Many observers have become unduly excited about what they depict as efforts to break the dollar hegeomony, such as the joint effort by the so-called BRICS nations to form a development bank. While having a suite of internationals funding entities, particularly ones focused on activities that in theory increase the collective benefits of relying on a reserve currency, are seen to be important, it does not follow that launching useful new funding institutions will break dollar dominance. As much as US abuse of its position as issuer of the reserve currency is correctly resented, there isn’t a competitor waiting in the wings. The Eurozone has blown it with its failure to clean up even sicker banks than the US has, and by compounding a bad situation with its adherence to destructive austerity policies. China clearly has the potential to displace the US longer-term, but it is unwilling to run the requisite trade deficits, since that means exporting demand and hence jobs. And no country had made the transition from being a major exporter to being consumer-driven smoothly; a crisis or protracted malaise would also delay China displacing the US as currency top dog.
But not being able to get rid of the dollar any time soon does not mean that countries that the US is trying to punish by using its influence over international payments system won’t find nearer-term escape routes. Russia, which has become America’s enemy number one apparently for its sins of interceding in Syria, (when Congress was firmly opposed to military action), successfully standing up against a US-backed coup in Ukraine, of collaborating with Iran, and harboring Edward Snowden, has become the target of increasingly stringent economic sanctions. The ones that really bite are those aimed at Russian banks, which have foreign currency exposures, and have used foreign capital markets to issue debt and equity.
Russia today announced that it plans to launch a new payments system so that it will no longer need to use the payments system SWIFT. From RT:
Russia intends to have its own international inter-bank system up and running by May 2015. The Central of Russia says it needs to speed up preparations for its version of SWIFT in case of possible ”challenges” from the West.
“Given the challenges, Bank of Russia is creating its own system for transmitting financial messaging… It’s time to hurry up, so in the next few months we will have certain work done. The entire project for transmitting financial messages will be completed in May 2015,” said Ramilya Kanafina, deputy head of the national payment system department at the Central Bank of Russia (CBR).
Calls not to use the SWIFT (Society for Worldwide Interbank Financial Telecommunication) system in Russian banks began to grow as relations between Russia and the West deteriorated over sanctions. So far, SWIFT says despite pressure from some Western countries to join the anti-Russian sanctions, it has no intention of doing so…
SWIFT, is currently one of Russia’s main connections to the international banking system, and if turned off, could hurt the Russian economy, in the short-term. Globally it transmits orders for transactions worth more than $6 trillion, and involves more than 10,000 financial institutions in 210 countries. According to SWIFT’s statute, the system has national groups of members and users in each country. In Russia it’s ROSSWIFT – the second biggest worldwide SWIFT association after the US.
I welcome reader comment, but I believe there are two issues here. First is that even though SWIFT is still open for business with Russia, it could be cut off at a future date. It can’t have escaped Moscow’s attention that Iran’s central bank and most other major banks were barred from SWIFT in 2012. From the Wall Street Journal:
The European Union said it was banning any kind of financial transactions with blacklisted Iranian financial firms, but U.S. policy makers made it clear they would keep up pressure for wider action.
The Belgium-based Society for Worldwide Interbank Financial Telecommunication, or Swift, a financial communication and clearing system used by most of the world’s major banks, said it would comply with the EU order.
The ban applies only to Iran banks that the EU has placed on a sanctions blacklist. They include Iran’s central bank and more than a dozen other firms.
The U.S. Congress, meanwhile, is asking transactions with all Iranian banks to be ended, and is threatening penalties against Swift’s board and directors if they don’t cut all ties with Iran’s financial sector. U.S. lawmakers argue that Iran is shifting funding for its nuclear program out of the sanctioned banks into other firms.
Second is that setting up a payments channel outside SWIFT can enable Russia to establish a financial system for those who don’t want to be subject to US dictates. Banks that did business with Iran, both before and after the SWIFT sanctions, were hit with money-laundering sanctions. The payments were dollar payments and were cleared thought the banks’ New York branches, making them subject to US law. All dollar transactions between banks are settled at the end of the business day in New York; interbank payment systems ultimately depend on a central bank backstop, and many large payments run over the Fed’s interbank system, Fedwire. So there’s no way of engineering around this issue, at least as of now. Benjamin Lawsky, New York’s superintendent of financial services, threatened to yank the license for the New York branch of the first miscreant he dealt with, Standard Chartered.
Federal and British regulators were outraged over his move, but Federal regulators swiftly recognized that Lawsky had done them a huge favor. They vastly upped the ante when they went after other foreign banks that were defying the US by doing business through US payment systems with blacklisted foreign countries. Lawsky fined Standard Chartered for $340 million in 2012 and the Federal fines were an additional $327 million. As staggering as that was deemed to be at the time, it paled next to the $8.9 billion in fines plus criminal charges against BNP Paribas earlier this year. (Lawsky also hit Standard Chartered with a $300 million fine in August for continuing compliance failures.)
But many foreign banks, and even foreign regulators, were incensed by the magnitude of fines the US imposed for money laundering (as in using the US payments system to conduct transactions with verboten parties). French newspapers and politicians howled over the $8.9 billion fine against BNP Paribas. If the Russian payment system works (as in is NSA-proof, you can bet the US will set its best hacking talent against it), it would allow banks like BNP Paribas and Standard Chartered to deal with Iran. It would likely please them no end to get a bit of revenge on the US that way.
In addition, there are likely businesses in Europe that are not keen about how complying with the EU sanctions against Russia is hurting their business. It isn’t clear how many would be willing to walk on the wild side and defy sanctions, but processing transactions through a Russian-controlled payment system would be far less susceptible to detection than through SWIFT.
In other words, this measure is intended to reduce the effectiveness of using the dollar dominance in payments as a weapon. Whether the Russians can launch a robust enough system quickly is an open question, but this is a sensible defensive and potentially offensive measure. It may have longer-term ramifications if other countries that are not happy with the US decide to employ it for practical or political reasons. Stay tuned.