- While countries are seeking to diversify their reserves out of the dollar, that pace has been glacial at best, with the dollar’s share of reserves going from 70% to 60% over the past two decades.
- An unexpected beneficiary of a possible decline in the dollar’s dominance could come from digital finance, from cryptocurrencies to stablecoins, or even central bank digital currencies, suggests Gopinath.
While many have cheered (and rightfully so) the unprecedented breadth and depth of Western sanctions against Russia for its invasion of Ukraine, it also raises uncomfortable questions about the dollar’s centrality to the global financial system.
According to Gita Gopinath, the IMF’s Deputy Managing Director, the sweeping measures imposed by Western countries on Russia, including restrictions on its central bank, would encourage the emergency of small currency blocs based on trade between smaller groups of countries.
And some of these countries may not even be that small.
Take China for instance, the world’s second largest economy.
Till date, Beijing has refused to condemn Russia’s invasion of Ukraine and U.S. officials report that China has remained open to providing both financial and military support to Russia as it finds itself excluded from the rest of the world.
In an interview with the Financial Times, Gopinath suggested,
“The dollar would remain the major global currency even in that landscape but fragmentation at a smaller level is certainly quite possible.”
“We are already seeing that with some countries renegotiating the currency in which they get paid for trade.”
One of those countries “renegotiating” has been Russia, with Moscow threatening to cut off gas supplies to Europe if these contracts are not paid for using Russian rubles.
For years, Russia has sought to reduce its dependence on the dollar, a campaign that accelerated in earnest after U.S. imposed sanctions in retaliation for Moscow’s annexation of Crimea in 2014.
But weaning the world off the dollar isn’t as straightforward as it may seem – Russia still had roughly a fifth of its foreign reserves in dollar-denominated assets even on the eve of its invasion of Ukraine.
And China is just behind Japan in terms of its holdings of U.S. Treasuries, with just over a trillion dollars in U.S. sovereign borrowings on Beijing’s books.
Even Gopinath concedes that in the medium term, dollar dominance is unlikely to be challenged given its backing by strong and highly credible institutions, deep markets and free convertibility.
And while countries are seeking to diversify their reserves out of the dollar, that pace has been glacial at best, with the dollar’s share of reserves going from 70% to 60% over the past two decades.
Much of that decline has been due to the growth of the Chinese yuan in international transactions – but that continued growth cannot be assumed.
China still lacks full convertibility of its currency, nor does it have open capital markets or the institutions to support them, something which may never arrive as it would require independent institutions and checks and balances, in a country where the Communist Party exerts its grip and influence on every aspect of life.
An unexpected beneficiary of a possible decline in the dollar’s dominance could come from digital finance, from cryptocurrencies to stablecoins, or even central bank digital currencies, suggests Gopinath
