Currency shifts
The three decades or so that coincided with the Bretton Woods system are often seen as a time of relative stability, order, and discipline. But given that it took almost 15 years after the Bretton Woods conference in 1944 for the system to become fully operational, and that even then there were many signs of instability, it is clear that it is not easy to maintain such a system. Bretton Woods was more of a transition phase to a new international monetary order that we still live with today. Bretton Woods gave rise to institutions such as the IMF and the World Bank which, together with the United Nations Security Council, were intended to ensure stability. When that system ran into trouble in the early 1970s, the G7 was created, which in 1998 became the G8 with Russia, and since 1999 there has been talking of the G20. But the system is starting to crack.
The US does not want to attend a G20 meeting where Russia is also present. The Security Council, too, is proving to be a toothless tiger. The chance of UN security forces in Ukraine is nil, no matter how great the genocide or the crimes against humanity. The IMF is supposed to promote financial stability, economic growth, and international trade, a role that is increasingly questionable after the Great Financial Crisis. The World Bank is identified with globalisation, whereas regionalisation has been going on for almost 15 years. It seems time for a new world order, with new institutions and new agreements.
It seems that the whole world is pulling together to condemn the Russian invasion, but there are also important countries that have abstained. Outside Europe and the United States, the war on the European continent plays a much smaller role, just as wars in Africa and the Middle East also receive only brief attention from the West. Countries like South Africa, India or China, and more emerging countries refuse to condemn Russia. Countries in the Middle East are also trying to cover themselves for the coming Sino-Russian dominance, especially now that the Americans have become self-sufficient in oil and their image has been dented after leaving Afghanistan. The Americans’ security umbrella has disappeared. With it, these countries are also detaching themselves from the system that emerged from Bretton Woods.
The dominance of a reserve currency usually ends with war and, at the same time, war is also the basis for a new monetary system. At the moment, China in particular has big plans to be less dependent on the euro and, given the sanctions against Russia, less dependent on SWIFT.
Last week, Zhang Yanling of the PBoC argued that the sanctions against Russia would cause the US to lose credibility and undermine the dollar’s hegemony. China wants to say goodbye to the dollar sooner rather than later. Now the end of the dollar has been predicted so many times, but in practice, it is much less easy. A characteristic of a reserve currency is that everyone accepts it and can work with it, just as internationally everyone takes English for granted and Windows for granted as an operating system.
The dollar has been used as a weapon before, but then it was mainly about blocking terrorists’ money or in very specific cases, such as blocking Iran’s nuclear programme. Targeting an entire country, including its central bank, financially is new. It is remarkable, for example, that last week sanctions were also announced against Putin’s daughters. The fact that Switzerland is cooperating fully with the implementation of sanctions can also be seen as a major step. During the Second World War, Nazi money was always safe in Switzerland, but the Russians, Arabs, and Chinese can no longer rely on it. An attractive feature of Western currency for foreigners has always been the presence of the rule of law. It offered protection to everyone, but now a Russian surname seems sufficient to seize houses, boats, and bank accounts. The fact that some European Member States are having difficulty seizing Russian assets rather means that there is something left of the rule of law. Furthermore, the Russian sanctions coincide with the monetary madness in the same group of Western countries that are undermining the purchasing power of various currencies. There is an overlap between countries that have apparently chosen to undermine their own currency and support the heavy financial sanctions against Russia and a group of countries that are keen to preserve purchasing power and distance themselves from the financial sanctions against Russia.
The PBoC has a discipline similar to that of the Bundesbank in the past, and many emerging countries have reacted energetically to rising inflation, in stark contrast to, for example, the ECB and, until recently, the Fed. The spread between a Chinese government bond and a US government bond has narrowed to 10 basis points, even though core inflation in China is more than 5 percentage points lower than in the US. Suddenly, this makes emerging market currencies look very attractive.
Saying goodbye to a reserve currency takes many years. In that respect, the dollar can hold out for some time. This does not apply to other Western currencies of countries that were involved in the sanctions. It is possible that many countries prefer to hold dollars to euros, if only because of the ECB’s monetary policy and the eurozone’s sensitivity to the Ukrainian war. Also, the premium on the Swiss franc may quickly disappear due to the shaming of its main customers (Russians, Arabs, and Chinese). Even the Japanese yen is struggling to maintain itself as a safe haven. There are not many alternatives, although the outlook for many emerging currencies is improving rapidly.
