Russia and China's Plans to Evade U.S. Economic Power

From Zongyuan Zoe Liu and Mihaela Papa, at Foreign Affairs, "The Anti-Dollar Axis":

Russian forces are now seizing territory across Ukraine, shelling military and civilian targets, and creeping closer to capturing the capital, Kyiv. The international response to Russian President Vladimir Putin’s invasion has been furious, and U.S. allies are united against the invasion. U.S. President Joe Biden has led the international community in slapping punitive sanctions on Russian elites and firms with the intention of crippling the Russian economy and forcing a change of course. But so far, these measures have failed to compel Russia to accept a cease-fire or to withdraw.

The war is barely ten days old, and it remains to be seen what Putin will do if and when sanctions stoke greater public discontent in Russia. But these punitive sanctions may also backfire in another way. Biden’s flexing of American economic muscle will only embolden Russia and other U.S. rivals, notably China, to deprive the United States of the very power that makes sanctions so devastating. Russia and China will expedite initiatives to “de-dollarize” their economies, building alternative financial institutions and structures that both protect themselves from sanctions and threaten the U.S. dollar’s status as the world’s dominant currency. Without concerted action, the United States will struggle to reverse this movement and see the weakening of its global standing.

The U.S. dollar’s preeminence in the global financial system, backed by vibrant U.S. markets and unmatched U.S. military strength, makes any sanctions imposed by Washington formidable. No other currencies, the euro and the yuan included, have come close to dethroning the dollar from its primary position in the global economy and in international financial markets. The dollar is the most widely held reserve currency in the world. It is the main invoicing currency in international trade and the leading currency across global financial institutions. It dominates global equity markets, commodities markets, development finance, bank deposits, and global corporate borrowing. In times of crisis, people around the world turn to the dollar as their first choice of a safe-haven currency. U.S. sanctions effectively amputate the financial power of a foreign aggressor, preventing it from raising capital in global markets to bankroll its activities.

Russia might be the most outspoken champion of throwing off the yoke of the dollar, but its agenda has great appeal among major powers. China’s commitment to diversifying its foreign exchange reserves, encouraging more transactions in yuan, and reforming the global currency system through changes in the International Monetary Fund further buttresses Russia’s strategy. Deteriorating U.S.-Chinese relations incentivize Beijing to join with Moscow in building a credible global financial system that excludes the United States. Such a system will attract countries under U.S. sanctions. It would even appeal to major U.S. allies who hope to promote their own currencies to the detriment of the dollar. When imposing sanctions, the Biden administration must not just consider how these measures will shape the war in Ukraine but also how they might transform the global financial system.

THE DOLLAR YOKE

For at least a decade, Russian policymakers have been wary of the preeminence of the dollar. In 2012, Russian Deputy Foreign Minister Sergei Ryabkov expressed Russia’s concern about the dollar’s dominance in international trade. After the annexation of Crimea in 2014, the Obama administration expanded sanctions on Russia that targeted several large Russian banks, as well as energy companies, defense corporations, and wealthy supporters of Putin. The Russian government subsequently launched two critical pieces of financial infrastructure to fend off sanctions and preserve its financial autonomy if cut off from the Society for Worldwide Interbank Financial Telecommunication system, also known as SWIFT, which allows banks to send messages to one another. One was an independent national payment system that worked as a Russian alternative to payment platforms such as Visa and Mastercard. The other was a proprietary financial messaging system called the System for Transfer of Financial Messages, or SPFS, the Russian version of SWIFT.

SPFS became fully operational in 2017, transmitting transaction messages in any currency. In December 2021, it had 38 foreign participants from nine countries. As of this March, SPFS has over 399 users, including more than 20 Belarusian banks, the Armenian Arshidbank, and the Kyrgyz Bank of Asia. Subsidiaries of large Russian banks in Germany and Switzerland, the two most important financial power hubs in Europe, have access to SPFS. Russia is currently negotiating with China to join the system. This alternative financial infrastructure enables Russian corporations and individuals to retain some access, albeit limited, to global markets despite sanctions.

Since 2018, the Bank of Russia has also substantially reduced the share of dollars in Russia’s foreign exchange reserves with purchases of gold, euros, and yuan. It also withdrew much of its reserves from U.S. Treasury bonds; between March and May 2018, the Bank of Russia reduced its holdings of U.S. Treasury securities from $96.1 billion to $14.9 billion. In early 2019, the bank cut its U.S. dollar holdings by $101 billion, over half of its existing assets. In 2021, after the Biden administration imposed new sanctions on Moscow, Russia announced its decision to completely remove dollar assets from its $186 billion National Wealth Fund, a major sovereign wealth fund.

Since the beginning of his fourth presidential term in 2018, Putin pledged to defend Russia’s economic sovereignty against U.S. sanctions and prioritized policies that steered the country’s economy away from the dollar. He advocated for getting “free” of the dollar “burden” in the global oil trade and the Russian economy because the monopoly of the U.S. dollar was “unreliable” and “dangerous.” In October 2018, the Putin administration supported a plan designed to limit Russia’s exposure to future U.S. sanctions by using alternative currencies in international transactions...

Keep reading.