Ukraine war: sanctions on Russia show the power of a weaponised US dollar

While Russia engages in physical war, the United States and its allies are engaging in a proxy war through sanctions and supplying aid to Ukraine
Money is at the root of all success in warfare – you fight for money, and you need money to fight

Andrew Sheng

Published: 1:30am, 26 Mar 2022

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The war in Ukraine is clearly a game-changer. It has upended many assumptions on who is strong militarily and who is weak in the media war. It will be remembered as the end of the peace dividend era, when the world enjoyed decades of global peace and stability without major wars.

China could not have risen without the peace dividend. Russia and Ukraine are now facing a war that will eat into their social and economic fabric. No one will win until both sides negotiate a pathway to peace.

Geopolitical strategist George Friedman said the biggest lesson from the current war has nothing to do with Russia or Ukraine; rather it was that “the United States has demonstrated that perhaps the most powerful weapon in the world is the weaponised dollar”.

The physical war is being fought by Russia and Ukraine while the US and Nato are engaging in a proxy war, using financial sanctions and supplying arms to help Ukraine fight to the last. As the US dollar accounts for about 40 per cent of global trade invoicing and about 60 per cent of official reserves, there is no question it has more clout than the euro, yen or yuan.

The fact that the European Union and Japan joined the sanctions means Russia finds it hard to evade sanctions or escape a liquidity crunch, not just in foreign exchange but also domestically. As Friedman observed, “The combination of banning Russian energy imports to the US and managing the dollar as a weapon – in concert with a large alliance – poses an unanticipated military crisis for Russia.”

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How international sanctions imposed since Ukraine invasion are hitting Russia

Why does the US dollar have such advantages? The standard argument is that it is a unit of account for global credit and invoicing, a means of payment and store of value, bringing the issuer privileges by being able to issue currency at will.

This has been true for many years. When the US dollar depreciated over time against other currencies, the world boomed with extra liquidity, ease of payment and higher returns on holding US bonds, equities and real estate.

However, whenever the currency appreciates, as US interest rates rose, global liquidity tightens and non-US borrowers holding US dollar-denominated debt will pay more, running the risk of debt defaults and asset bubble deflations.

The 1997-98 Asian financial crisis can be understood as US dollar appreciation without a US dollar lender of last resort. Only when the US Federal Reserve lowered interest rates and expanded dollar liquidity did the Asian economies recover.

Thus, the rest of the world felt obliged to hold the US currency. As former US Treasury secretary John Connally said, “The dollar is our currency, but it’s your problem.” The problems multiplied after the global “war on terror”, when the US started applying sanctions against countries such as Iran.

Over time, sanctions expanded in scope and intensity. One problem with sanctions, though, is that despite inflicting economic pain, some countries never seem in a hurry to come to the negotiating table.

Some scholars have brought fresh insights into why the dollar benefits not just the US but also its users, who create an ecosystem that entrenches its superiority. Harvard’s Yakov Feygin and Dominik Leusder examined the class politics of the US dollar system and concluded that it has an ecosystem supported by global private and political elites.

They wrote that “in many countries, the dollar system allows corrupt elites to safely transport their ill-gotten earnings to global banking centres located in jurisdictions with opaque ownership laws”.

The rich in developed and developing markets prefer to trade in and hold assets in US dollars. Global corporations, pension funds and asset managers hold US dollar assets because they can have a store of value and quick liquidity from swaps.

Political scientist Herman Mark Schwartz perceived the US dollar as the state currency of a quasi-imperial global system, in which different economic regions are tied together by a shared reserve currency. Reserve currencies that neither have the military clout nor the depth of stock markets that yield superior returns – such as the euro, yen or sterling – cannot seek to be a dominant currency.

Are there alternatives to the US dollar system? The Organisation for Economic Cooperation and Development, in its latest assessment on the war in Ukraine, has warned that attempts to develop alternatives could “potentially reduce the dominant role of the dollar in financial markets and cross-border payments”.

My view is that the yuan is still a long way from offering an alternative. But the Bank for International Settlements Innovation Centre recently published the preliminary results of Project Dunbar, a collaborative effort between the central banks of Australia, Malaysia, Singapore and South Africa, to see how a common platform for multiple central bank digital currencies could enable cheaper, faster and safer cross-border payments.

The project is technically feasible, but many regulatory and policy barriers remain. One possible issue is how national security issues play out on such platforms.

As the Roman Empire understood, money is at the root of all success in warfare – you fight for money, and you need money to fight. But the Roman empire fell after its currency was continually debased. The denarius was strong as long as Rome did not lose wars. The minute that was challenged, people went back to gold. The more things change, the more they stay the same.

Andrew Sheng writes on global issues from an Asian perspective