US sanctions on Russia may weaken dollar’s hold over world trade
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The Russian-Ukrainian conflict and its economic consequences on one level can be likened to a movie cliché where one character warns another: “This town’s not big enough for the both of us.” But this crisis is more than a cowboy power struggle — it has the potential to deal a decisive blow to the global economic and financial system as we know it.
The world has seen the rise of emerging economies, which have become a force to reckon with, accounting for almost two-thirds of the world’s gross domestic product growth over the past 15 years, and comprising over half of new consumption. Brazil, Russia, India, China and South Africa, collectively known as BRICS, are among the few emerging economies that have been able to forge a powerful financial position internationally.
Also, the trade interconnectedness of these countries has risen rapidly, adding to the perception that they are becoming increasingly less dependent on traditional economic powers — such as the US and the EU — and more correlated with one another.
Former US President Donald Trump’s trade war between China and the US, which began in 2018 and is ongoing, is just one feature of rising international economic tensions that have transformed into what, Carnegie senior fellow, Yukon Huang, likens to a cold war between these countries.
The economic uncertainties that followed the global downturn after the pandemic added to the cold war between the West and the East, led by the US and China, respectively.
The world’s great powers have been playing a dangerous game of Russian roulette, adding a new bullet to the cylinder at regular intervals instead of resorting to diplomacy. Now it appears the revolver has finally been loaded, and unfortunately, Ukraine’s people find themselves staring down its barrel.
The war in Ukraine may give us valuable clues into the possible development of a new, and vastly different, economic and financial world order.
Effectively, and not even a month after Russia’s invasion of Ukraine, the US, EU and their allies have imposed brutal sanctions on Russia that are unprecedented in modern history. The long list of sanctions targets Russian President Vladimir Putin himself, his inner circle of wealthy oligarchs, the Central Bank of Russia, its commercial banks, and as always, take the heaviest toll on the Russian people.
The magnitude of the West’s response severed Russia’s economic and financial ties to most of the rest of the world in a matter of days. However, where bridges are being burned, it pays to look at possible bridges being built elsewhere.
But while America’s allies have been quick to fall in line, governments with weaker ties to the West have shown a mix of reactions.
US political scientist John Mearsheimer has openly criticized American policy towards the crisis for pushing Russia into China’s arms, while China’s stance on the matter has become less ambiguous by the day.
China’s reluctance to condemn the invasion has been mirrored by other countries, with India, South Africa, Iran and Vietnam being among those who abstained from voting to condemn Russia at the UN General Assembly earlier this month.
Brazil’s Foreign Minister Carlos Franca said he will not take sides over Russia’s invasion of Ukraine; Mexico and Turkey have also refused to impose sanctions on Russia, and it doesn’t seem like Indonesia is rushing to join either.
These countries above are among the largest emerging economies in the world, together comprising over 30 percent of the world’s GDP with strong growth rates. These countries are carefully watching the current crisis unfold, perhaps with an emphasis on its economic implications, rather its political outcome.
The crushing sanctions on Russia’s central bank have highlighted a major pitfall of holding foreign currency reserves in dollars, particularly for those who fall under America’s ire. Currently, over 60 percent of the world’s foreign currency reserves are held in dollars, but the aftermath of the crisis will invoke consequences on reserve currency hierarchy.
When the US and its allies froze Russia’s central bank’s assets, the Russian ruble collapsed, because the bank could no longer use foreign reserves to defend its value.
Non-Western aligned economies may end up banding closer together, favoring alternatives to the status quo and creating an economic and financial alliance to be reckoned with
Roupina Maalouf
It is unclear whether Russia will be able to avoid defaulting on its debts, while its financial system has been all but paralyzed.
China stood aside as this happened, aware of the legal precedent that had just been established by the West. A central bank’s foreign reserves are arguably its most important asset, usually considered safely stored and always accessible. But whatever the result of this war, it is unlikely Russia will ever hold such large parts of reserves in dollars again.
These tough sanctions have also spooked other countries, which may feel that this risky precedent leaves their financial systems highly vulnerable, which will need a response on their part. One course would lie in the speedy diversification of foreign currency reserves, and if China establishes itself as a fair and balanced alternative, the shares of foreign currency reserves held in the Chinese renminbi may climb quickly.
A direct effect of these sanctions may also be the decline in dollar-denominated international trade, as countries attempt to steer clear of the danger of harsh sanctions.
The Gulf region already seems to recognize the need to ease its reliance on the traditional economic powers. The UAE has stalled a billion-dollar weapons deal with the US and is looking to China to diversify its military hardware. Saudi Arabia is weighing up using the renminbi for Chinese oil trade, and has invited China’s President Xi Jinping to visit the Kingdom.
These moves on behalf of two large regional powers could be the unprecedented step forward that marks the end of the dollar’s hegemony over the international oil and arms market, and in such a case, many smaller economies with no strong alliances to the West would surely follow suit.
Furthermore, the politicization of the SWIFT bank payments system and its use against major Russian banks may prompt countries to opt for more secure substitutes, moving the center of the global financial transactions away from the West.
China’s equivalent, the Cross-Border Interbank Payment System, has been operating in the shadow of SWIFT for some time, and while it has a long way to go, the search for less risky alternatives may lead to faster development and adoption of the Chinese alternative worldwide.
This begs the question, will these sanctions have the effect Western allies hope for? We might find answers in a brief historical survey of the heaviest sanctions America has imposed on adversaries.
It seems that states often find ways to weather the economic storm without changing course. In Venezuela, sanctions have not pushed out President Nicolás Maduro, although his position as head of state has been disputed since 2019. Sanctions were not effective in Cuba against former President Fidel Castro. And over four decades of harsh economic sanctions on Iran have done little to change the course of the government.
To further complicate matters, the EU is reeling alongside Russia in the face of the current sanctions given its dependency on Russian oil and gas, sparking inflation as well as outflows from European stocks.
This has prompted the world to stop and think about what comes next, and that may not bode well for the status quo. The US has maintained its hegemony in what has been termed as a unipolar world order over the past three decades through control of international money transfers and dollar dominance over the world economy. In what may be a surprising side effect of this war, the dollar’s dominance of the global financial system is threatened, a possibility perhaps foreseen by Putin and Jinping.
Non-Western aligned economies may end up banding closer together, favoring alternatives to the status quo and creating an economic and financial alliance to be reckoned with.
How fast these changes will occur, to what extent, and how much economic clout can the US and EU hold on to, are questions for another day.
• Roupina Maalouf holds a dual degree in Economics and Political Science from the Lebanese American University. She discusses how politics and economics interact in global affairs.
