The Axis of Anti-Dollar

Russia and China's Attempts to Avoid US Economic Power.

Russian forces are already gaining territory across Ukraine, shelling military and civilian targets, and closing in on Kyiv, the country's capital. The international reaction to Russian President Vladimir Putin's invasion has been vehement, and US allies are unified in their opposition to the attack. President Joe Biden of the United States has led the international community in putting severe sanctions on Russian officials and corporations in order to cripple the Russian economy and force a change of course. However, thus far, these measures have failed to convince Russia to agree a cease-fire or withdraw from the conflict.

The fight has just been going on for ten days, and it remains to be seen what Putin will do if and when sanctions exacerbate public anger in Russia. However, these punitive measures may potentially backfire in another way. Biden's flexing of American economic strength will only embolden Russia and other US adversaries, particularly China, to deny the US of the same leverage that makes sanctions so damaging. Russia and China will accelerate efforts to "de-dollarize" their economy by establishing alternative financial institutions and structures that will safeguard them from sanctions while also threatening the US dollar's dominance as the world's dominating currency. Without concerted effort, the United States would struggle to reverse this trend and will see its global standing erode.

The US dollar's dominance in the global financial system, supported by thriving US markets and unrivaled US military might, makes any sanctions imposed by Washington formidable. No other currency, including the euro and the yuan, has come close to dethroning the dollar as the dominant currency in the global economy and international financial markets. The dollar is the world's most extensively held reserve currency. It is the primary currency for worldwide trade and the dominant currency among global financial institutions. It has a stranglehold on global equity markets, commodities markets, development financing, bank deposits, and global corporate borrowing. People all throughout the world look to the dollar as a safe-haven currency in times of distress. Sanctions imposed by the United States effectively amputation a foreign aggressor's financial power, stopping it from raising funds in global markets to fund its activities.

Russia may be the most vocal opponent of the dollar's yoke, but its aim enjoys widespread support among key states. China's resolve to diversifying its foreign exchange reserves, encouraging more yuan transactions, and restructuring the global currency system through IMF revisions strengthens Russia's plan. The deterioration of US-Chinese relations encourages Beijing to collaborate with Moscow in developing a credible global financial system that excludes the US. A system like this will entice countries that are subject to US sanctions. It would even entice important US allies who want to promote their own currencies at the expense of the dollar. When applying sanctions, the Biden administration must evaluate not only how these measures may shape the Ukrainian conflict, but also how they may affect the global financial system.

THE YOKE OF THE DOLLAR

For at least a decade, Russian policymakers have been apprehensive of the dollar's dominance. Sergei Ryabkov, Russia's Deputy Foreign Minister, underlined Russia's concern over the dollar's dominance in international trade in 2012. Following the invasion of Crimea in 2014, the Obama administration increased sanctions against Russia, targeting several significant Russian banks, as well as oil businesses, defense corporations, and wealthy Putin allies. Following that, the Russian government launched two critical pieces of financial infrastructure to fend off sanctions and maintain financial autonomy if it was cut off from the Society for Worldwide Interbank Financial Telecommunications system, also known as SWIFT, which allows banks to send messages to one another. One was a self-contained national payment system that functioned as a Russian alternative to payment platforms such as Visa and Mastercard. The other was a proprietary financial messaging system known as the System for Transfer of Financial Messages, or SPFS, which is the Russian equivalent of SWIFT.

SPFS became live in 2017 and can now send transaction messages in any currency. It had 38 international participants from nine nations in December 2021. SPFS has over 399 users as of March, including more than 20 Belarusian banks, the Armenian Arshidbank, and the Kyrgyz Bank of Asia. SPFS is accessible to subsidiaries of significant Russian banks in Germany and Switzerland, Europe's two most important financial powerhouses. Russia is now in talks with China about joining the system. Despite sanctions, this alternative financial infrastructure allows Russian firms and individuals to maintain some, albeit limited, access to global markets.

The Bank of Russia has also significantly cut the share of dollars in Russia's foreign exchange reserves since 2018 by purchasing gold, euros, and yuan. It also removed a large portion of its reserves from US Treasury bonds; between March and May 2018, the Bank of Russia's holdings of US Treasury securities fell from $96.1 billion to $14.9 billion. In early 2019, the bank reduced its holdings of US dollars by $101 billion, accounting for more than half of its total assets. Following the imposition of new sanctions on Moscow by the Biden administration in 2021, Russia announced its intention to withdraw all dollar assets from its $186 billion National Wealth Fund, a major sovereign wealth fund.

At a currency exchange in Moscow, January 2016
At a currency exchange in Moscow, January 2016
Sergei Karpukhin / Reuters

Putin has pledged to defend Russia's economic sovereignty against US sanctions since the start of his fourth presidential term in 2018, and has prioritized policies that steer the country's economy away from the dollar. He called for being "free" of the dollar's "burden" in the global oil trade and the Russian economy, claiming that the US dollar's monopoly was "unreliable" and "hazardous." In October 2018, the Putin administration backed a plan to use alternative currencies in international transactions to limit Russia's exposure to future US sanctions. Since then, major Russian energy corporations have abandoned the use of the US dollar. In 2015, Russia's third-largest oil producer, Gazprom Neft, sold all of its shipments to China in yuan. In 2019, Rosneft, Russia's largest oil and gas corporation, converted all export contracts from US dollars to euros. The euro has already surpassed the dollar as the major medium of exchange between China and Russia. According to data from the Bank of Russia, more than 83 percent of Russian exports to China will be settled in euros by the end of 2020. Russia and China inked a 30-year pact last month in which they agreed to use euros in gas sales associated to a new pipeline connecting the two nations, which is expected to be operational in the next two to three years.

