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The world economy is in danger of falling apart into different power blocs, with each bloc trying to involve other countries in its sphere of influence. This fragmentation can accelerate quite suddenly and undermine the dollar's international status as the world's reserve currency. ECB President Christine Lagarde said this in a statement this week speech for the American think tank Council on Foreign Relations. She warns that a process of deglobalisation could be accompanied by increasing instability, which will lead to higher prices. But what can central banks do about it?
Since Russia's invasion of Ukraine, the shift to a multipolar world order has accelerated. The sanctions war waged by Western countries against Russia more or less forces the rest of the world to choose a side. Since then, more and more countries in the Middle East, Asia, Africa and South America have joined a new Eurasian power bloc led by Russia and China. This is not only reflected in the growth of the BRICS countries, but also in the fact that more and more countries want to commit to the Shanghai Cooperation Organisation (SCO). This alliance, founded by China, can now count on the support of Russia, Iran and Saudi Arabia, among others.
According to Lagarde, this development, in which more countries are orienting themselves towards the East, could have far-reaching consequences for central banks. Indeed, their task of ensuring price stability will prove much less effective if the world is faced with more geopolitical conflicts. These conflicts can disrupt supply lines, for example of energy sources or rare earths. If prices rise as a result, there is little central banks can do about it. These are new challenges that did not exist in the era of globalisation and increasingly efficient world trade that is now behind us. Lagarde says:
"This period of relative stability may now give way to a period of persistent instability, leading to lower growth, higher costs and more uncertain trade partnerships. Instead of more elastic global supply, we may risk repeated supply shocks. Recent events have shown the extent to which critical supplies depend on stable global conditions."
Lagarde speaks of a new world map, in which global companies are regionalizing their production processes and building in extra buffers to absorb shocks in logistics chains. With all the consequences that this entails for the global economy, because a Recent study Based on data since 1900 has shown that geopolitical risks lead to high inflation, lower economic activity and a decline in international trade. "If global value chains fragment along geopolitical lines, it will have a price-pushing effect."
Following on from that, Lagarde also says some interesting things about the shift in the central banking landscape. After World War II, the U.S. dollar became the world's reserve currency and the main currency for international trade. More recently, the euro has also gained a position as an international currency. Also, the Western SWIFT messaging system now accounts for more than 90% of all international transactions between financial institutions. However, new trading patterns can put pressure on these established structures. Lagarde says:
"Recent studies indicate that there is a significant correlation between a country's trade with China and how many reserves a country holds in renminbi. New trade patterns can also lead to new alliances. One study finds that alliances can increase a currency's share of the partner's reserves by about 30 percentage points. All of this may create an opportunity for certain countries looking to reduce their reliance on Western payment systems and currency frameworks – for reasons of political affiliation, financial dependencies, or because of the use of financial sanctions over the past decade."
Lagarde mentions a number of trends that are indicative of the shifts in the monetary landscape. For example, more and more countries want to use their own currencies for international trade instead of dollars or euros, more and more countries are adding gold to their reserves, and attempts are being made to develop alternatives to SWIFT. As a result, the international status of the dollar as a reserve currency is no longer so self-evident, according to the central banker:
"Since 2014, Russia has developed such a system for domestic and cross-border use, with more than 50 banks in a range of countries using it last year. And since 2015, China has set up its own system to settle payments in renminbi. These developments do not indicate an immediate loss of dominance for the US dollar or the euro. So far, the data does not show any substantial changes in the use of international currencies. But they do suggest that international currency status can no longer be taken for granted."
Lagarde's speech contains a number of striking statements for a central banker, which are indicative of the times in which we live. The U.S. dollar and the euro are still the most dominant currencies, but that is no longer a given. China has already set up several currency swaps with other central banks in recent years to promote the use of the yuan. At the end of last year, Chinese President Xi Jinping also proposed paying for oil and gas in yuan during his visit to the Middle East. In this way, the petroyuan gaining a foothold.
To strengthen the position of the euro, Europe must complete the capital markets union, Lagarde concludes. "This will be crucial in determining whether the euro will remain one of the most important global currencies or whether others will take its place." According to the central banker, the ECB must also remain at the forefront of innovations in the payment system and the development of a digital currency. Will that be enough to cope with the shift to a multipolar world order? Only time will tell.
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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.
