It’s time for an unaligned financial system

The story of the Russian-Ukrainian war unfolds like the plot of Homer’s Iliad rewritten by the famous science fiction writer Issac Asimov. Russia, it seems, is orchestrating not only military attacks, but also cyber warfare. Ukraine retaliated with automated drones, while the US and EU launched a concerted financial war to contain Russia.

The Russian-Ukrainian war demonstrates a new world order where automation, information technology, control of narrative and finance will dictate the winner of the game of thrones. This worries countries that are not part of the US-led alliance.

“If used too widely, sanctions could reverse the process of globalization that has enabled the modern world to prosper,” former Reserve Bank of India (RBI) Governor Raghuram Rajan wrote in a recent essay. Current Governor Shaktikanta Das has warned against overreliance on the US dollar and said RBI is diversifying its foreign exchange reserves.

The important question is, is India ready for a financial war if it finds itself on the wrong side of a superpower in the future? What does war mean for countries like India that are not part of the great power game?

Dedollarization on cards

Ironically, in the war between Russia and Ukraine, the US dollar could be the loser as nations realize the importance of diversifying foreign exchange reserves. The expulsion of Russia from the SWIFT financial system and the decision to freeze Russian currencies by the United States and its allies have laid bare the glaring risks associated with dollar hegemony for central banks around the world.

An interesting conundrum in today’s world is that the more productive a country is, the more it exports. The more it exports, the more foreign exchange it has. The more surplus it has, the more it invests abroad. The hegemony of the dollar guarantees that the preferred destination for these investments is the United States. The trend accelerated after the 1997 Asian financial crisis that prompted developing countries to hoard foreign exchange to protect their currencies from meltdowns, pushing official reserves from less than $2 trillion to a record 12,900. billions of dollars. in 2021, according to the IMF.

While central banks have recently sought to buy more gold, it still represents only 13% of their foreign exchange assets. Foreign currencies are at 78%. The rest is made up of special drawing rights (SDRs), a claim created by the IMF. Russia, however, is more diverse. According to the Bank of Russia, the country holds 21.7% of its assets in monetary gold, 21.7% in euros, 6.6% in US dollars, 10% in yen and 14% in renminbi.

According to Jefferies’ Greed and Fear report, China with $3.2 trillion, Saudi Arabia with $447 billion, and India with $632 billion are a few nations with the largest foreign exchange reserves. They hold US Treasury bonds worth $1.07 trillion, $199 billion and $119 billion respectively.

China and Russia have already started to move away from the dollar and SWIFT. After the Russian-Ukrainian war, more countries may find merit in this strategy. Nations have realized that with the exception of gold, foreign currency assets are the responsibility of someone else, someone who can simply decide that they are worthless.

In an exclusive chat with Fortune India, World Gold Council head of research Joan Carlos Artigas said the role of the U.S. dollar in international trade is well established, but is slowly moving towards a more “multi-currency” system. “, especially with China’s growing importance in international trade.

In 2016, the Chinese renminbi became the first emerging market currency to be included in the SDR. The others are the US dollar, euro, yen and pound sterling. China advocates the use of the SDR basket as the global reserve currency. China’s long-term strategy is to peg the currencies of its major trading partners to the renminbi while the renminbi itself is pegged to this super sovereign reserve currency.

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Don F. Davis