Debt binge, Russia sanctions will hasten end of US dollar global hegemony

The US has rapidly rising debt levels at the same time as the value and integrity of its assets are being eroded
Its weaponisation of the official reserves issue also increases the incentive for others to create alternatives, for both trading and reserves purposes

Anthony Rowley

Published: 9:30pm, 10 Apr 2022

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The term “currency wars” has taken on a whole new meaning with the freezing of much of Russia’s foreign exchange reserves by Western central banks and the implied threat of similar actions against others, including China. The very idea of reserve currencies serving as safe assets is now open to doubt.

As the US government adds to the supply of US dollar reserve assets by going deeper into debt and issuing more Treasury bonds, the quality of those very assets and the integrity of the US Treasury market is being eroded.

Goldman Sachs said recently that the US dollar could go the same way as the British pound in losing its status as an international reserve currency. Gita Gopinath, the International Monetary Fund first deputy managing director, has suggested the US dollar could be damaged by Western sanctions against Russia.

The Tina principle – “there is no alternative” – continues to keep the US dollar and US Treasury market afloat. However, the weaponisation of the official reserves issue by a US administration intent on sanctioning Russia and warning others risks increasing the incentive to create alternatives.

What could conceivably emerge is one bloc of US dollar and euro-based currencies and another bloc based on the Chinese yuan and Russian rouble, accompanied by multiple bilateral payment arrangements. Countries could then decide which of these currencies they use for trading and reserve purposes.

I recently participated in a webinar organised by the City of London that was provocatively titled “Future Of Reserve Currencies – The Myth Of Safe Assets”. It certainly seems like the concept of safe assets is under threat now. More controversial was the claim by veteran Financial Times and The Economist writer John Plender that “there is no such thing as a safe asset” now. A former colleague of mine at The Times in London, Plender is not someone given to making flippant comments.

His claim there is no longer any such thing as a safe asset rests upon an assumption that IOUs issued by the US and other governments are backed not by other assets but by the perceived ability of the issuer to service and, if necessary, repay debt. The US dollar, and before that the British pound, went off the gold standard long ago, so holding US Treasury securities is an act of faith in government creditworthiness and in the existence of deep, highly liquid Treasury securities markets and free movement of capital.

These things can no longer be taken for granted, however. US government debt has reached 123 per cent of GDP and will continue rising with fiscal pump-priming being used to avert recession. A larger supply of US government debt could in theory expand the pool of safe assets.

But there have been examples of volatility in the US Treasury market of late. With banks ceding place to shadow banks and hedge funds as market makers, and foreigners selling off periodically, the US Federal Reserve is likely to need to step in and stabilise the market.

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This brings us back to the Tina principle. US Treasuries are the prime liquid securities for the world, and their share in official reserves remains large. US dollar securities make up just under 60 per cent of total global reserve assets while the euro’s share is around 21 per cent and the yuan’s is about 3 per cent.

Until recently, the status quo regarding supremacy of the US dollar as a reserve asset had appeared likely to remain unchanged, all things being equal. Euro zone governments are less prone to issuing debt than the US Treasury, while China’s capital controls limit the yuan’s potential as a reserve currency.

All things are no longer equal, however. As Goldman Sachs economist Cristina Tessari noted in a commentary, the US has a deteriorating net foreign asset position given the country’s rising foreign debt in the Treasury market. She also said that market faces “geopolitical problems, such as Russia’s war in Ukraine”.

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The US is unlikely to default formally on its debt, but, as Plender observed, there is always the alternative of “inflating” away the real value of the debt. The Fed launching a fight against inflation while the Treasury decides to court it so as to reduce US government debt is an intriguing thought.

If countries decide to break away from the US dollar, where could they store the foreign currency balance they earn from trade and account surpluses, as in the case of China and other East Asian nations? They could, of course, run down their surpluses over time in favour of domestic consumption.

For now, though, they need to invest them in liquid securities and in long-term investments. Hence there are moves to explore new currency arrangements that facilitate non-US dollar trade and provide new reserve assets. The US dollar’s decline could come sooner than many people expect.

Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs