‘Nuclear’ sanctions on Russia threaten long-term dollar dominance as China has more geopolitical incentive to ditch the greenback
https://asiatimes.com-by David P. Goldman
China likely sees a golden opportunity in shifting away from the US dollar. Image: Facebook
China is looking for alternatives to the US dollar as a reserve currency after Western nations froze the foreign assets of Russia’s central bank last week, former IMF chief economist Kenneth Rogoff told media on March 1.
The seizure of Russian sovereign assets has no precedent in postwar history, and sets a precedent for similar action against China in the event of hostilities over Taiwan.
“It’s an absolutely radical measure to try to freeze assets at a major central bank. It’s a break-the-glass moment,” said Rogoff, now a professor at Harvard University.
“It’s a major thing,” Rogoff added. “I mean, if you want to look at the long-run picture of dollar dominance in the global economy, believe me, China’s looking at this. They have, I don’t know, US$3 trillion in dollar reserves.
“And someday they may well do a similar thing in Taiwan. And they’re thinking about how to shield themselves. And it could have very big, longer-term ramifications for the global economy, for dollar dominance.”
China’s problem, as ever, is a dearth of alternatives. Europe and Japan joined the United States in imposing “nuclear” sanctions against the Russian Federation, and Beijing must assume that they might take similar action against China in the future.
Gold is an alternative but China’s $3.2 trillion of foreign exchange reserves is greater than the $2.3 trillion value of all the world’s central bank gold reserves. The value of all the gold ever mined is less than $17 trillion at the current price of $1,944 an ounce, according to World Gold Council estimates. China presently holds only about 5% of its total reserves in gold.
During the past dozen years, gold has traded in tandem with inflation-indexed US Treasury securities. The chart below shows the relationship between the yield of the 10-year Treasury Inflation-Protected Security and the spot gold price.
Under normal market conditions, the two instruments fulfill the same function. Both act as a form of insurance against unexpected inflation shocks. TIPS are more liquid than gold and do not require expensive transportation and storage.
Investors have had little reason during the past dozen years to own gold rather than inflation-protected US Treasuries – until now. If the United States and Europe can seize the assets of the Russian central bank by administrative fiat, without a declaration of war, Treasuries become a risky investment for a significant part of the world.
China alone owns $2 trillion of US Treasury securities.
How to respond to sanctions is the subject of intense debate in the Chinese media. “The United States and Europe should realize that sanctions are a double-edged sword,” economist Gao Desheng wrote on March 1 in the “Observer” (guancha.cn) website, a Shanghai-based news and opinion group that often reflects deliberations in China’s State Council.
“While hitting the Russian economy, sanctions will also harm Europe’s interests and weaken the independence and credibility of international organizations, including SWIFT,” the global messaging service for international bank transfers, Gao wrote. “For the United States, the frequent use of the financial sanctions weapon will accelerate the process of de-dollarization of the world, which is tantamount to digging a grave for dollar hegemony.”
The obvious response, Gao added, “is to aggressively reduce holdings of US debt in international reserves and increase gold reserves. By November 2021, Russia’s holdings of US Treasuries had fallen from $176.3 billion at the 2010 peak, to just $2.409 billion, accounting for less than 1.4% of total reserves, an insignificant proportion.”
Meanwhile, Gao added, “The Russian central bank’s gold purchases reached 46.5 tons in 2020 and increased by 3 tons in 2021. At present, the Russian central bank’s gold reserves have risen to 2,300 tons.”
As noted, China’s $3.2 trillion in foreign exchange reserves are greater than the total volume of central bank gold reserves, and roughly equal to 16 times annual gold production. It is difficult for China to source enough gold to make a difference without driving up the price.
There are ways to get around this, however. One is to acquire gold mining assets directly. Reuters reported last year that Chinese miners had spent $452 million buying gold-mining assets in Africa and the Middle East. The actual total may be higher than that. Another is to buy forward production from gold miners.
China will also likely increase its stockpiles of other precious metals, including platinum and palladium, as well as base metals. The volume of newly-produced metals and the mining investment opportunities available to China, though, remain small in relation to its foreign exchange reserves.
It seems likely that China will bid up the price of gold to increase its reserves. Although China is reluctant to overpay for reserve assets, an expensive reserve asset that is immune to sanctions may be more attractive than a cheap asset that might be seized in some future geopolitical crisis.