Since March, the situation in Ukraine has grabbed headlines in major news media, and doubts about the status of the U.S. dollar as the number one reserve currency have gradually increased. One of the triggers is that the United States has frozen Russia’s foreign exchange reserves.
Goldman Sachs mentioned in a report released on March 30 that three potential changes in global capital flows in the future may lead to a decline in the proportion of US dollar assets in foreign exchange reserves of various countries - the European Central Bank withdraws from negative interest rates, and funds return to the euro area; the stock market weakens , funds may flow out of the United States; de-dollarization efforts by official institutions in various countries may reduce exposure to dollar-centric payment networks.
A number of investors from international asset management institutions interviewed by the First Financial Reporter said that if the possibility of the US dollar being "politicized" further increases, global investors and reserve managers may consider reducing their holdings of US dollar assets.
In addition to potential "successors" from other countries, gold will gain more momentum in this round of interest rate hike cycle.
U.S. financial sanctions hit global financial system
The freezing of Russia's central bank by the United States and its allies was one of the most important landmark events in the international financial system since the Nixon shock in 1971.
"The international monetary system is built on the basis of national credit. The actions of the United States have completely destroyed the national credit basis of the international monetary system. If the assets of foreign central banks can also be frozen, what contracts and contracts cannot be torn up in international financial activities? What?" Yu Yongding, a member of the Chinese Academy of Social Sciences, told reporters.
Rajan, the former governor of the Central Bank of India, pointed out in a recent column that after freezing the foreign exchange reserves of the Russian Central Bank, India and many other countries will be worried about their foreign exchange reserves. If some countries decide to freeze their assets, foreign exchange Reserves may become unusable.
He further noted that with only a handful of liquid reserve currencies like the euro and the dollar, many governments will have to impose restrictions on activities such as corporate cross-border lending.
Some countries will have to consider building their own messaging systems together as an alternative to SWIFT.
And this could mean fragmentation of the global payment system.
"This is an issue that every country will start to consider. In other words, even if it is a quasi-ally that the United States is desperately trying to win over, India has to consider the security of its foreign exchange reserves." Yu Yongding mentioned.
He said U.S. financial sanctions on Russia would lead to two outcomes.
First, the credit foundation of the post-Bretton Woods system has been shaken, and the call for reforming the existing international monetary system will be louder again.
The direction of the reform may be very different from the direction proposed by the United Nations Commission on Reform of the International Financial and Monetary System in 2009. Second, the more urgent issue is how to ensure the safety of foreign exchange reserves.
The traditional decentralization of foreign exchange reserves has been unable to ensure the safety of foreign exchange reserves in extraordinary times.
"For developing countries, there is no foolproof solution. Therefore, developing countries will try to reduce their holdings of foreign exchange reserves as much as possible, or try to keep their overseas assets and liabilities in a basically balanced state. Changes will have a profound impact on the future world trade pattern, balance of payments pattern and overseas investment structure." Yu Yongding said.
U.S. dollar share of global foreign exchange reserves shrinks
“Unless Russian authorities completely cut off energy supply to Europe, Russian banks will still have access to the global banking system. Russia is China’s second largest energy supplier and will likely become increasingly important. Over time, this will also It may weaken the market's confidence in the U.S. dollar as a global payment and stable wealth reserve currency, and may strengthen the internationalization of the renminbi." Zhao Yaoting, global market strategist at Invesco Asia Pacific, told reporters.
The dollar's share of global foreign exchange reserves has dwindled over the years.
The share of dollar reserves held by central banks fell to 59% in the third quarter of 2021, the lowest level in 25 years, according to the International Monetary Fund's latest survey of official foreign exchange reserves.
History has shown that the world reserve currency fluctuates globally as trade patterns change, and these patterns evolve slowly, but a very large shock will surely speed up the process.
"The suffering of the pound after the First World War offers us an opportunity to examine this inertial process, as even after the US economy surpassed the UK in size in the 1870s and became a major exporter and financial power in the 1910s, the pound It still maintains its international dominance." Goldman Sachs mentioned.
