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The IMF warns that Western sanctions against Russia could undermine the dollar's dominance. It can lead to fragmentation of the international monetary system. This is what the chief economist of the IMF, Gina Gopinath, said in an interview with the Financial Times. In response to Russia's invasion of Ukraine, Western countries imposed severe financial sanctions, such as blocking foreign exchange reserves held by the Russian central bank. As a result, Russia no longer has access to more than half of its reserves. She can still access her gold reserves and the reserves in yuan.
These kinds of measures can lead to countries worldwide trading in other currencies more often. Currently, the US dollar and the euro are the most important in international trade, with the dollar being by far the largest reserve currency. Many countries hold their reserves in dollars because they can use them to import commodities such as oil from anywhere in the world. But if access to dollar reserves can no longer be guaranteed, countries may decide to switch to other currencies. As a result, they need fewer dollars, which will undermine the dollar's dominance. Precisely because the whole world holds dollars, the U.S. can borrow cheaply and go into debt.
"The dollar will continue to be the most important world currency, even in that landscape. But fragmentation at a lower level is certainly possible", Gopinath said. "We are already seeing some countries renegotiating the currency in which they want to be paid", she added. Still, she remains of the opinion that the U.S. dollar will remain the most important currency for international trade. Over the past two decades, the dollar's market share in central bank reserves has fallen from 70% to 60%. This is not only because of the euro, but also because of the rise of, for example, the Chinese yuan. About a quarter of the decline in the dollar's share is attributable to the yuan's advance.
These developments also have an effect on the composition of central banks' foreign exchange reserves. "Countries tend to hold reserves in the currencies they trade with and borrow from the rest of the world. So we could see a slow trend where other currencies start to play a bigger role.", according to the IMF's chief economist. Nevertheless, she remains of the opinion that the dollar will remain the most important currency, because she believes that there are strong and reliable institutions behind it and the market for dollars is very large and liquid.
The euro also had international ambitions, but the financial sanctions against Russia have not helped confidence in the currency. The euro has recently depreciated against the dollar. And where European countries used to pay predominantly with euros for Russian gas, Putin is now demanding rubles. Until recently, Russia was still very positive about the use of the euro as an alternative to the dollar. Europe will now have to significantly reduce the international ambitions of its common currency.
In recent years, Russian President Vladimir Putin has often Warned that the United States should not use the dollar as a weapon use. Previously, countries such as Venezuela and Iran were already cut off from the international SWIFT payment system, now it is Russia's turn. According to the Kremlin, freezing the central bank's foreign exchange reserves is an outright economic declaration of war. According to former President of Russia, Dmitry Medvedev, these sanctions will boomerang return. It will drive up fuel and energy prices, especially in Europe, and undermine confidence in the dollar and the euro.
"The world is waking up. Confidence in reserve currencies is melting like snow in the sun. Abandoning the dollar and the euro as the main reserve is no longer a fantasy", Medvedev said. He added that the era of regional currencies will dawn. He is referring to a world in which countries pay for raw materials not only in dollars, but also in euros, rubles and Chinese yuan. For example, India already has a Currency Swap Russia to circumvent sanctions. Earlier, India bought 3 million barrels of Russian oil against Substantial discount. Saudi Arabia, meanwhile, is considering paying for part of its oil exports to China in yuan.
These developments could undermine the dollar's position. At the same time, many countries and companies worldwide have still borrowed large amounts in dollars. In that perspective, the world is still very much 'dollarized'. This means that countries will still need dollars to meet their obligations in the coming years. As a result, they are often unable to switch to another currency overnight. But it is now certain that the monetary world order is about to change structurally.
This contribution comes from Geotrendlines
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On behalf of Holland Gold, Paul Buitink and Joris Beemsterboer interview various economists and experts in the field of macroeconomics. The aim of the podcast is to provide the viewer with a better picture and guidance in an increasingly rapidly changing macroeconomic and monetary landscape. Click here to subscribe.
