World Economy
National Currencies in International Settlements
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Geopolitical risks that were unimaginable just a few years back are turning the idea of reliable currencies and global financial centres upside down. The countries that created and controlled the existing global financial system in mid-20th century, receiving global rent or seigniorage in the process, have dealt the most devastating blow to their own system, writes Valdai Club expert Alexander Losev.

The unparalleled financial sanctions imposed on Russia threaten to gradually erode the US dollar and could result in a more fragmented international monetary system, IMF First Deputy Managing Director Gita Gopinath said in an interview with the Financial Times in late March 2022.

Experts from the Institute for the Analysis of Global Security (IAGS) agree with the IMF and also argue that the extremes to which Washington has gone in an effort to punish Russia have made other states realise the importance of moving beyond any dependence on the US dollar and a financial system backed by the United States. IAGS Director Dr Gal Luft told CNBC that “Washington's trigger-happy sanctions” on Russia mean that the “central banks are beginning to ask questions if putting all their eggs in one basket” and relying heavily on the dollar is a smart idea. The United States has also imposed similar sanctions on Cuba, Iran, Venezuela and Afghanistan, thus putting these countries’ economies in a difficult situation.

Economic and sanctions wars undermine global integration and increase countries and regions’ striving for financial independence and economic self-sufficiency.

Control over global finances is one of the pillars of America's might, but every time the United States weaponises the dollar's leading role in the global financial system to punish a country, the rest of the world starts looking for alternatives to the dollar for cross-border transactions and international trade. Seizing Russian assets, freezing the Bank of Russia’s foreign exchange reserves and blocking Eurobond transactions at clearing houses is the West’s  strategic mistake that makes the prospects for keeping the existing global finance structure the way it is unviable. A crisis is unfolding.

The dollar remains the main global reserve currency and that’s why the distribution of cash and capital flows around the world are largely determined by monetary and economic cycles in the United States. The point is that with the US national currency being used for both domestic circulation and also for servicing significant amounts of international transactions and the accumulation of reserves by the central banks in other countries, there has to be as many dollars in circulation outside the United States, so that America can import as many goods and services as possible in exchange for its dollars, that is, export dollars, the supply of which, in turn, depends on the US Federal Reserve’s monetary policy and the volume and healthy condition of the US consumer market. However, this creates a negative trade balance and pushes up US national debt because the Fed issues non-cash dollars in exchange for Treasury bonds.

In order to expedite international settlements and to promote global economic growth, the balance of payment deficits in the United States and the debt of the US government, banks, corporations and households must constantly increase because consumption expansion usually follows credit expansion. That was the model of modern financial supercapitalism. Clearly, this cannot continue indefinitely. Financial system imbalances and measures to combat record high inflation, quantitative tightening by the US Federal Reserve, a recession in the US economy and the early phases of the debt crisis will take a significant amount of “external” dollars out of the global financial system. The shortfall in the main settlement currency in regional trade can only be replaced by the national currencies of the countries involved in this trade.

Thus, processes that stimulate the widespread transition to transactions in national currencies are now beginning to unfold in the global economy. The countries that already are under US and EU sanctions, as well as countries that feel threatened by Washington, are trying to avoid settlements in US dollars, to stop accumulating reserves in US dollars and euros and, if possible, to withdraw their funds from assets located in the United States and the EU. Geopolitical risks are forcing countries to convert to national currencies in transactions and to create alternative payment systems.

Countries that are concerned about importing inflation from the United States and the Fed with its monetary tightening which can reduce the supply of dollars are also trying to convert to transactions in the strongest available regional currency in accordance with the cross-border trade structure. So, as of late 2021, the Chinese yuan ranked fourth in terms of its share in international transactions.  

Reserve currencies

International reserves that are often referred to as gold and foreign exchange reserves are reliable and liquid external assets that can be used for balancing purposes in the event of a balance of payment deficit or in order to intervene in the forex market and to adjust the trade balance. That’s why central banks accumulate reserves in the currencies in which the companies of these countries carry out international trade and in which borrowing is conducted on the foreign capital markets. Prior to the coronavirus pandemic, central banks around the world held 62 percent of their foreign exchange reserves in US dollars, because the dollar was the main settlement currency in foreign trade operations in most countries. However, the situation is changing. 

Inflation in the developed countries and the all-out economic war waged by the United States and its allies are forcing countries to convert to transactions and trade in national currencies. 

Andrey Kostin, head of VTB, had the following to say at SPIEF 2022, “We are fully converting to roubles and soft currencies that can be used in settlements with the countries that are, let’s put it this way, not hostile to us. The topic (of currency) as well as currency clients is becoming irrelevant to us because, to reiterate, we are unable to provide a set of services that can be provided by the banks that are free of sanctions.” If the use of dollars and euros in international transactions is declining, the share of these currencies in the central banks’ reserves will steadily decrease as well. 

