in August will look at trading between members in their own currencies (or a basket thereof).
Closer to home, Afreximbank has developed the Pan-African Payment and Settlement System for trading in local currency pairs within the African Continental Free Trade Area (AfCFTA) and kicked off with a pilot project in 2022 in the West African Monetary Zone. Some players in the private sector have platforms to trade currency pairs without dollar exposure.
Also, central banks are currently buying gold for their reserves at a frantic pace. Their purchases comprise one third of monthly demand for gold and underpin a gold price hovering around a healthy USD2,000/oz. We no longer look at the monsoons in India and their impact on gold buying for the wedding season as the principal price determinant. Unsurprisingly, the leading buyers are the central banks of Russia, China and India. Provided that the bullion is not stored in vaults in the West, this is a way of building buffers against international sanctions.
Another challenge could come from the launch of digital currencies by more than 100 central banks across the world including the CBN’s e-naira. In time these could become the currencies of choice for bilateral trade. There are some threats we have seen but TINA still applies.
China does not have a fully convertible currency. This restricts the potential of the renmimbi of course but also reflects the determination of the Chinese authorities not to lose control. That determination extends to the flow of information. Investors do not warm to institutions that practice opacity. (You do not have to be a Donald Trump supporter to worry about the official Chinese handling of Covid-19.)
In contrast, they feel comfortable with the core financial and economic agencies in the US. Stakeholders feel the same about the rule of law. We may all have criticisms of the US but most of us would prefer that the world financial order is based on US institutions (and the dollar) rather than any alternative such as the Chinese offering. We decide very little ourselves but stakeholders who make the decisions about currencies traded and investments placed would appear to think similarly.
Western sanctions can be highly restrictive, as we have seen in the recent case of Russia. More countries are subject to sanctions than we might think but in most cases such as Zimbabwe these are imposed on the elite in a despotic state. The full force of sanctions is not applied lightly. The Russian government miscalculated because it did not think they would extend to the exclusion of its banks from SWIFT and to the cap on the price of its oil sales.
As a footnote, we see that the latest World Economic Outlook from the IMF regrets what it terms “splitting the world into geopolitical blocs” for the negative impact on the flow of global trade and investment. The invasion of Ukraine has accelerated this process but the erection of national barriers predates February 2022.
The free and open movement of people and goods has gone into reverse in several respects as a result of populist election results, which, in turn, show that globalisation has not always benefited the majority. These barriers are not coming down, whatever the outcome in Ukraine.