Is the U.S. dollar over as a reserve currency?
That is one of several takeaways from the increasingly anfractuous conflict between Russia and Ukraine. A flurry of heavy-handed sanctions has isolated Moscow, and may yet ricochet across the global economy in unexpected ways (not the least of which includes inflation spurred by skyrocketing energy prices, and fears surrounding Russian supply).
The debate over the morality (and feasibility) of blockading Russia has amplified another debate that’s brewed for years. Namely, can the greenback maintain its superiority over other currencies as the reserve instrument of choice?
Some think that the international community’s response to Moscow may light the fuse that makes other countries finally dump the dollar for good — as Russia itself has done for years, since its aggressive behavior caused governments to put the squeeze on its finances. That suggestion was reinforced on Wednesday by Fed Chairman Jerome Powell, who raised eyebrows by floating that it was possible to have more than one reserve currency.
Joe Weisenthal and Tracy Alloway told this week, investor Zoltan Pozsar warned that Russia’s loss of access to its reserves has sent the message that institutions can’t count on dollars if geopolitical issues arise, making the dollar less attractive as a safe haven.
And Dylan Grice, founder of Calderwood Capital, warned this week that the sanctions squeeze represented “a turning point in monetary history: the end of [dollar] hegemony the acceleration towards a bipolar monetary order.”
At well over $600 billion, Russia sits on one of the world’s largest currency and gold reserves, but that money is now fairly useless in the face of tough sanctions that are foreclosing the ability of the country’s institutions to conduct transactions.
So is the dollar’s demise really as imminent as it seems? Not quite — and maybe, not at all.
It bears repeating that a number of global crises — and the U.S.’s own fiscal baggage — have yet to knock the greenback off its perch. China, one of the single biggest holders of dollar-denominated assets, was once thought to be primed to sell them in the wake of former President Donald Trump’s trade war with Beijing. That never happened, and there are a few solid reasons why.
“I don’t buy it,” said Marc Chandler of Bannockburn Global Forex, when asked by the Morning Brief whether the Russia-Ukraine crisis would lead to a wholesale abandonment of the dollar.
It’s “the same problem as always, no clear compelling alternative,” he said in an email.
“Moreover, the Europeans have also sanctioned Russia’s central bank so that the alternative could not be the euro,” he added.
Cryptocurrencies are currently seen as the most feasible (or at least proximate) alternative. In recent days, digital tokens have seen strong demand despite risk aversion, raising speculation that Russians and Ukrainians are both migrating to crypto given the constraints placed on them by sanctions.
Yet in a research note Wednesday, Citigroup downplayed the impact of Russia flows, suggesting the bid in crypto was mostly speculative. Bannockburn’s Chandler was also skeptical of the idea that crypto could eventually supplant the dollar, even in the near term.
“Crypto to replace the role of Treasuries that stand behind the dollar? Nowhere close,” the analyst said. “To move out of Treasuries is to give up yield, liquidity, transparency and security for what exactly?”
Given the unanimity of international consensus against Russian President Vladimir Putin, it seems unlikely that any major economy would opt out of a global financial system that’s predicated on dollar dominance, at least for the moment.
“Putin has done what several American presidents have failed to do: Re-invigorate NATO, boost German defense spending, and get multinational companies around the world to participate in sanctions,” Chandler pointed out.
“Pax Americana seems to be stronger post-Russian invasion of Ukraine. Even Chinese banks continue to adhere to U.S. sanctions and there seems to be greater space between Russia and China than before,” he added.
One option on the table is a central banking digital currency. The Fed’s incipient moves toward creating a CBDC is unlikely to happen for quite a while.
The Fed’s incremental moves toward a digital dollar are in part why bitcoin investor Anthony Pompliano wrote last week that America “has to start considering what to do in a world where a large portion of the world doesn’t use the U.S. dollar as their reserve currency.”
Given the widening divergence between the U.S., China and Russia, the latter two may well decide that “the costs [of] using the current global reserve currency has become too high. They are unlikely to use rubles or renminbis as the new reserve currency. There isn’t enough global buy-in, along with a general challenge of convincing the world that these new nation states won’t repeat the mistakes of the past nation states,” Pompliano wrote.
Suggesting bitcoin is “the next best option,” he listed a few ways that the U.S. could incentivize its use, he suggested monetary authorities could start adding it to their books like any other reserve asset, and “treat it like a traditional currency.”
Yes, the use cases and appeal of cryptocurrency are certainly growing. But the sector is not nearly stable or established enough to touch dollar-denominated Treasuries, which every central bank and institutional investor in the world still wants — even with all the U.S.’s debt and deficit spending.