The agency believes that looking back at the pound in the 1940s and 1950s provides a better understanding of the risks facing the dollar today.
During the interwar period, the pound maintained its dominance as a key currency.
As World War II approached, foreign central banks tried to replace their foreign exchange reserves with gold because they feared that the pound was not as good as gold.
During World War II, Britain's international position situation deteriorated sharply as Britain liquidated foreign investments and sold gold.
After 1945, Britain's sterling liabilities to foreigners (i.e. foreign holdings of liquid sterling assets) were three to four times the UK's gold reserves.
This huge short-term debt, backed by relatively small official reserves, essentially constitutes a problem for the pound.
Holders want to dispose of most of their sterling assets as soon as possible.
At the time, the UK government used capital controls, geopolitical influences, etc. to manage expectations, which actually slowed this adjustment, and the Bank of England also raised interest rates sharply during this period.
Like the hegemonic pound at the beginning of the 20th century, today's dollar faces many challenges - while the dollar dominates international payments, it accounts for only a small fraction of global trade, deteriorating overseas net worth, geopolitical Politics is headed in an unfavorable direction.
However, Goldman Sachs believes that the difference is that today's domestic economic situation in the United States is not as serious as that in Britain after World War II.
If foreign investors become more reluctant to hold U.S. debt (such as U.S. Treasuries), especially due to structural changes in world merchandise trade, the result could be a depreciation of the dollar and/or higher real interest rates to prevent or slow the depreciation of the dollar.
U.S. policymakers could also take other steps to stabilize net foreign debt, including tightening fiscal policy.
The key is that whether the dollar can maintain its status as the main reserve currency depends first and foremost on the US's own policies.
Policies that allow unsustainable current account deficits to persist, lead to the accumulation of huge foreign debts, or lead to high inflation in the United States could prompt a shift to other reserve currencies.
In his book, Bridgewater founder Ray Dalio argues that the currencies of the richest and most powerful countries become the world's reserve currencies, giving them the "excessive privilege" of being able to borrow more.
This privilege boosted the first empire's spending power in the short run, but weakened its financial strength in the long run, driving it deeper into debt.
With initial stellar returns, this over-borrowing has the potential to persist for a long time.
This is an early sign of a relative wealth transfer when the richest people borrow money from emerging markets.
For example, the British borrowed a lot from their much poorer colonies (especially during World War II), and the Dutch Empire did the same before it reached its peak.
These actions lead to a reversal in the position of its currency and economy (others are suddenly less willing to hold their currency and debt).
The U.S. also borrows and monetizes a lot of debt, and if new creditors start to run out, those dollar holders will start looking to sell and exit, and reserve currency nations will start to lose their strength.
Gold's safe-haven status
In the interest rate hike environment, gold, which has historically underperformed, has soared against the trend this year, hitting a new staged high of $2,070 on March 9, up nearly 15% from the beginning of the year.
Even with the recent "peaceful trade" in the market, gold remains tenaciously trading above $1,900.
As the U.S. dollar begins to be politicized and the list of “safe haven assets” that institutions can choose from is shrinking, gold will increasingly become a key component of reserve currencies.
According to data from the World Gold Council, central banks will increase their gold holdings by a total of 463 tons in 2021, an increase of 82% from 2020.
Many central banks from emerging and developed markets have increased their gold reserves, bringing the total amount of global central bank gold reserves to the highest level in nearly 30 years.
Standard Chartered's global chief strategist Robertson told reporters that as discussions about the possible "weaponization" of related commodities and financial assets are heating up, "we need to re-examine the definition of safe-haven assets. We still maintain a constructive view on the price trend of gold, And it is expected that the demand for gold will rise.” In addition, the CFETS RMB exchange rate hit a record high before, in his view, the recent positive correlation between the RMB exchange rate and the gold price trend tends to strengthen, and the RMB exchange rate is less volatile.
Although China's foreign trade accounts for a large share of the global trade market, RMB assets currently account for less than 3% of global reserve assets and only 3.2% of SWIFT-related transactions.
Against the backdrop of increasingly differentiated global financial markets, global investor demand for RMB assets is expected to rise further.