Why Russia and China’s move to shift world away from the US dollar is doomed to fail

Attempts to de-dollarise global trade so Russia can keep selling commodities are running into difficulties while the rouble continues to depreciate
The US dollar’s role as a freely exchangeable currency recognised the world over is withstanding attempts to weaken the West

Brian P. Klein

Published: 4:45am, 29 Mar 2022

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Russia has been cut off from the global financial system for more than a month now as its war on Ukraine continues. That has led to calls by Moscow to de-dollarise global trade so it can continue selling oil, gas, wheat and other commodities. It would take rupees, yuan or maybe even barter.

The result was speculation about the death of the US dollar as China and India considered their now-increasing purchasing power over a declining rouble. Avoiding the US currency, however, will turn out to be far harder than it seems.

Russia’s plan to replace the dollar is already starting to fall apart. Even though Indian Prime Minister Narendra Modi had said he was open to a rouble-rupee exchange for goods – India imports a significant amount of military weapons and natural gas – Moscow then said it wanted gas payments in euros instead.

It turns out Russia doesn’t want Indian rupees. Russian exporters are getting far less for their goods. The depreciating rouble has weakened about 18 per cent against the rupee versus only 12 per cent against the euro.

And while Beijing is a stalwart ally of Moscow and talking up a new Sino-Russian bloc to counter the United States and Nato, Chinese traders have been reluctant to do business with their Russian counterparts over fears they won’t be paid.

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China’s yuan is unlikely to be a global challenger to the US dollar in the short term because it is still not freely convertible. To rival the US currency as a medium of international business and store of value, its exchange rate would need to be freed from a relatively narrow band set by Beijing. That is still a move too far.

Capital controls would also need to be loosened so that holders of yuan could easily convert their currency. That could mean a run for the exits by those seeking a currency that is more easily used internationally.

Even with its managed float, the yuan is expected to weaken by roughly 5 per cent against the US dollar this year, according to Fitch Ratings. This band has kept the yuan relatively immune to sudden currency shocks from international events like surging trade imbalances or geopolitical risks such as war.

However, trading freely would probably mean it would appreciate because the high demand for Chinese goods would drive up its price. That, in turn, would make exports more expensive and could raise the risk of unintended, undesirable economic consequences.

This type of volatility runs counter to Beijing’s emphasis on economic stability. Global macro trends are already pointing to a broad-based slowdown. Trying to make the yuan an international currency of choice would only add further risk.

Despite the capital controls in place, money is still flowing out of China since the Ukraine crisis began. The International Institute of Finance’s chief economist Robin Brooks wrote recently that “outflows from China on the scale and intensity we are seeing are unprecedented, especially since we are not seeing similar outflows from the rest of emerging markets”.

The Shanghai Composite Index has dropped more than 7 per cent in March alone. More data is needed to see if this turns into a longer-term trend. Still, the China risk-off sentiment remains strong among foreign investors for both Chinese bonds and equities.

And with all the talk of a new global financial order, the US dollar still accounts for nearly 60 per cent of globally allocated foreign exchange reserves as of the third quarter last year. That is practically unchanged from a year ago, according to International Monetary Fund data. Collectively, the US dollar, euro, yen and pound make up roughly 90 per cent of these reserves.

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Even though Russia can work something out with China and India separately, a broader political bloc that includes both countries is highly unlikely. New Delhi has little incentive, and plenty of disincentives, to strengthen economic ties with Beijing.

China is one of the strongest backers of nuclear-armed Pakistan, India’s main rival. India and China have a disputed border which has been the scene of recent deadly violence. China is also expanding its economic presence through its Belt and Road Initiative in Bangladesh and Sri Lanka.

Russia’s global trade is too small to make any real difference if countries shift to roubles or even cryptocurrencies such as bitcoin. Before its economy started to collapse under the weight of sanctions, Russia’s global trade accounted for 1.89 per cent of the world total, according to the World Trade Organization.

The US dollar is still the reserve currency of choice, even with years of loose US monetary policy that has swelled the Federal Reserve’s balance sheet to US$9 trillion as of this month. That is up from just over US$4 trillion two years earlier.

Its dominance has begun to wane a little, according to the IMF, as countries look to diversify their holdings. About 75 per cent of the shift has gone towards unconventional holdings and 25 per cent has flowed into the yuan.

Still, the US dollar remains the most fungible, secure and best store of value. There are no serious competitors to the rules-based international financial system, in place since the end of World War II.

Even with all its problems, the US dollar continues to serve a valued purpose as a freely exchangeable currency recognised in practically every country. That isn’t changing any time soon, no matter how Russia tries to weaken the West in pursuit of an empire beyond its borders.

Brian P. Klein is founder of RidgePoint | Global, a strategic advisory firm. He is a former US diplomat