Will the Sanctions Against Russia Accelerate the De-Dollarization of the World?

Not for now, but the changeover seems to have started.

The Russian invasion of Ukraine and the salvo of economic sanctions that followed will upset the international financial system in the medium and long term, even if the uncertainties about the evolution of the conflict should make us cautious about the extent of the possible changes. On Saturday 26 February, the West decided to freeze the reserves of the Russian central bank held abroad with other monetary institutes, such as those in the eurozone.

By prohibiting it from dipping into this war chest, the Americans and Europeans want to prevent the Russian central bank from defending the ruble in the face of the economic and financial crisis into which the country is about to plunge.

This unprecedented measure is a thunderclap on the monetary planet. It will leave its mark. It means that the security of a country's reserves held abroad is not guaranteed. They can be held hostage to sanctions, particularly from Washington - because they are still largely held in dollars, at 59% of the world's foreign exchange reserves, according to the International Monetary Fund (IMF). Far ahead of the euro (20.5%):

After the Asian crisis of 1997, many emerging countries greatly inflated their reserves to protect their currencies in the event of a crisis. Will the sanctions targeting the Russian central bank prompt some to diversify their reserves - for example, into gold or the yuan - to remove them from US influence? Without a doubt.

This is a move that Russia has been following since 2014 and that has led its sovereign wealth fund to completely break away from the US dollar in early summer 2021.

What is even more problematic with the dollarization of the world is that in recent years, the United States has also taken advantage of the greenback's dominant position to impose fines on foreign companies trading in dollars with certain states. An example is BNP Paribas, which in 2014 was ordered by Washington to pay $9 billion for circumventing U.S. embargoes in four countries, including Iran.

Since the invasion of Crimea in 2014, Russia has begun to diversify its reserves, in particular by increasing the share held in yuan (around 17% today, which is huge compared to other central banks where the allocation on the yuan is between 2 and 3%). It has also developed its own financial communication system, the SPFS (System for Transfer of Financial Messages), to reduce its dependence on the western SWIFT network, from which seven of its banks were excluded at the beginning of March 2022. The SPFS already accounts for 20% of the payments made in Russia and is used by a host of banks in the former Soviet bloc.

China is doing nothing different. Since 2005, it has been slowly internationalizing its currency to accompany the rise of its economy, while de-dollarizing it. In 2010, Chinese companies were allowed to pay for their imports and exports in yuan - until then, they had been paying in dollars. In the wake of this, the government made Hong Kong the first offshore center for its currency, authorizing a subsidiary of the Bank of China to manage the international supply of yuan.

This has allowed the development of a host of financial services and products around the Chinese currency, such as investment advice, asset management, and, above all, bond issues in yuan. Finally, in recent months, Beijing has accelerated the deployment of its digital yuan, a currency that could eventually replace coins and bills. This is an attempt to take advantage of the first-mover advantage in the CBDC field to challenge the hegemony of the US dollar in a future world where everything will be digital.

But the yuan, partially convertible, remains a dwarf compared to the dollar: it represents only 2.66% of the world's foreign exchange reserves, according to the International Monetary Fund. Its internationalization leaves many observers skeptical. It can only become a major alternative currency to the dollar if Beijing agrees to liberalize its use more widely, which is far from obvious. Moreover, it is not even certain that this is part of the Chinese Communist Party's plans.

The de-dollarization of the financial system is therefore not for tomorrow, but the changeover is underway, and it will inevitably be accompanied by monetary instability. This war between Ukraine and Russia, as well as the unprecedented sanctions taken by the West against Russia, could act as a gas pedal in this new trend for the future.

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