About the author: Christopher Smart he is chief global strategist and head of the Barings Investment Institute, and is a former senior economic policy officer at the United States Treasury and the White House.
The whispered warnings have been under construction for some time as the United States adds sanctions on sanctions to targets from Myanmar to Venezuela. The more Washington turns the dollar into a foreign policy tool, the logic is, the more everyone will look for alternatives.
But in the weeks following the most dramatic sanction by an evil government the world has ever seen, does the idea that sanctions will be counterproductive still hold true? Should attentive finance ministers now have their fill of renminbi, gold and bitcoin in case their country collides with the US Treasury? Or the lesson is that there are simply no good alternatives to the world’s reserve currency, especially when America gets the support of its most important partners in Europe, Japan and beyond?
As Russia begins its long descent towards autarchy, the answer is clearer and clearer.
Concern over the excessive use of dollar sanctions has increased as the list of US targets has grown by 933% (according to the US Treasury’s own tally!) Across both Republican and Democratic administrations since last year in office. by President Bill Clinton. Of the approximately 9,400 sanctions currently in place, most have been directed against Iran, Venezuela and North Korea. About 1,600 targeted terrorist groups.
Sanctions always seem tempting to besieged US politicians who don’t want to send troops to quell a crisis but simply can’t do anything. So it should come as no surprise that the steady escalation over the course of two decades turned into a financial carpet bombing after the attack on Russia last month. Among all the bans on technological exports, travel by oligarchs and transfers of assets, the Coup de grace it was the coordinated decision by the US and Europe to sanction the Russian Central Bank.
Russia has now become a grim economic experiment in what happens to a country that is isolated from its most important financial and trade flows. Of course, for now, Europe continues to buy a lot of Russian oil and gas, and trade with the likes of India and China will continue. But it’s one thing to lose access to imported Brie and Gucci loafers; it’s another if you can’t buy medicine or airplane parts. Soaring inflation looms as the value of the ruble plummets, but factories that can’t keep their foreign capital goods will lay off swarms of workers long before price increases escalate.
These consequences would be terrible for any country, but above all for the one that has spent years isolating itself from the damage of sanctions. After Russia’s annexation of Crimea in 2014, Moscow reduced its dollar reserves from 40% of reserves to just 16% last year. The government sold almost all of its holdings in the US Treasury and the sovereign fund got rid of the dollars completely.
In many ways, of course, the invasion is so dramatic that it may not be a useful precedent. If Vladimir Putin had simply tried to reclaim some of the Russian-speaking Donbass in eastern Ukraine, it is unlikely that the international reaction would have been nearly as severe. Furthermore, Russia had found a way to adapt to the long list of recently imposed minor penalties for assassinations and cyber attacks related to its secret services.
Large economies like China, India or Brazil may feel less vulnerable to such extreme measures because they are more integrated into the world’s trade and financial flows. Russia’s sanctions will have unexpected repercussions on international food and energy markets, but the risks of a global recession appear low. Imposing such stringent measures on much larger economies would result in much larger supply chain disruptions and lasting price spikes. They risk injuring the sanctioner almost as much as the sanctioned one.
But the drama unfolding in Russia will still force many countries to think carefully about what to do with their reservations and they won’t find many good answers. The Chinese renminbi will certainly continue to grow in importance as a global currency, but it will likely have its constraints. Cryptocurrencies and precious metals sound attractive and apolitical, but they are not very useful in a world where the overwhelming share of foreign exchange trade and transactions is conducted in euros and dollars.
Are these considerations enough to determine misconduct or encourage market reforms and political openness? Probably not. Another lesson from this invasion is that leaders don’t always do what is strictly in their financial interest when emotions are high and decisions are impulsive.
But if most of the things a country needs to buy are denominated in reserve currencies, and if these currencies mostly hold their value and pay interest on their debts, then perhaps diversifying from them makes no sense. And anyway, maybe that’s not possible.
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