Russia’s war in Ukraine today is a hot one, with thousands of casualties on both sides and the Ukrainians deploying missiles, tanks, and arms supplied by western countries, particularly the U.S. But one of the most far-reaching consequences of the war may be an early — and nonviolent — response from the G7 nations, when they unleashed the most stringent round of sanctions ever placed on a major economy, effectively kicking Russia off the U.S.-controlled financial system, seizing its foreign assets, and blacklisting imports of its oil.
The effects of the unprecedented financial sanctions have been mixed. The war drags on, and Vladimir Putin has functionally lost his most important customer, Europe, for his country’s most valuable export, energy. But it also exposed the limits of the Almighty Dollar as the world’s most powerful economic and financial weapon. On Monday, Christine Lagarde, the president of the European Central Bank — Europe’s equivalent of the Federal Reserve — warned that the west’s power is getting depleted and that the world is heading rapidly toward a new economic arms race.
Lagarde’s speech didn’t come out of nowhere. Since the early months of the war, Wall Street analysts including Credit Suisse’s interest-rates guru Zoltan Pozsar have argued that the days of singular American economic dominance are over and that the Biden administration went too far with its sanctions, and ultimately undermined the dollar as the only viable currency for global trade. (The dollar’s unchallenged dominance as a global currency dates back to at least the 1940s and has endowed the U.S. with tremendous economic power.) This was a controversial take, one that was dismissed as “finance fiction” by Columbia University economic historian Adam Tooze, who argued that the dollar is just too central to the way that the world works for there to be any meaningful change. But as the war has gone on, Putin echoed this analysis and has found, at least to some extent, willing partners in China, Saudi Arabia, India, and Brazil in defying the U.S. sanctions — countries that are rich in oil and other minerals that have largely been priced in dollars.
To Lagarde, this is not just a big deal; it’s the beginning of an entirely new economic and geopolitical era — the beginning of a “multipolar” world. “We are witnessing a fragmentation of the global economy into competing blocs, with each bloc trying to pull as much of the rest of the world closer to its respective strategic interests and shared values,” she said in her speech, which was given at the Council on Foreign Relations in New York. “And this fragmentation may well coalesce around two blocs led respectively by the two largest economies in the world,” which would be the U.S. and China. For a central banker, this is about as clear and direct as you could ever hope to get, but Izabella Kaminska, the senior finance editor at Politico Europe, has an excellent thread on Twitter that translates Lagarde’s speech into even plainer language:
This is arguably the highest-level endorsement of the idea that we are in the midst of the world powers splitting apart, and that the post–Cold War trade agreements that have held nominally crosswise nations together — like the U.S. and China — are now frayed, perhaps beyond repair. The warning signs are fairly clear: Here’s China’s president Xi Jinping meeting with Brazilian president Lula da Silva, with their shared antipathy toward the dollar front and center. “Every night I ask myself why every country needs to trade in the dollar,” da Silva said. Saudi Arabia has also invested heavily into China’s oil industry. Jinping is even striking at the heart of Europe by doing an energy deal with France denominated in the Chinese currency. Larry Summers has noted the waning international patience for the American way of doing things:
Lagarde points to studies showing that nations that trade more with China tend to hold onto that country’s currency in their central bank reserves. This reinforces China’s status as dominant trading partner, but it also boosts its currency. Unlike the dollar, the renminbi’s value is still tightly controlled by the Chinese government, making it less appealing on the global market. But any currency is ultimately valued based on the strength of that country’s economy, its resources, and, among other things, the quantity of money it holds in its reserves. For decades, that wealth held by nations has tended to be mostly in dollars and euros. As more countries use renminbi in their reserves (which is happening), China’s currency strengthens, nudging it closer to becoming a direct competitor to the dollar (though that is still far off).
For Lagarde, this vision of a more fractured world without clear and unchallenged U.S. leadership is a darker future. In a multipolar system with competing blocs, there would be higher inflation and more fragile, fractured supply chains.
The west’s best response to this changing geopolitical landscape, Lagarde said, is for central banks in the U.S.–led bloc to work in concert with each other to become more energy independent — essentially denying the China-bloc countries the sway they would hold with their energy reserves. But getting wealthier independent, democratic nations to work in concert at the pace of more autocratic countries like China, Saudi Arabia, Russia, and Iran? Is that even the right prescription?
When the war was just getting started, the idea that a group of China-led countries could remake the global economy felt far-fetched, or at least something that required too much coordination from the world’s most powerful men to pull off anytime soon. And to be clear, the west still controls the vast majority of the global financial system. But a year later, the bigger challenge seems to be for the U.S. and its allies to keep that control.