The British pound ceased to be the world's reserve currency after World War II because the UK had amassed enormous debt. The US dollar followed in the footsteps of the pound in the mid-20th century. There’s a rule in the financial world: if the debt of a reserve currency issuer in relation to GDP continues to grow and the country's “net foreign assets position” worsens as its external debt continues to grow, foreign counterparts will eventually lose interest in that currency.

According to the IMF report, the share of the US dollar in central bank reserves has decreased from 71 percent in 1999 to 59 percent in late 2021. A transition to “unconventional reserve currencies,” in particular, by a quarter to the Chinese yuan and by three quarters to the currencies of a number of smaller economies, including the Australian and Canadian dollars, as well as the Korean won, is underway.

New multi-currency “Bretton Woods”

“We are witnessing the birth of Bretton Woods 3.0, a new global monetary order based on commodity-backed currencies,” Credit Suisse wrote in a report. 

“Commodities act as collateral, and collateral becomes money, and the crisis stems from the growing appeal of external money compared to internal money. The fiat currencies of the developed countries are internal money, and they have not been tied to any collateral since the 1976 IMF Jamaica conference. These currencies are losing their appeal due to extremely high inflation triggered by uncontrolled issuance.

The suppliers of material resources are beginning to dictate the rules that govern the global economy and global finance. Head of Gazprom Alexey Miller had the following to say at SPIEF 2022, “the demand for raw materials is increasingly replacing foreign exchange reserves; this is a major tectonic shift” and “the paradigm is shifting, the dominance of the dollar is giving way to transactions in national currencies.”

Credit Suisse was among the first to notice that the EU countries and the United States have so far been reluctant to admit that President Putin's decision to convert payments for gas to roubles was a forced step, but it turned out to be of strategic importance and is becoming a pivotal point in the global financial system going forward. Payments in roubles for energy supplies and other goods coming from Russia do not run the risk of being blocked. Countries that are unfriendly, and even the ones that are friendly to Russia, have little choice. They either have to agree to buy oil and gas from Russia for roubles, or start looking for alternatives. Europe has few alternatives to Russian energy, though. Outside the EU, Russia and India are converting to transactions in national currencies, and Saudi Arabia is negotiating with China to sell a portion of its oil for Chinese yuan, not US dollars. Backed by China's manufacturing industry, the yuan is on its way to becoming the new Bretton Woods currency. Not only energy will back up national currencies like gold once did.
Confidence in the major regional economies’ national currencies will rely on the resources and technologies accumulated by the countries, their industrial output and transport infrastructure.

The integration of the Eurasian space through the efforts of large regional associations such as the SCO and ASEAN can launch the creation of a continent-wide economic, financial, investment and energy space with transactions in the member countries’ national currencies. Deeper strategic partnership within BRICS will expand the use of transactions in national currencies on three continents.  

Alternative payment systems are pushing the traditional SWIFT system aside as well. Now that Russian banks have been cut off from the SWIFT system, the creation of alternative systems will progress at a faster clip. These payment networks are based on common principles. An alternative system must rely on a group of participating banks, its own secure software and a system of message codes with payment instructions. An alternative system can use any settlement currency. Most importantly, the participating banks need to have proper corresponding accounts with the banks of the countries in whose currencies payments will be made. The system must operate its own data centres, central transaction storage and information transfer network.

If these conditions are met, many countries will have their own alternatives to SWIFT for making payments in national currencies. 

China has already created an alternative, the China International Payments System (CIPS). The Bank of Russia’s Financial Message Transmission System (FMTS) – the interbank network for transmitting financial information and making payments is already being used internationally and is, in fact, an actual alternative to SWIFT.

Russia suggested that India join Russia’s FMTS since it is adapted to sending SWIFT-format messages and foreign banks will have no trouble using it. If the Russian-Indian experience goes well, the geography of the Russian alternative to SWIFT may well expand.

Geopolitical risks that were unimaginable just a few years back are turning the idea of reliable currencies and global financial centres upside down. The countries that created and controlled the existing global financial system in mid-20th century, receiving global rent or seigniorage in the process, have dealt the most devastating blow to their own system. The world is gradually entering a new monetary order and the dollar, ironically, is becoming a victim of geopolitics.

De-Dollarization of the Economy as a Way to a New Economic Order
The change in monetary policy of China and Russia is the most dramatic turn since the Bretton Woods Conference in 1944.
Views expressed are of individual Members and Contributors, rather than the Club's, unless explicitly stated otherwise.
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