- Sanctions on Moscow show that foreign reserves held by central banks are never truly ‘safe’, which is bound to make Beijing uncomfortable
- Yet when it comes to shifting away from Western currencies, the alternatives – gold, the yuan and foreign infrastructure investment – struggle to match up
Since the Russian invasion of Ukraine, the West’s financial sanctions against Moscow have been among the most draconian in modern history. The Russian central bank’s assets are frozen, state-owned banks’ assets have been confiscated and the personal wealth of rich Russians has been seized without much due process.
While this financial war will undoubtedly hurt the Russian economy badly, it will also produce many long-lasting consequences for the global financial system.
The US dollar, the euro and many other Western currencies have long been considered global reserve currencies, used to store up the national wealth of other nations.
They are often regarded as safe havens – they are not only fully convertible and free floating, but their underlying assets also enjoy protection under the rule of law. As a result, over 95 per cent of global reserve assets are held in Western currencies, the US dollar in particular.
The financial sanctions following the Russian invasion of Ukraine have profoundly shaken many of these fundamental assumptions and principles. They have demonstrated that financial assets of Western adversaries should never be considered “safe” because they can be easily confiscated or turned into weapons of financial destruction.
This must deeply worry China’s policymakers. As recently as last August, former US president Donald Trump called for all countries to “collectively cancel any debt they owe to China as a down payment on (Covid) reparations”. Although President Joe Biden has rejected the idea, it is clear that seizing Chinese wealth has been on the minds of many US politicians, and possibly, of some policymakers.
What can China do to protect its wealth that has been stored in the Western financial system? The simple answer is to diversify away from the US dollar. Before Russia’s invasion of Ukraine, Moscow had already diverted nearly all its foreign exchange reserves away from the US dollar and into gold, the euro and other currencies.
Even so, this helped very little when the entire West joined the sanctions, collectively freezing two-thirds of Russia’s reserve assets. The lesson for China’s leadership is that if the US and its allies act in unison, it does not matter whether assets are held in US dollars or in other Western currencies: they are subject to possible seizure.
Can China convert all its stock of US$3.2 trillion in foreign exchange reserves into gold? The answer is no. The total value of above-ground gold is around US$12.5 trillion, with about half in the form of jewellery.
That leaves US$6.7 trillion of gold held as a financial asset, of which US$2.1 trillion is owned by central banks and is unlikely to be for sale. The remaining US$4.6 trillion is simply too small to absorb a sizeable chunk of China’s US$3.2 trillion of non-gold reserves.