Ukraine war impact on the US dollar a challenge to American hegemony

The US dollar’s dominance is being challenged like never before in the last half-century.

The New York Stock Exchange, a file photograph. The rise in oil prices, induced by the war, is a major contributor to the acceleration in the inflation rate in the US, for controlling which, given the confines of orthodox economic thinking, a recession is being engineered in that country. | Photo Credit: John Minchillo/AP

Capitalism requires a stable medium for holding wealth—stable in the sense that the prices of commodities in terms of this medium must not be expected to rise “too much” (that is, at a rate higher than the “carrying cost” of commodities, for then commodities themselves will become the medium of wealth-holding). Gold has historically played this role, or some currency convertible to gold at a fixed rate, that is, some currency “as good as gold”. The pound sterling in the pre-war years had been one such currency; and the dollar under the post-war Bretton Woods system has been another.

Even after the convertibility of the dollar into gold was officially ended towards the end of the Bretton Woods system, the dollar continued to be considered by the world’s wealth-holders to be “as good as gold” because the dollar prices of goods in general were expected to be relatively stable. This was because the unit wage cost in the US (that is, money wage divided by labour productivity) was expected to be relatively stable, as was the dollar price of the most important current input, oil, notwithstanding its short-term dollar price fluctuations. The pre-eminence of the dollar owed so much to the stability of the dollar price of oil that the world may be said to have been on an “oil standard” of late, reminiscent of the Gold Standard of the old days.

Apartment buildings, with some of their windows lit, in Berlin, Germany, at twilight on September 8. Germany, long dependent on energy imports from Russia, is facing uncertain times as it seeks to pivot away from Russian gas, oil and coal. | Photo Credit: SEAN GALLUP/Getty Images

The United States, however, has upset this entire arrangement underlying the supremacy of the dollar, because of the sanctions it has imposed, along with the European Union, on Russia following upon the Ukraine war. In effect, the Western powers have scored several self-goals, one of which is the weakening of the dollar. (Europe’s closure of factories because of the absence of Russian natural gas is another, not to mention Europe’s prospect of freezing in the coming winter months.) Ironically, the sanctions were imposed with the confidence that the “rouble will be reduced to rubble” in no time, bringing Russia to its knees; and in the beginning it appeared that this prognostication had been right. The financial sanctions that basically constrained Russia from bringing back home the dollars it earned through its exports meant a dollar shortage in Russia that pushed up the price of the dollar against the rouble to astronomical heights. From a price of around 77 roubles in mid February 2022, the dollar rose to 136 roubles in mid March 2022.

Supporters of the left-wing Die Linke party in Leipzig, Germany, demanding measures to alleviate the impact of high food and energy prices, on September 5. Germany is likely to see a socially restive fall as people continue to struggle under the burden of skyrocketing inflation brought on by consequences from Russia’s ongoing war in Ukraine. | Photo Credit: JENS SCHLUETER/Getty Images

Dollar vs Rouble: Western miscalculation

Then two things happened: first, to stem the fall of its currency, Russia declared that it would sell oil in future only against rouble payments; and, second, the reduction in the volume of Russian oil exports, even though it was small, enabled speculative activity to push up the dollar price of oil in the world market. Both these developments contributed to a decline in the value of the dollar vis-à-vis the rouble. The insistence on rouble payment for oil did so for obvious reasons; and the rise in the dollar-price of oil did so because the dollar price of a barrel of oil suddenly went up relative to its rouble price.

So significant was the turnaround that on September 20, a dollar exchanged for 62 roubles, a far smaller figure than when the Ukraine war began. And because of the rise in the dollar price of oil in the world market, Russia’s export earnings have increased despite lower export volumes. The higher oil price is also a major contributor to the acceleration in the inflation rate in the U.S., for controlling which, given the confines of orthodox economic thinking, a recession is being engineered in that country and elsewhere, which would involve a significant increase in the unemployment rate.

