The Last Hurrah of Western Global Financial Hegemony

 

The West's moves to exclude Russia from foreign exchange markets and to freeze its foreign exchange reserves may have been seen by policymakers in Brussels, London and Washington D.C. as an appropriate and proportionate tool to punish Russia. But like many decisions driven by geopolitics, these sanctions will have unintended outcomes and derivative impacts.

Not only do they raise profound questions about the financing of trade and the management of foreign exchange reserves, but their scale and severity must be ringing alarm bells in any country not completely aligned with the Western view of the world. And nowhere will the bells be ringing louder than in the corridors of power in Beijing.

China has always held long-term ambitions to reduce its reliance on the dollar and internationalize the yuan, although progress toward this objective has been slower than expected. But the sanctions imposed by the West on Russia have highlighted the dangers it incurs by remaining dependent on its rival's currency and will inject greater urgency to its attempts to reduce this vulnerability.

This is seen in its efforts to convert payments for imported commodities to yuan instead of dollars. Although this has had mixed success in recent years, the news that Saudi Arabia is now considering accepting yuan as payment for some of its oil shipments to China suggests that the impetus to de-dollarize such trade flows is gaining momentum. Importantly, it is not alone in such efforts to switch away from the dollar. India is also apparently exploring whether Russian oil could be purchased using rupees and by means independent of Western financial mechanisms.

Western policymakers have failed to understand the derivative longer-term impacts of their actions. The sanctions were imposed with the self-assured belief that the world's continued reliance on the existing Western financial mechanisms was sacrosanct.

But by sanctioning the world's fourth-largest foreign exchange reserves, they have triggered shock waves that will reverberate around global finance for many years to come, create new risks, instabilities and vulnerabilities, and ultimately reduce the role and influence of Western financial systems.

The U.S., and more broadly, the West, will lose geopolitical influence while China will gain, although the extent of China's gain will depend on its ability to persuade others of the merits of a yuan bloc. The U.S. will lose the substantial economic benefits it derives from having the world's dominant currency. But conversely, some countries will benefit from the emergence of an alternative financial system more closely aligned with their stage of economic development.

Geopolitics will, at some stage, force international corporates operating across multiple financial systems, especially banks, to choose between the dollar framework and a rival yuan system. 

 Anonymous