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- Russia, China and others steadily reducing exposure to Dollar
- Euro increasingly used as substitute reserve currency
- Could explain resilience in the face of ECB reversal
A growing number of disaffected states are strategically trying to reduce their reliance on the U.S. Dollar for routine international transactions, using the Euro or local currencies instead. This trend may explain the common currency’s unexpected resilience in the face of considerable headwinds in 2019.
The U.S. Dollar is the world’s largest reserve currency. It is used in most transactions involving trade in commodities, especially oil, and also for many international financial transactions and large deals. The U.S. Dollar’s preeminence in the world financial system provides it with stability due to broad global demand.
However a retreat from globalisation via China-U.S. trade wars, and an increasing hawkishness in foreign policy by the U.S., Russia and China could offset the Dollar's dominance.
Russia is said to be trying to de-dollarise after President Vladimir Putin pledged to reduce the country’s dependence on the U.S. Dollar following the imposition of U.S. sanctions over its incursions into Ukraine and the use of prohibited nerve agent Novichok in the attempted assassination a UK-based former spy.
The Euro has been the unlikely winner in the war on the Dollar’s dominance and has come to replace the Dollar in all of Russia’s oil exports to China.
“The share of Euros in Russian exports increased for a fourth straight quarter at the expense of the U.S. currency, according to central bank data,” says Andrey Biryukov in an article on Bloomberg News. “The common currency has almost overtaken the Dollar in trade with the European Union and China, and trade in rubles with India has surged. The dollar’s share in import transactions remained unchanged at about a third.”
The total share of Russian exports to China transacted in U.S. Dollars fell to below 50% for the first time in history in Q1 of 2019, and showed a sharp fall from 75% in 2018.
Meanwhile, the share of Russian exports traded with China in Euros increased 10-fold.
“The Euro’s share in payments of Russian exports to China increased tenfold over the year from 0.7% in the first quarter of 2018 to 37.6% in the first quarter of 2019,” says the Moscow Times. “The Euro is increasingly being used in payments for crude oil - Russia’s main export to China - in what’s been seen as a deliberate move away from the petrodollar because of sanctions risks.”
The Euro has now also almost surpassed the Dollar as the currency of choice for Russian exports to the EU.
Russia still relies on the Dollar for more than half of its $687.5bn annual total trade even though less than 5% of that is directly with the U.S.
A large part of Russia’s motivation to switch is that companies suffer delays on almost a third of international payments when they are in Dollars because Western companies have to first check with the U.S. whether the transactions are allowed, Russian Finance Minister Anton Siluanov said in December.
It is not just in the realm of trade that countries are trying to lessen their reliance on the Dollar but also in payment systems. The most widely used interbank payment messaging and transaction service, for example, is the Dollar-based SWIFT (Society for Worldwide Interbank Financial Telecommunication) service, and here too Russia is trying to diversify.
“Russia created the SPFS payment system “which began in 2014 in response to Washington’s threats of disconnecting Russia from SWIFT. The first transaction on the SPFS network involving a non-bank enterprise was held in December 2017,”” says Timothy Alexander Guzman, a researcher at The Centre for Research on Globalization (CRG), an independent research and media organization based in Montreal, citing an article by Tim Rickards author of “Currency Wars”.
The EU is also considering setting up its own payment system separate from SWIFT given the increasing threat of sanctions or tariffs from the U.S, says Guzman.
“A new financial system was mention by German Foreign Minister Heiko Maas who recently called for a new EU-based payments system independent of the U.S. and SWIFT (Society for Worldwide Interbank Financial Telecommunication) that would not involve Dollar payments.
Jim Rickards describes the SWIFT system as the “nerve center of the global financial network," adding, "all major banks transfer all major currencies using the SWIFT message system. Cutting a nation off from SWIFT is like taking away its oxygen.”
India is another country which is moving away from the U.S. Dollar in its trade with Russia.
“The most dramatic shift is visible in Russia’s $11 billion trade with India. The ruble accounted for three-quarters of total settlement in exports between the two emerging markets after they agreed on a new payment method through their national currencies for multi-billion-dollar defense deals,” says Andrey Biryukov.
India already pays for its oil imports from Iran using Rupees to bypass U.S. sanctions on the rogue state.
It bought a record 27.2m tons of Iranian crude last year, a 114% increase. India would ignore the US trade sanctions against Iran, said former foreign minister Sushma Swaraj. “India will comply with UN sanctions and not any country-specific sanctions,” said Swaraj.
Other countries bypassing the use of the Dollar include Iraq and Iran and Russia and Syria.
Pakistan is considering replacing the U.S. Dollar with the Yuan for trade with China, according to an article by Reuters which appeared in December 2017, entitled ‘Pakistan considering plan to use yuan in trade with China’.
There is speculation the move came after President Trump heavily criticised Pakistan on Twittersphere for providing cover for terrorists escaping from Afghanistan whilst at the same time happily taking $33bn a year in aid from the U.S.
More worrying for the U.S. is how China is slowly eclipsing the U.S. as the dominant influence in the subcontinent. It is currently collaborating heavily with Pakistan to build the “One Belt, One Road” trade route from China to Europe, which would revive the ancient silk route.
The rejection of the Dollar by a handful of states hardly suggests an end to its preeminent reserve status. However, it is a worrying sign, especially given China and the EU’s potential involvement and the increasingly tense trade relations between the U.S. and many of its partners. The more enemies the U.S. makes the more the countries may come to reject the U.S. Dollar as a unit of international exchange.
The move away from the Dollar as the primary reserve currency and increasing reliance on the Euro may, in part, explains the common currency’s resilience in 2019 despite a complete 180-degree policy turn by the European Central Bank (ECB) - something which would normally see a currency decline sharply.
At the start of the year the ECB was of the view that it would probably have to raise interest rates sometime towards the end of 2019, however, pretty quickly this view drastically altered to not expecting any rate hikes until 2020, then not expecting any at all, to eventually expecting possibly cuts and QE.
The Euro has not declined as heavily as might have been expected as a result of this pivot and although it fell from 1.1305 to 1.1195 after the March 7 ECB meeting when an extension of stimulus in the form of cheap bank loans or TLTROs was unveiled, it spent the rest of March rallying to a high of 1.1450.
It is possible that part of the reason is the impact of the increased use of the Euro in international transactions as an alternative to the U.S. Dollar.
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