At the end of January, Russia had foreign exchange reserves worth $469 billion. This treasure was the result of the prudence taught by the 1998 bankruptcy and, Vladimir Putin hoped, also a guarantee of his financial independence. But when his “military special operation” began in Ukraine, he learned that more than half of his reserves were frozen. The currencies of his enemies were no longer viable money. This action is significant not only for Russia. Targeted demonetization of the world’s most globalized currencies is having major implications.
Money is a public good. A global money – one that people rely on for their cross-border transactions and investment decisions – is a global public good. But the providers of this public good are national governments. Even under the old gold currency standard, that was the case. In our era of fiat currency (manufactured by the government), this has been even more evident since 1971. In the third quarter of 2021, 59 percent of global foreign exchange reserves were denominated in dollars, another 20 percent in euros, 6 percent in yen and 5 percent in sterling. China’s renminbi still accounted for less than 3 percent of world reserves. Today, global funds are spent by the US and its allies, including small ones. (See diagrams.)
This is not the result of a conspiracy. Useful funds are those of open economies with liquid financial markets, monetary stability, and the rule of law. But weaponizing these currencies and the financial systems that handle them undermines these qualities for any holder who fears being targeted. Sanctions against the Russian central bank come as a shock. Who, governments ask, is next? What does this mean for our sovereignty?
One can object to the West’s actions on purely economic grounds: arming currencies will fragment the world economy and make it less efficient. That, one might reply, is true but increasingly irrelevant in a world of severe international tensions. Yes, it’s another force for deglobalization, but many will ask, “So what?” A more worrying objection for Western politicians is that using these weapons could harm them. Won’t the rest of the world rush to find ways to trade and store assets that bypass the currencies and financial markets of the US and its allies? Isn’t that what China is trying to do?
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It is. In principle, four substitute currencies would be conceivable for today’s globalized national currencies: private currencies (e.g. Bitcoin); commodity money (like gold); a global fiat currency (like the IMF’s Special Drawing Rights); or another national currency, most obviously China’s. The first is unimaginable: the market value of all cryptocurrencies is currently $2 trillion, only 16 percent of the world’s foreign exchange reserves, while direct transaction in cryptocurrencies is incredibly cumbersome. Gold can be a reserve asset but is hopeless in transactions. There is also no chance of agreeing on a global currency with sufficient weight to replace reserves, let alone be a global transaction vehicle.
This leaves another national currency. An excellent recent pamphlet by Harvard’s Graham Allison and colleagues on The Great Economic Rivalry concludes that China is already a formidable competitor to the US. History suggests that the currency of an economy of this size, sophistication, and integration would become a global currency.
So far, however, this has not happened. That’s because China’s financial system is relatively underdeveloped, its currency is not fully convertible, and the country lacks a true rule of law. China is far from providing what the sterling and dollar offered in their heyday. While holders of the dollar and other major Western currencies might fear sanctions, they certainly need to be aware of what the Chinese government might do to them if they don’t like them. Equally important, the Chinese state knows that an internationalized currency requires open financial markets, but that would radically weaken its control over China’s economy and society.
This lack of a truly credible alternative suggests that the dollar will remain the world’s dominant currency. But there is an argument against this smug view, set out in Digital Currencies, a thought provoking booklet from the Hoover Institution. In essence, this means that China’s cross-border interbank payment system (Cips – an alternative to the Swift system) and digital currency (the e-CNY) could become a dominant payment system and vehicle currency, respectively, for trade between China and many trading partners . In the longer term, e-CNY could also become a major reserve currency. Furthermore, the brochure argues, this would give the Chinese state detailed knowledge of the transactions of each entity within its system. That would be an additional source of strength.
Today, the overwhelming dominance of the US and its allies in global finance, a product of their overall economic size and open financial markets, gives their currencies a dominant position. Today there is no credible alternative for most global monetary functions. Today, high inflation is likely to pose a greater threat to dollar confidence than its arming against rogue nations. In the longer term, however, China may be able to create a walled garden for the use of its currency by those closest to it. Despite this, those wishing to do business with Western countries will still need Western currencies. What could emerge are two monetary systems – one Western and one Chinese – that operate in different ways and overlap uncomfortably.
As in other respects, the future promises less a new world order centered around China and more disorder. Future historians might see today’s sanctions as another step along this path.
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