Russia is reportedly working to establish a state-backed cryptocurrency capable of circumnavigating the dollar. Sanctioned Russian firms can trade directly with anyone who accepts the digital ruble without first converting it to dollars, effectively circumventing the dollar-based system. The government would invite non-banking financial entities, like as exchanges and credit institutions, to join the digital ruble network, according to a 2020 Bank of Russia consultation paper on the digital ruble. This arrangement might offer Russian banks with an alternate source of international cash while also reducing their vulnerability to sanctions.

A STRONG COALITION

Russia's unilateral measures to break free from the dollar's grip may be defensive in character, but it has also collaborated with other countries to weaken the dollar's grip. These alliances provide a long-term danger to the dollar's dominant role in international commerce, as well as a challenge to US global leadership. Russia and China's relationship has been reinforced by their common ambition to lessen reliance on the currency. Bilateral currency swaps between the two central banks aided Russia in evading US sanctions in 2014, facilitating bilateral trade and investment. In 2016, Prime Minister Dmitry Medvedev asked for the two nations' national payment systems to be harmonized and considered the possibility of developing a new Russia-China cross-border payment system for yuan and ruble direct settlements. According to Putin, Russia and China "reaffirmed their desire in using national currencies more actively in reciprocal payments" in 2018.

In 2019, China elevated its relations with Russia to a "comprehensive strategic partnership of coordination for a new era," the highest degree of bilateral relations between the two countries. Following that, the Russian central bank invested $44 billion in yuan, raising its share of Russia's foreign exchange reserves from 5% to 15% in early 2019. Russia's yuan holdings are around 10 times the global average, accounting for nearly a quarter of total global yuan reserves. China and Russia inked a deal in 2019 that mandates the usage of their respective national currencies in cross-border commerce to be 50%. Russian Foreign Minister Sergei Lavrov asked China in 2021 to collaborate with Russia to lessen their reliance on the US dollar and Western financial systems. The Russian government granted permission for Russia's sovereign wealth fund to invest in yuan reserves and Chinese state bonds. Chinese policymakers expect that cooperation with Russia will aid in the development of a yuan-based financial infrastructure, such as a Chinese counterpart to SWIFT and a rival bank card payment system, enhancing the yuan's reputation as a reserve currency and bolstering China's financial autonomy.

Through Russia's dealings with other countries, Putin hopes to expand such alternative financial infrastructure. In 2019, Iran and Russia linked their financial messaging systems, allowing banks in both countries to exchange cross-border transaction messages without using SWIFT. Russia and Turkey have considered the use of the Russian ruble and the Turkish lira in cross-border trade. Russia introduced their version of SWIFT to banks in the Eurasian Economic Union (a collaboration of five post-Soviet governments) and stated interest in expanding it to Arab and European countries. Russia has attempted to rally additional support for de-dollarization in multilateral forums such as the BRICS grouping of Brazil, China, India, Russia, and South Africa, as well as the Shanghai Cooperation Organization. As part of its ambition to "break away from the tyranny of hard currencies," the BRICS New Development Bank has raised funds in local currencies. In 2020, SCO members emphasized the necessity of using national currencies in cross-border trade and proposed the establishment of a development bank and fund. Russia and China may utilize these venues to forge a wide de-dollarization alliance, promising greater financial autonomy and less reliance on the dollar.

IMPROVING THE DOLLAR

The Biden administration must assess the broader context while deciding how to best compel Russia to leave Ukraine. Additional sanctions against Russia could aid Ukraine in the near term, but they risk speeding a broader de-dollarization drive that could fundamentally harm US global leadership in the long term. If the United States wants to maintain the foundation of its hegemonic status and the dollar's service as a stable public good necessary for global financial stability, it should enhance the dollar-based global financial system. By lowering tensions with China and encouraging China to use SWIFT rather than transitioning to alternate systems, the Biden administration can maintain the dollar's global dominance. The United States should not pursue policies that would result in a financial decoupling from China. Financial authorities in the United States should respond to their Chinese counterparts' call to improve communication and collaboration on market regulations. US officials could also encourage more Chinese enterprises to list on US equity markets, which would incentivize China to maintain the stability of global financial systems based on the US dollar.

The US should erode Russia's primary financial strength: the earnings generated by oil and gas exports. Energy cooperation between the United States and Europe is critical to reduce the EU's reliance on Russian energy. To do this, the Biden administration should give alternate energy supplies to its European and Asia-Pacific allies in the short term. In the medium to long term, the US should collaborate with its allies to counter Russia's nuclear power exports. Russia's total dominance in the worldwide nuclear energy exports market (it controls 60% of the industry) allows it to weaponize its control over nuclear power technology and fuel supply during times of geopolitical conflict. Congress should expand the Export-Import Bank of the United States' ability to form new public-private partnerships and provide additional financial assistance to U.S. firms in the nuclear energy exports market.

Congress should also provide the Development Finance Corporation, the United States' development finance agency, the authority to become a reputable source of capital for emerging markets and low- and middle-income countries. Development finance is a critical but underutilized tool of economic diplomacy. Russia has attempted to push de-dollarization measures via international development institutions, and the US must respond. Washington should enhance the DFC's prominence and collaborate with U.S. allies' development finance institutions, such as the Japan Bank for International Corporation, to strengthen the dollar's position and U.S. leadership in international development finance.

A strong US economy is the most effective and credible tool for combating rivals aiming to undermine currency confidence. Countries and businesses comply with US sanctions in order to maintain access to US markets, the US dollar, and the larger US-led global system. The United States should be cognizant of the unintended implications of its sanctions policy and work to undercut Russia and China's de-dollarization collaboration. If Washington does not act, it is effectively opting to relinquish the role of global leadership.

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