Can U.S. sanctions on Russia backfire on the dollar's dominance?

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Many of the recent sanctions leveled on Russia have power because they're based on the U.S. dollar, which is the most-widely used currency in global financial markets, trade and central bank reserves. However, some are cautioning that weaponizing the greenback in this fashion could erode its dominance, stoking fears that smaller currencies like the renminbi could gain a big role on the international stage. China is already buying Russian energy with the yuan, while India is looking into a rupee-ruble trade arrangement. "Wars upend the dominance of currencies and serve as a doula to the birth of new monetary systems," cautioned Zoltan Pozsar, analyst at Credit Suisse.

Snapshot: This time around, the U.S. went ahead with unprecedented sanctions on Russia's central bank, which has roughly a fifth of its $630B of foreign reserves in dollar-denominated assets. Many central banks across the globe have dollars in their "rainy day funds" given their longtime marking of continuous stability, but data from the IMF shows that reserves have been coming out of the dollar and trickling into other currencies. There was $12T worth of foreign reserves held by central banks around the world at the end of 2021, with the dollar accounting for about 59% of the total, down from 71% in 1999 (the year the euro was launched).

"This is the beginning of the end of the dollar's monopoly in the world," declared Vyacheslav Volodin, speaker of the Russian Duma lower house of parliament. "Anyone who keeps money in dollars today can no longer be sure that the U.S. will not steal their money." While the ruble this week recovered all of the losses seen since the invasion of Ukraine in February, many caution that the rebound was due to severe capital controls imposed by the Kremlin, a doubling of interest rates and foreign traders being barred from exiting their investments. "Sanctions cause the U.S. to lose its credibility and undermine the dollar's hegemony in the long run," added Zhang Yanling, former executive vice-president of Bank of China.

Outlook: While the decline of the dollar has been predicted many times before, the U.S. has been through many turbulent periods with its currency still reigning supreme in global markets. America is also coordinating its sanctions with major allies, meaning other key currencies that can be used as an alternative (like the pound, euro, yen) are also off the table. Moreover, countries may be hesitant to diversify their reserves to currencies like China's yuan, which is still not fully convertible and mixed into added geopolitical risks associated with the country. On the other hand, the U.S. market offers a level of liquidity that is not seen anywhere else in the world, backed by free markets and strong financial institutions.

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