The lead story in tonight’s Financial Times is Russian companies prepare to pay for trade in renminbi, on how Russian companies are seeking to protect themselves from the impact of possible increasing US sanctions against Russia by denominating more of their foreign transactions in the renminbi and other non-dollar currencies.
The critical question is: how serious a development is this? The short answer is that there is less here than there appears to be. In general, the eagerness to see a declining and increasingly aggressive and inept hegemon get its comeuppance has led a lot of commentators to look forward to the demise of the dollar. However, changes of currency regimes are protracted affairs that typically entail a great deal of instability.
Nevertheless, the US’s deliberate and heavy-handed use of its influence over the international payment system to engage in economic warfare is leading countries like Russia and China to look more seriously than they would have otherwise into to building up independent payment and financing networks. Here, the Rothchilds were far shrewder players. Precisely because they knew their ability to make and break governments would lead to resentment and challenges, they went to some lengths to reduce the visibility of their role in state affairs.
Key sections of the Financial Times’ account:
Russian companies are preparing to switch contracts to renminbi and other Asian currencies amid fears that western sanctions may freeze them out of the US dollar market, according to two top bankers.
“Over the last few weeks there has been a significant interest in the market from large Russian corporations to start using various products in renminbi and other Asian currencies and to set up accounts in Asian locations,” Pavel Teplukhin, head of Deutsche Bank in Russia, told the Financial Times.
Andrei Kostin, chief executive of state bank VTB, said…“Given the extent of our bilateral trade with China, developing the use of settlements in roubles and yuan [renminbi] is a priority on the agenda, and so we are working on it now,” he told Russia’s President Vladimir Putin during a briefing. “Since May, we have been carrying out this work.”
The move to open accounts to trade in renminbi, Hong Kong dollars or Singapore dollars highlights Russia’s attempt to pivot towards Asia as its relations with Europe become strained.
Sanctions are pushing Russian companies to reduce their dependence on western financial markets while US and European banks have dramatically slowed their lending activity in Russia since the annexation of Crimea in March.
The central bank is working to create a national payment system to reduce the country’s dependence on western companies such as Visa and MasterCard.
“There is nothing wrong with Russia trying to reduce its dependency on the dollar, actually it is an entirely reasonable thing to do,” said the Russia head of another large European bank….“There is no reason why you have to settle trade you do with Japan in dollars,” he said….
Alexander Dyukov, chief executive of Gazprom’s oil division, has said that the company has discussed with its customers the possibility of shifting contracts out of dollars, while Norilsk Nickel told the FT that it was discussing denominating long-term contracts with Chinese consumers in renminbi.
There are two issues that are conflated that are actually important to pick apart: the use of the dollar as a means of denominating trade transactions (as in a convention) versus the use of the dollar as a payment mechanism, which then entails the use of dollar-based payment networks.
This is simplified version but will do for the purposes of this discussion. Large US and international banks operating in the US run intra-day balances with each other that they settle up at the end of each business day. The largest transactions run over Fedwire, and payment system experts such as Perry Merhling contend that this system depends on the Fed’s de facto backstopping of the payment system (that is, its lender of the last resort role). The Fed has considerable sway over European banks because they have large dollar exposures, both in the US and the Eurozone (by virtue both of trade transactions and much more important, investment-related exposures). Remember the controversy over the Fed opening up a currency swap line to the ECB during the crisis? The ECB needed to provide dollar financing to European banks that were financing dollar exposures and didn’t have access to the Fed’s discount window. The Fed stepped up in its lender of the last resort capacity (although the ECB was taking the bigger risk of credit loss; the Fed was only exposed to the ECB repayment risk, which was deemed to be minimal).
Similarly, have you taken notice of the furor over the proposed $10 billion in sanctions against BNP Paribas over (mainly) money laundering to Iran? Not only is the French bank also being told it need to plead guilty to criminal charges, but another part of the penalty being sought is being suspended from direct access to dollar payment systems. That alone is a a significant punishment. During the period when BNP Paribas was in the penalty box, it would have to go the more costly route of executing dollar transactions through correspondents. Large customers who have relationships with multiple banks would presumably route business away from BNP to other banks, and they might not switch back when the ban was reversed. As we wrote in 2012, when Lawsky proposed ending the access of another recidivist Iran money launderer, Standard Chartered, to dollar clearing:
[Lawsky’s order] threatens SCB with the loss of its New York banking license and termination of access to dollar clearing services. The latter alone is as huge deal. You are not a real international bank unless you have dollar clearing. Sumitomo Bank looked at giving up its US banking license in 1985 when it was examining deal structures for making an investment in Goldman, and ascertained that giving up access to Fedwire would cost it over $100 million a year and considerably weaken its position in Japan. SCB is certain to be a much more active dollar player than Sumitomo was and the volume of international transactions has grown hugely since then.
While China and Russia looking for more ways to collaborate economically and build more ways of conducting ruble and renminbi transactions outside the US dollar payment network is a step towards reducing US influence, it’s important to recognize that this is only a very modest move. With the US still serving as the consumer of the last resort, China and other exporting nations will have meaningful levels of dollar transactions. And as Claudio Borio and Piti Disyatat stressed in an important Bank of International Settlements paper in 2011, gross cross border capital flows are over sixty times as large as the value of international trade. Much of that is also in dollars.
There is yet another layer of difficulty, if you are a financial firm, of escaping the dollar hegemony. As the ancient-looking 1985 Sumitomo Bank example illustrates, large banks like to provide a wide range of products to corporate customers. The cost of selling to them and servicing them is meaningful, so the more services you can provide, the better the odds of recouping those costs and showing a profit. In particular, smaller international customers can be nicely profitable because they will turn to one or two banks for their international services, and most of them are willing to pay more in return for more hand-holding. Thus, as the Sumitomo case demonstrates, it has long been true that having a gap (and the lack of dollar clearing services is a huge gap) in your product offerings makes you uncompetitive even to customers who only conduct a minority of their business in dollars.
An additional impediment to building an alternative to the dollar now is that there is no credible alternative. The Eurozone has ruled itself now due to its incipient deflation and questionable economic prospects. The renminbi is not yet a candidate because China remains committed to running trade surpluses (a reserve currency issuer needs to run deficits, at least for a sustained period in order to get its currency in foreign hands).
Mind you, the Russian-Chinese effort is an important start, but it is only a start. They are seeking to insulate bilateral transactions from the dollar payment system, and Russian companies are trying to do the same with other non-American customers. Other countries targeted by the US, such as Iran and Syria, and ones interested in promoting alternatives like the renminbi to dollar dominance will likely participate in these efforts. As trade volumes in this trade bloc grows, the depth of services in critical financing activities like international letters of credit will also increase. But even with a clear perceived need among some players, initiatives like this take a long time to reach critical mass and build out the needed infrastructure.
The Russians appear to be realistic about what they are up against:
But while in recent discussions with big business about how to make the economy less vulnerable the government has advocated listing back home and settling more trade in currencies other than the dollar, it has rejected more extreme measures.
“As long as Russia is not subject to systemic sanctions, which could bring an artificial limit to our economy’s access to dollars . . . then I don’t think Russia will take any steps in order to bring about artificial de-dollarisation,” said Andrei Belousov, economic adviser to Mr Putin.
And even if the Russians harbor bigger aims, given the time it would take to achieve them, better to under-promise and stealthily out-deliver than announce a course of action that would provoke more aggressive US measures now. Like it or not, the dollar is and will remain the reserve currency for quite some time, and the Russians understand the implications.