Opinion – Martin Wolf: A new world of currency disorder lurking

At the end of January, Russia held foreign exchange reserves worth US$469 billion. This buildup was caused by the prudence taught by its 1998 moratorium and, as Vladimir Putin had hoped, also guaranteed its financial independence. But when he began his “special military operation” in Ukraine, he learned that more than half of his reserves were frozen. Your enemies’ coins are no longer cash. This action is not just significant for Russia. A targeted demonetization of more globalized currencies has major implications.

Money is a public good. A global money—one that people rely on for their international transactions and investment decisions—is a global public good. But the providers of this public good are national governments. Even under the old gold standard, it was. In our era of fiat (government-made) money, since 1971 this has most obviously been the case. In the third quarter of 2021, 59% of global foreign currency reserves were denominated in US Dollars, another 20% in Euros, 6% in Yen and 5% in Pounds Sterling. China’s yuan still constituted less than 3% of the world’s reserves. Today, global monies are issued by the United States and its allies, including small ones.

This is not the result of a plot. Useful monies are those from open economies with liquid financial markets, monetary stability, and the rule of law. But the “armorization” of these coins and the financial systems that control them undermines these properties for any holder who fears being targeted. The sanctions against Russia’s central bank are a shock. “Who will be next?”, ask the governments. What does this mean for our sovereignty?

One can object to the West’s actions on strictly economic grounds: the armorization of currencies will fragment the world economy and make it less efficient. That’s true, one might answer, but increasingly irrelevant in a world of severe international tensions. Yes, it’s more of a force for deglobalization, but many will ask: so what?

A more troubling objection to Western politicians is that using these weapons can harm them. Won’t the rest of the world rush to find ways to transact and store value that bypass the currencies and financial markets of the US and its allies? Isn’t that what China is trying to do now? IT’S.

In principle, we could imagine four replacements for today’s globalized national currencies: private currencies (like bitcoin); money in commodities (such as gold); a global fiat currency (such as the IMF’s Special Drawing Rights); or another national currency, most obviously the Chinese one. The first is inconceivable: the market cap of all cryptocurrencies today is $2 trillion, just 16% of the world’s foreign exchange reserves, while transactions directly in cryptocurrency are extremely complicated. Gold can be a reserve asset, but it is impossible to carry out transactions. There is also no possibility of agreeing on a global currency of sufficient weight even to replace reserves, let alone to be a vehicle for global transactions.

That leaves another national currency. An excellent recent pamphlet by Graham Allison and colleagues at Harvard on “The Great Economic Rivalry” concludes that China is already a formidable competitor to the United States. 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, 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 a long way from offering what the pound and dollar offered in their heyday. While holders of dollars and other major Western currencies may fear sanctions, they should certainly be aware of what the Chinese government could do to them if they displease it. Equally important, the Chinese state knows that an internationalized currency requires open financial markets, but that would radically weaken its grip on the Chinese economy and society.

This lack of a genuinely credible alternative suggests that the dollar will remain the world’s dominant currency. But there is an argument against this complacent view, set out in “Digital Currencies,” a pamphlet from the Hoover Institute. In essence, it is that the international interbank payment system (Cips – an alternative to the Swift system) and the digital currency (e-CNY) could become a dominant payment system and vehicle currency, respectively, for trade between China and China. its many trading partners. In the long term, the e-CNY could also become an important reserve currency. Furthermore, the pamphlet states, this would give the Chinese state detailed knowledge of each entity’s transactions in its system. It would be an additional source of power.

The overwhelming dominance of the US and its allies in global finance, a product of its aggregate economic size and open financial markets, gives its currencies a dominant position. Today there is no credible alternative for most global currency functions. Today high inflation is probably a greater threat to confidence in the dollar than its armorization against villainous countries. In the long run, however, China may be able to create a walled garden for the use of its currency by those closest to it. Even so, those wishing to transact with Western countries will still need Western currencies. What could emerge are two currency systems – one Western and one Chinese – operating in different ways and uncomfortably overlapping.

As with other matters, the future promises not so much a new global order built around China as more disorder. Historians of the future will be able to see today’s sanctions as another step on that journey.

Translated by Luiz Roberto M. Gonçalves