The Big Picture: De-Dollarization Stalemate

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• The US' readiness to resort to sanctions and tariffs to put pressure on its political opponents and economic rivals has stimulated a de-dollarization drive by Russia, China, Venezuela, Iran -- and even Europe. • If successful, efforts to move away from the dollar could in the long run make US foreign policy less effective, and its economic policy less flexible. But plenty of hurdles stand in the way. The view from the outside is that the US is increasingly playing politics with the dollar -- from its sanctions drive against Iran, Venezuela and Russia to its trade standoff with China -- prompting the targets of such pressure to seek ways to disengage with the dollar in a bid to avoid further pain. Steps so far include increasing the use of local currencies in bilateral trade; selling oil in euros; pricing crude in yuan; developing financial messaging alternatives to the Society for Worldwide Interbank Financial Telecommunication (Swift), which is interlinked with the US banking system; and switching to gold and other currencies for government savings. The stakes are high. If alternatives to the dollar gain real traction, US sanctions policy could lose its power, while Washington could be deprived of its “exorbitant privilege” of issuing debt in its own currency, which could rebound on the size and reach of the US economy in the future (EC Jan.19'18). But the reality is that inroads against the dollar have been modest so far. The strength of the US dollar, soundness of US banks, depth of US companies in global supply chains and transparency of the US financial system mean it will be difficult to undermine the role of the US dollar as a major reserve and payment currency, an April study by the Center for New American Security (CNAS) points out -- with only something like a massive federal debt crisis or major US foreign policy blunder making it possible. But the US' opponents are nonetheless girding for a longer battle. Russia has been working hard on the de-dollarization of its economy, foreign trade and banking operations, or, as President Vladimir Putin put it, "it's not us who is leaving the dollar, it's rather the dollar that is leaving us" -- seen as a pointed a reference to US financial sanctions against Russian state-controlled banks and corporations. Moscow plans to increase the share of payment in rubles in external trade to 30% by 2024 from 20% in 2018, and to lower the share of US dollars in its savings from the current 40% to some 24%. But increasing the role of the ruble in external trade is challenging because it lacks liquidity compared to the dollar and the euro. Moreover, Russia's decision to sell $100 billion in US dollar-denominated assets and shift them into euros and yuan didn’t result in a sell-off of US treasuries -- with foreign holdings of US treasury securities instead up from a year ago, wrote Cornell University's Eswar Prasad in a September Brookings paper on the dollar’s dominance. De-dollarization politics were behind the decision by Russia’s biggest oil producer, Rosneft, to transfer all of its crude and oil products contracts to euros (IOD Oct.25'19). But the move is not expected to undermine the petrodollar. Instead, Rosneft's move means buyers face additional costs to convert dollars into euros. “Each cargo of Rosneft crude will be more expensive now,” one of its customers admits. According to calculations by Bloomberg, Russia's experiment in diversifying away from the dollar has already seen Moscow miss out on some $7.7 billion in potential returns, with the Russian central bank increasing its exposure to "underperforming currencies such as the euro and yuan" and missing out on rallies in the dollar. Depreciation of the yuan is also one of the reasons behind the poor performance this year of China's first oil futures contract, launched in March 2018. The Shanghai International Energy Exchange was hailed as the biggest bet on the yuan's internationalization. While volumes increased almost every month last year to top 5 billion barrels in December 2018 and January 2019, they have fallen almost steadily since then, to below 2 billion bbl in October and November. “The Chinese yuan is not convertible and the Chinese government has imposed various controls over capital outflows. Such controls have been strengthened by the trade war and the yuan depreciation. So I don’t think the internationalization of the yuan has strengthened over the past year," says Xing Yuqing, a visiting economics professor at the National University of Singapore (EC Oct.5'18). What's more, “to have internationalization of the yuan, you need a third party willing to trade it. Bilateral trading does not mean internationalization," he continues. Moreover, despite the political will of Russia and China to move away from the dollar, each side is pushing for a bigger role for its own currency. Where the yuan has gained strength, it has been in countries whose currencies "are even less stable than the yuan” -- such as Vietnam, Cambodia and Myanmar, Xing adds. Both Russia and China have developed alternatives to Swift -- while Europe has put forward its not-yet functioning Instex system as a means to trade with a sanctioned Iran -- but volumes of transactions remain low. That the Chinese International Payments System has partnered with Swift to expand its reach also undermines its independence from the US financial system. The dollar's strength is meanwhile telling, its status reinforced despite the 2008-09 global financial crisis that originated in the US. By contrast, the eurozone debt crisis, Prasad said, "put to rest any pretensions the euro might have had of challenging the dollar’s supremacy as a reserve currency." That strong US dollar and of the costs of abandoning it speaks to another reason why any move away from it will be a slow and gradual one: As the CNAS study points out, while sanctioned governments are motivated to create alternatives to the US dollar-led system, non-sanctioned entities lack incentive to join them. But it's not all problem-free for the US. As US sanctions and tariffs target an ever-widening list of countries -- rivals and allies alike -- governments around the world will be prompted to consider reducing their economic ties with the US, CNAS notes. As such, US firms -- and US energy exports -- could suffer broadly reduced opportunities as a result of Washington's aggressive economic policies (EC Nov.8'19). Longer term, the ripple effects of that reduced US exposure to the global economy could widen -- from less leverage when it comes to trade, to greater momentum behind de-dollarization. Nelli Sharushkina, Moscow, Emily Meredith, Washington, and Maryelle Demongeot, Singapore

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