Sanctions And The Dollar

The West’s financial assault on Russia may strengthen the yuan and cryptocurrency, but slowly.

The Western world has been united in its rejection of Russia’s invasion of Ukraine, and in punishing the invader with unprecedented financial sanctions. But the rest of the world isn’t necessarily going along. Some governments may fear their turn could be next.

As a result, a movement is emerging to strengthen alternatives to the West’s financial system. The backlash is evident in a raft of actions, or hints at actions, to loosen the dollar’s stranglehold on global trade and reserve holdings. Saudi Arabia has started talking to China about pricing oil shipments in Chinese yuan, Riyadh officials leaked to reporters. India quadrupled oil imports from Russia in the early weeks of the war and proposed paying for them in rupees. Federal Reserve Chairman Jerome Powell testified before Congress on March 2: “It’s possible to have more than one large reserve currency.”

“De-dollarization by several central banks is imminent,” wrote Sachchidanand Shukla, chief economist at Mahindra Group, one of India’s top 10 conglomerates, in an editorial for The Indian Express.

That’s an exaggeration. But there is reason to believe that the dollar, with its allies, is peaking as a transnational political weapon. The yuan, and possibly cryptocurrency, can at least nibble at the greenback’s edifice.

Responding to Conflict

After Russian President Vladimir Putin attacked Ukraine February 24, the West attacked Russia on three fronts: It severed key Russian banks from the Swift system for international settlements. It froze Russian central bank reserves in dollars, euros and yen, effectively impounding two-thirds of the national treasury. And it broadened sanctions on Russian companies and individuals, leaving billionaire oligarchs who allegedly prop up Putin’s regime temporarily broke. Well-connected business figures elsewhere might be wondering who is next.

“If I were a Saudi prince, I would be very worried by what’s going on with Russia,” quips Mike Edwards, deputy chief investment officer at Weiss Multi-Strategy Advisers in New York.

The effectiveness of this onslaught depends on the dollar’s dominance in world commerce and savings, and Swift as a chokepoint that Washington can easily monitor to impose “secondary sanctions” on banks that do not obey its edicts. Nearly 45% of global trade is denominated in dollars, according to the Bank of International Settlements—and adding euro, yen and British sterling covers 75% of all trade. The yuan’s share: 2.2%. The greenback alone accounts for some 60% of global reserves; the yuan, 2.6%.

The weakest link in this American financial empire is probably Swift, which is a bit like an old-fashioned telephone exchange in a world of Telegram and WhatsApp. “Innovations such as Bitcoin’s blockchain technology could render Swift’s business model obsolescent within a few years,” Cornell University professor Eswar Prasad wrote recently in Barron’s. China is getting ready to fill the breach with a Cross-Border Interbank Payments System it has been nurturing since 2015.    

The yawning mismatch in trade finance—China accounts for 15% of world trade, but less than 3% of finance—also looks ripe for some correction. Saudi Arabia, for instance, exports about $4 billion a month to China, and imports back $2.5 billion, according to CEIC data. Most of those imports and exports could be priced in yuan, which would be quickly recycled. The same goes for most of Brazil’s $135 billion in annual two-way trade with Beijing.

Holding on to Reserves

Shifting longer-term global savings, i.e., reserves, from the capricious clutches of the West is much more challenging. Nearly half of all central bank and sovereign wealth fund dollar reserves around the world are held by “autocracies,” which would happily rid themselves of the US nanny state, Edwards estimates. But technocrats at the helm may fear China’s capital controls more than Washington’s penchant for sanctions.

Beijing has been known to block currency exits, formally or informally, when it feels the yuan is under pressure. It won’t yield that privilege anytime soon. “Altering the fundamental structure of global finance would require deep-rooted reforms that China has long scorned,” Prasad noted.

Then there is the question of earning a return on your yuan. China’s bond market has grown impressively, to nearly $20 trillion; dollar debt around the world is more than $800 trillion. US-listed stocks represent two-thirds of global equity value. China’s market is a sliver, which shrunk appreciably over the past year as Beijing “reformed” the internet and other sectors in ways that alarmed investors. There is nothing for deep-pocketed foreigners to do with Chinese currency beyond a low threshold.

Crypto Effects and Limits

While the dollar and its discontents maneuver at the apex of world politics, cryptocurrency has made gains on the ground. Russia and Ukraine were among the top countries for crypto penetration before the war, combining tech-savvy populations with wobbly fiat currencies and broad distrust in government. Those crypto wallets have proved valuable as the conflict forced millions to flee their homes—particularly for the large number of Russians who packed up in fear or disgust since Putin launched his invasion.

Many of these voluntary refugees were frozen out of their own bank accounts first by sanctions and then by the capital controls Moscow struck back with. “I know so many people who have left Russia for Turkey, Georgia or Uzbekistan,” says Kevin Dougherty, a former Moscow financier turned crypto consultant. “They are using their cryptocurrency savings to survive.”

Volodymyr Zelensky’s Ukrainian government, with its typical flair for publicity, announced it would accept donations in 50 varieties of crypto. These brought in nearly $100 million from global well-wishers in the first two weeks of the war, Kyiv claimed.

Investors seem to be taking note. Crypto-oriented funds raised $3 billion in fresh capital in the early weeks of the war, according to sector watcher Fundstrat. “The conflict in Ukraine weaponized our digital economy and really accelerated blockchain adoption,” Paul Hsu, CEO of US-based crypto venture capitalist Decasonic, told Reuters.

Crypto’s efficacy for evading financial sanctions, on the other hand, may be overrated. US President Joe Biden fretted on this score himself, while issuing a March 9 executive order to regulate digital currencies. “Crypto may be used as a tool to circumvent United States and foreign financial sanctions regimes,” he said.

Evidence of actual evasion from Russia is slim, though, research from the Washington-based Center for Strategic and International Studies concludes. Despite its decentralized ideology, 95% of actual crypto trading flows through fledgling exchanges like Coinbase (in San Francisco) or Binance (Cayman Islands), which are eagerly cooperating with US and European authorities.

“Cryptocurrencies are the digital equivalent of marked bills,” CSIS scholars Aidan Arasasingham and Gerard DiPippo wrote in a recent commentary. “Assets are pseudonymous, not anonymous, meaning that their transactions and wallets can be traced.”

Putin’s invasion of Ukraine has the makings of a catalytic event politically, psychologically and for the future of energy. The early fighting on the financial front shows the lingering power of a united West to control the 21st century equivalent of sea lanes. But a uniting event on this scale will, hopefully, remain rare. Even Switzerland, which banked all sides in World War II, threw in this time with the rest of Europe.

Beneath the surface, financial power, like economic and military power, is creeping toward the multipolar. This could be the moment of peak dollar, though it may take awhile to notice.