Last week, former New York Fed staffer Zoltan Pozsar sent shock waves through Wall Street as he last piece of researchhe hinted that following the war in Ukraine, which resulted in a “commodity collateral” crisis (and which is rapidly turning into an old fashioned liquidity crisis), the Chinese PBOC will soon emerge as a dominant central bank and as the commodity-backed yuan rises to a position of power, the world’s reserve currency, the dollar, would lose much of its global clout, leading to even higher inflation around the world western:
This crisis is unlike anything we’ve seen since President Nixon pulled the US dollar out of gold in 1971 – the end of the era of commodity-based money. When this crisis (and war) is over, the US dollar should be much weaker and, conversely, the renminbi much stronger, backed by a basket of commodities. From Bretton Woods era backed by gold bullion, to Bretton Woods II backed by internal money (Treasury with risks of confiscation not covered), to Bretton Woods III backed by external money (bullion gold and other raw materials). Once this war is over, “money” will never be the same…and Bitcoin (if it still exists then) will likely benefit.
Of course, not everyone agreed with this radical view, with Rabobank’s internal team geostrategist Michael Every among the strongest critics of the Pozsar capture. Over the weekend another skeptic emerged, this time the global head of FX EM at Morgan Stanley, James Lord who, in the bank’s Sunday Start (available for pro subs) note request “Have the sanctions undermined the dominance of the dollar? and answers: no… but only for now, and warns that in the long term it is likely that Pozsar’s austere vision will be validated, such as the act of sanctioning Russia and expelling it from the Western financial system”likely challenges the idea of a risk-free asset that underpins central bank foreign exchange reserves in general, and not just specifically for the dollar and US government-backed securities.”
Assuming there is a risk that all foreign authorities could potentially freeze another country’s sovereign assets – as has happened now – what are the implications? Lord sees at least three: i) Identifying the safest asset; ii) political alliances will be key (“To seriously endanger the dominance of the dollar in the international financial system, potential challengers to the system should build strategic alliances with other major economies”), and iii) Onshoring foreign currency holdings foreign (“external money” from Pozsar).
Related: US Sanctions Can’t Stop China From Buying Russian Oil
The Morgan Stanley strategist also notes that one way to proceed “is to buy physical gold and store it securely in the home jurisdiction.”
The same could be said for other foreign exchange assets, as reserve managers will certainly have access to banknotes printed in USD, EUR or CNY if they are stored in safes at home, although there may be have practical difficulties in making large transactions in this scenario.
The other key beneficiary of Russia’s shocking financial expulsion – as Zoltan correctly noted – is the yuan, as Lord explains:
… there will be diversification of reserves, and we continue to believe that the share of the Chinese yuan in global foreign exchange reserves could reach 5 to 10% by 2030 at the expense of other reserve currencies. If some states explore alternative payment systems to SWIFT or seek to pursue greater bilateral trade in national currencies, the economic sanctions imposed on Russia could act as an accelerator.
Yet while the countdown to the dollar’s demise may indeed have begun, Morgan Stanley sees nothing actionable for long, as “recent actions do not undermine the dollar as a global reserve asset the safer, and it is likely to remain the dominant global currency asset for the foreseeable future.”
Read his full note below.
Since the United States and its allies announced their intention to freeze the Russian Central Bank’s foreign exchange (FX) reserves, market practitioners were quick to argue that this would likely accelerate the abandonment of an international financial system based on the US dollar. It’s easy to see why: Other central banks may now worry that their foreign exchange reserves are not as secure as they once thought and begin to diversify away from the dollar.
Yet despite frequent calls for an end to the dollar-based international financial system over the past two decades, the dollar remains overwhelmingly the world’s dominant reserve currency and the ultimate safe-haven asset, its advantage over the others slipping only moderately in recent years. the last 20 years. Could the step of sanctioning the foreign exchange reserves of a central bank the size of Russia be a tipping point?
The willingness of US authorities to freeze supposedly liquid, safe and accessible deposits and securities of a foreign state certainly raises many questions for reserve managers, sovereign wealth funds and perhaps even some private investors. One is likely to be: Could my FX assets also be frozen?
We must also remember that the United States does not act alone. Europe, Canada, the UK and Japan have joined in the freezing of CBR reserve assets. So an equally valid question is: Could a foreign authority potentially freeze my assets?
If the answer is ‘yes’, it probably calls into question the idea of a risk-free asset that underpins central bank foreign exchange reserves in general, and not just specifically for the dollar and collateralized securities. US government.
If there is a risk of all foreign authorities potentially freezing another country’s sovereign assets, what are the implications? We see at least three of them.
- Identify the safest active: Reserve managers and sovereign wealth fund investors will need to determine where they can find the safest assets and not only safe assets, the notion of the latter having been seriously altered. But the dollar and US government-backed securities may still be the safest assets, as the latest CBR sanctions involve a wide range of government authorities acting in concert.
- Political alliances could be essential: These sanctions demonstrate that international relations between different states can play an important role in the security of reserve assets. While the dollar might be a safe bet for powerful US allies, its opponents might see things differently. To seriously jeopardize the dominance of the dollar in the international financial system, the pretenders to the system should forge strategic alliances with other major economies.
- Offshoring of foreign currency assets: Recent sanctions have crystallized the fact that there is a big difference between a foreign currency deposit in a foreign bank account under the jurisdiction of a foreign government and a foreign currency deposit that you physically own in your territory. Although the two can be considered “money”, they are not equivalent in terms of accessibility or security. So another outcome could be that reserve managers bring foreign currency assets ashore.
One way to do this is to buy physical gold and store it securely in the home jurisdiction. The same could be said for other foreign exchange assets, as reserve managers will certainly have access to banknotes printed in USD, EUR or CNY if they are stored in safes at home, although there may be have practical difficulties in making large transactions in this scenario.
Diversification of reserves still likely: Our long-standing view is that there will be a diversification of reserves, and we continue to believe that the share of the Chinese yuan in global foreign exchange reserves could reach 5-10% by 2030 at the expense of other reserve currencies.
To the extent that SWIFT sanctions and reserve assets imposed by other authorities around the world encourage some states to explore alternative payment systems such as China’s CIPS or to pursue greater bilateral trade in national currencies, recent events are likely to act as an accelerator of a transition to a “multipolar world”.
But it’s not clear that recent actions have undermined the idea that the USD is the world’s safest reserve asset and it may well remain the dominant global currency for some time to come, albeit at odds. slightly lower levels than before.
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