Russia Sanctions Accelerate Risk to Dollar

Dominance
By Rachel Evans - Aug 6, 2014
U.S. and European Union sanctions against Russia threaten to hasten a move away from the
dollar thats been stirring since the global financial crisis.
One place the shift has become evident is Hong Kong, where dollar selling has led the central
bank to buy more than $9.5 billion since July 1 to prevent its currency from rallying as the
sanctions stoked speculation of an influx of Russian cash. OAO MegaFon, Russias second-
largest wireless operator, shifted some cash holdings into the citys dollar. Trading of the
Chinese yuan versus the Russian ruble rose to the highest on July 31 since the end of 2010,
according to the Moscow Exchange.
While no ones suggesting the dollar will lose its status as the main currency of business any
time soon, its dominance is ebbing. The greenbacks share of global reserves has already shrunk
to under 61 percent from more than 72 percent in 2001. The drumbeat has only gotten louder
since the financial crisis in 2008, an event that began in the U.S. when subprime-mortgage loans
soured, and the largest emerging-market nations including Russia have vowed to conduct more
business in their currencies.
Waging Financial War
The crisis created a rethink of the dollar-denominated world that we live in, said Joseph
Quinlan, chief market strategist at Bank of America Corp.s U.S. Trust, which oversees about
$380 billion. This nasty turn between Russia and the West related to sanctions, that can be an
accelerator toward a more multicurrency world.
Such a transformation may take as long as 25 years, with the dollar remaining top of the heap
even as other currencies play a greater role, Quinlan said, speaking by phone on Aug. 4 from
New York.
Weapons Embargo
The U.S. and EU announced further restrictions on trade with Russia over its support of
insurgents in Ukraine on July 29. The additional sanctions limit state-owned banks access to
European and U.S. capital markets. Europe also imposed an embargo on weapons sales while the
U.S. added a shipbuilder to a list of blocked defense-technology entities.
A Snapshot of Ukraine's Past and Future
MegaFon, a Moscow-based company that hasnt been targeted by the sanctions, is moving funds
into the Hong Kong dollar, Chief Financial Officer Gevork Vermishyan said in a phone
interview last week. Billionaire Alisher Usmanovs wireless operator has traditionally kept its
foreign cash in U.S. dollars and euros, according to the company.
Wealth Exits
OAO GMK Norilsk Nickel, the worlds largest producer of nickel and palladium, is also keeping
some of its cash in the Asian currency, two people with knowledge of the situation said last
week, asking not to be identified because the information isnt public.
The nickel producer keeps its free cash-flow in a variety of currencies and instruments,
spokesman Petr Likholitov said last week, declining to elaborate or comment on the use of Hong
Kong dollars.
In addition, rich Russians are looking to move funds to banks in Hong Kong, Singapore and
Dubai, Danilo Lacmanovic, chief executive officer of Moscow-based Third Rome LLC, which
manages $400 million on behalf of high net-worth individuals, said in a phone interview
yesterday.
Dollar Trials
Since the U.S. currency replaced gold as the bedrock of the financial system after World War II,
the greenback has weathered numerous crises. It emerged from the collapse of the Bretton
Woods system in 1971, endured the introduction of the euro almost three decades later and
maintained its status as a haven currency even when the 2008 collapse spread from Wall Street to
economies around the world.
The Federal Reserves unprecedented monetary stimulus to stem that crisis channeled cash into
the economy through debt purchases, leading nations including Brazil and Germany to claim the
U.S. was debasing its currency.
The crunch increased interest in tenders divorced from a single nations strength, spurring the
International Monetary Fund to boost almost 10-fold the allocation of special drawing rights, a
reserve asset whose value is based on a basket of currencies, and fueling demand for so-called
virtual currencies, such as bitcoin.
A $9 billion fine imposed on BNP Paribas SA, Frances largest bank, by U.S. regulators in June
has also made some institutions wary of the penalties dealing in dollars can bring, according to
Steven Englander, the head of Group of 10 currency strategy at Citigroup Inc. in New York.
BNP was banned from clearing certain dollar-denominated commodity trades for a year after the
lender admitted to violating U.S. restrictions on doing business with Iran, Sudan and Cuba.
Geopolitical Baggage
You used to think that you had to worry about the Fed and about the supply of dollars and the
monetary policy reaction function, and now you have to worry about potentially sanctions and
other kind of regulatory liabilities, so its baggage, said Englander, speaking by phone on Aug.
4. If you see yourself on the receiving end in some geopolitical dispute with the U.S., holding
liquid dollar assets is risky.
The risk may be something institutions stomach in the near term. About 38.8 percent of global
payments by value were denominated in the U.S. currency in January 2014, up from 29.7 percent
in January 2012, according to data compiled by the Society for Worldwide Interbank Financial
Telecommunication, or Swift. Use of the euro slipped from 44 percent to 33.5 percent of
transactions over the same period.
Dollar World
The dollars share of foreign-exchange transactions has also increased. Buying or selling the
greenback against another currency accounted for 87 percent of all trades in April 2013, about
two percentage points more than in 2010, according to a September report from the Bank for
International Settlements.
Dollar pairs comprised about $705 billion of the $811 billion average daily volume seen by
North American financial institutions this April, the Fed-sponsored Foreign Exchange
Committee said last week.
You cant escape the stratosphere, Sebastien Galy, a senior currency strategist at Societe
Generale SA in New York, said Aug. 1. Its a broad dollar world which is dominating
everything and the consequences are suffered when theres mismanagement of the system. But
its one that has no good alternative at this point in time.
The U.S. currency climbed against all 16 major peers last month as fighting in Ukraine and the
downing of a Malaysian jet over the country enhanced the appeal of haven assets. It extended
gains today as NATO warned of a Russian incursion in Ukraine under the pretext of a
humanitarian mission, pushing its advance to 2.5 percent against the euro since the start of last
month. It traded at $1.3354 as of 11:50 a.m. in New York.
Citigroup forecasts a rally to $1.33 per euro by the end of the year, compared with a median
forecast in a Bloomberg strategist survey of $1.32. SocGen predicts an advance to $1.32.
China Challenge
China is making a push for greater use of its currency in international trade. The Peoples Bank
of China extended a yuan swap line to Switzerland in July after agreeing a facility with the
European Central Bank last year. The nation also agreed to allow companies to clear yuan-
denominated transactions in London and Frankfurt for the first time.
The Hong Kong Monetary Authority bought U.S. dollars in the foreign-exchange market this
week to curb gains in the local dollar, which is pegged to the greenback, after purchasing $8.4
billion in July, the most since at least October 2012.
Sanctions show the potential for an increasing reliance on economic measures -- such as
restricting the use of a currency - - as an alternative to military action, according to Marc
Chandler, the chief currency strategist at Brown Brothers Harriman & Co. in New York.
This represents a big step in the evolution of U.S. foreign policy toward Russia, he said by
phone on Aug. 4. The real challenge is converting that financial power into political influence.