Why Russian sanctions could make the dollar less attractive

The West’s decision to sanction Russia’s central bank raises deep questions about the future of the global monetary system, says Jon Sindreu in The Wall Street Journal.

The US and its allies have frozen Moscow’s access to more than half of its $630bn in foreign reserves in response to its invasion of Ukraine.

The implication – that reserves held by unfriendly governments can be turned into “worthless computer entries” – is likely to drive a shift out of dollar assets and into alternatives such as “gold and Chinese assets”. That could undermine the dollar’s role as the world’s leading currency.

Challenging the dollar’s hegemony

Dollar dominance rests on two pillars. First, it accounts for about 59% of the foreign exchange reserves held by the world’s central banks, far above the second-placed euro, on 20%. China’s renminbi accounts for less than 3%, a lower share than the British pound. Second, the dollar is the default currency used in international transactions. Oil, for example, is almost always priced in greenbacks. “In February only one transaction in every five registered by the Swift messaging system did not have a dollar leg,” says The Economist.

Yet the more the US “weaponises the dollar” against the likes of Russia and Iran, the more it “undercuts the attraction of the dollar as a reserve currency”, says Andrew Stuttaford in National Review. Saudi Arabia has moved to start pricing “some of its oil sales to China in yuan”. That’s “a noteworthy step as the Saudis have been selling oil exclusively in dollars since 1974”. India and China are setting up alternative payment systems to buy Russian energy.

The greenback’s hidden strengths

Still, the dollar’s rivals face steep hurdles. The renminbi is not fully convertible, meaning there are limits on how much it can be traded on foreign exchange markets. In a future crisis, “the Chinese government might not appreciate Russia dumping renminbi… to prop up the rouble”, says Eswar Prasad in Barron’s. Investors also expect a reserve currency to be backed by institutions such as “independent central banks… and the rule of law” that are much better established in the West.

That may help explain why, even as the dollar’s share of global reserves has slipped over the last two decades, the “chief beneficiaries” have been not China, but the small, open economies of “Canada, Australia, Sweden, South Korea and 

These currencies are not so much rivals as “extended buttresses… providing options for diversification while continuing to benefit from the liquidity and sophistication provided by America’s financial markets”.

China and its allies may start to trade more in renminbi, but this is unlikely to account for a big slice of global trade, says Neil Shearing of Capital Economics. Few currencies can compete with the “deep and liquid” markets for dollar assets. Tellingly, “as China and Russia have tried to reduce their use of the dollar in bilateral trade”, they have turned to “the euro, rather than the rouble or renminbi”. A decade from now, “the most likely outcome is a more fragmented global financial system – but one that still has the US dollar at its core”