International | Apr 07 2022
The impact of the Russian invasion and Western sanctions in response is creating a fresh geopolitical segregation, with potentially far-reaching consequences
By Danielle Ecuyer
The 1989 fall of the Berlin Wall was one of the most seminal moments in history.
How many of us, of a certain age, up until that point had feasted on a diet of Cold War John Le Carre fiction such as Tinker, Tailor, Soldier, Spy, one step away from the reality of real fear generated post WWII from the US/Soviet Cold War?
We could all breathe again as the anxiety of nuclear warfare faded into annals of history. The prospect of open markets and tourism behind the once iron curtain was now possible and globalisation thrived.
When I worked at Baring Securities (emerging markets specialists) in the 1990’s, amidst the 300-person trading room floor in London, there was a team dedicated to the BRIC countries of Brazil, Russia, India, and China.
These were the growth emerging markets that bankers, index providers and global fund managers sought to profit from the possible wealth generation of opening economies and financial markets.
“When the facts change, I change my mind, what do you do (sir)?”, John Maynard Keynes once upon a time declared.
A New Axis Of Autocracy
February 24, 2022, the world changed again, point out a battery of experts, including Jonathan Pain, macro-economic commentator, and author of The Pain Report.
At the March 2022 Australian Investors Association national conference, Pain outlined his view of a ‘new axis of autocracy’ that would shape and define decades to come.
The Russian invasion of Ukraine is a “new geo-political reality” with far reaching consequences for the world, Australia, and financial markets, Pain declared.
Some experts have noted the profundity of this event as a shifting of the global and economic tectonic plates. Simon Hunt Strategic Services describes Ukraine as “the battleground for how the future of the world will evolve”.
To appreciate the magnitude of the event, one need look no further than the global reaction to Russia’s invasion as the starting point as to how the battle lines are being drawn.
A First With Impact
Let’s start with the United States.
America, in collaboration with the European Union and the UK, sanctioned not only some of Russia’s banks, through the SWIFT payments system, but also the country’s Central Bank.
With the very real threat of nuclear retaliation if the US or NATO entered the war, the US instead turned to its financial might rather than military force to strangle the Russian economy and the country’s ability to trade.
Make no mistake about the enormity of this decision to weaponise the US dollar.
With one decision the United States rendered 60% of Russia’s central bank reserves, or US$600bn, as redundant.
This meant Russia lost the ability to use part of their reserves instrumental to a fully functioning economic financial system, in the same way as if our own cash in our bank accounts was frozen.
The sanctions from the western allies were not unexpected. Bloomberg reports Russia had been de-dollarising their reserves for the last five years, selling US Treasuries (as much as US$175bn according to Jonathan Pain) and buying gold instead.
What was a surprise was the all-out sanctioning of the Russian central bank, thereby creating a precedent for other autocratic nations to take note of.
Every nation state opposed to the western rule of law will now have to consider where they invest and how they hold their reserves.
Here we have a major geopolitical problem that served up a financial response. We could argue the rights or wrongs about the western allied response, but one takeaway from this action that is without debate is the unintended consequences of escalating an emerging trend that had already been in chain.
That trend is the gradual but steady building of a Euro-Asian alliance of autocratic states that “share the same world view and challenge the western liberal democratic order” as described by Jonathan Pain.
The two main protagonists are Russia and China, who have been steadily putting in place the building blocks to diversify away from the hegemony of the US dollar and its financial control on their economies, trading, and financial systems.
Organisations such as the Shanghai Cooperative Organisation (SCO), founded in 2002 and the Eurasian Economic Union (EAEU), 2015, are developing a “New Stage of Monetary, Financial and Economic Cooperation between the EAEU and the PRC [China]; Global Transformation, Challenges and Solutions’’, highlights Simon Hunt.
The Eurasian Group Currency is evolving and although the members to date are small, the scope to develop an alternative currency which could embrace more commodity trading nations is now on the table.
This has many experts querying whether we are witnessing the decay of US dollar hegemony.
The nations to date include China, Kazakhstan, Russia, Tajikistan, Uzbekistan, and Kyrgyzstan.
Other countries such as Brazil, India as well as African and Middle East states with an antithetical US stance may well be keen to be part of the evolving alternative currency regime.
US Dollar Losing Its Mojo?
The decline of US dollar hegemony won’t be inevitable, says Simon Hunt.
Goldman Sachs concurs with the view that the change in FX markets and the dominance of the US dollar will not change overnight, but the tightening of geopolitical financial sanctions may act to accelerate the probability of “official de-dollarisation efforts”, which in turn may affect the valuation of the US dollar over time.
The work of economist Barry Eichengreen and IMF economists published in a report ‘The Stealth Erosion of Dollar Dominance’ noted that a decline in US dollar foreign exchange reserves saw a 25% move into the yuan and the remaining 75% into Australian and Canadian dollars and the Korean won.
The IMF has calculated that the percentage share of US dollar global reserves has declined from 70% in 1998 to 60% at the end of 2021.
The euro remains the second largest currency reserve, alternatives have increased from 2% to 7%, and although China’s renminbi has grown from 1% in 2016, the percentage of total reserves remains low at 3%.
Martin Wolf at the Financial Times observed in his piece ‘A new world of currency disorder looms’ there are several reasons why the US dollar reserve currency status will not be challenged immediately.
But a paper delivered by the Hoover Institute as cited by Mr Wolf highlights that China’s development of an alternative payment system to SWIFT, and the digital yuan (e-CNY), opens up the ability for countries to trade with China outside of the western payment systems and currencies.
Our World Is Changing
On balance, the war in Ukraine is a conflict that will potentially re-shape the future of not only geopolitics but our financial and economic systems.
Whether the audacity of the US and western allies to sanction a central bank will accelerate and further erode the power of the United States, and the dominance of the US dollar and globalisation in general, remains to be seen.
However, as investors we should all accept our world changed, for better or worse, on February 24, 2022.
As Martin Wolf wrote post the invasion “the West must reinforce its defences, on all fronts — military, energy, cyber and economic”.
Wolf is not alone in his views. Jonathan Pain and Simon Hunt echo the chorus that the Ukraine invasion is much, much more than just boots and tanks on the ground.
The world is now locked in an ideological battleground of what has existed for the last fifty years and how the autocrats in today’s world are ready to take back what they felt had been lost.
The Ukraine chapter is not finished, but China will be closely watching as the reunification of Taiwan remains firmly in Xi Jinping’s commitments.
Danielle Ecuyer has been involved in share investing in Australia and Internationally for over three decades, both professionally and personally and is the author of ‘Shareplicity. A simple approach to investing’ and ‘Shareplicity 2. A guide to investing in US stock markets’.
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