A customer at a currency exchange bureau in the city centre of Liverpool, UK, on September 27. The UK’s stock and bond markets have lost at least $500 billion in combined value in September. | Photo Credit: Anthony Devlin/Bloomberg

This Western miscalculation has been a product of sheer hubris. First, it was believed that sanctions could be simultaneously imposed on any number of countries with impunity; at this very time, apart from Russia, several other countries like Iran and Venezuela (both oil producers), not to mention Cuba, are the victims of Western sanctions. Second, it was believed that a country as large as Russia, which accounts for 10 per cent of the world’s oil production and meets a substantially larger share of Europe’s oil needs, would be as helpless as the smaller victims of sanctions (and even the smaller countries have by no means been brought to their knees by these sanctions). And third, it was believed that most countries of the world would fall in line with the Western diktat. In fact, however, not only China, but a host of other countries including India, Pakistan, Bangladesh and Indonesia have carried on trade with Russia despite the Western sanctions.

The consequences of this hubristic decision would not have been as serious for the West if the shortfall in Western oil imports from Russia had been offset through larger production, and hence exports, from other oil producers. But two of the oil producers are themselves under sanctions and would hardly be willing to help Western powers in their fight against Russia by producing more oil; and Saudi Arabia, despite being a close ally of the West, declined to raise its output, citing various logistical reasons. As a result, sanctions against Russia have lowered overall oil output and have boomeranged devastatingly on the West.

If the rouble price of oil is fixed, and can be kept fixed as Russia happens to be a major oil producer, while the dollar price of oil cannot be kept fixed, and has indeed risen, as the U.S. cannot overcome the demand-supply mis-match in the world oil market caused by sanctions, then the dollar effectively loses out to the rouble as a currency under the present de facto “oil standard”; this is exactly what has been happening.

Dollar woes: Bilateral arrangements

There is, however, an additional factor as well. The economic agents who hold dollars as their assets are of two kinds: private and public wealth holders; and central banks of different countries that hold dollar reserves. While the wealth-holders’ decision depends on expectations about the price of dollars, vis-à-vis both other currencies and also commodities, central banks’ decisions are influenced by an additional factor: since the dollar is the medium of transaction in much of world trade, they carry dollar reserves for settling accounts.

Now, one of the consequences of the sanctions against Russia has been the revival of bilateral payments arrangements between Russia and other countries, of the kind that used to exist between the Soviet Union and India in the old days. The dollar simply does not enter as the medium of transaction into such trade. In a bilateral arrangement between Russia and India, for instance, the exchange rate between the two currencies is fixed, and the balance of trade is simply held as a claim by one country upon the other. Such arrangements, therefore, eliminate the demand for dollars as a reserve currency, replacing it with a plethora of currencies, including the rouble.

A vegetable market in Madrid, a file photograph. Inflation in 19 European countries using the euro currency hits another record at 10 per cent as energy prices soar. | Photo Credit: Manu Fernandez/AP

It would be utterly premature, however, on the basis of the foregoing arguments, to start writing obituaries for the dollar. Dollar hegemony is certainly being challenged like never before in the last half-century but is nowhere near being replaced. Much of the world’s trade is still carried on with the dollar as the medium of transaction. Most of the world’s wealth-holders still see the dollar as a stable medium of holding wealth, and a move to the dollar as synonymous with “returning home”. True, the US is facing unprecedented inflation at the moment, but this problem, it is assumed with confidence, will be resolved at the expense of the working class (by engineering recession, and hence unemployment which reduces workers’ ex ante share in output and thereby controls inflation); and wealth-holders, needless to say, never shed tears over the fate of the working class.

An indication of this “returning home to the dollar” syndrome is provided by the other important development occurring in the world economy today. The interest rates in the US which had been close to zero for a long time are being jacked up as a means of controlling inflation (through ushering in a recession). This has the effect of sucking in finance from all over the world, especially from the third world countries, back to the US, causing a depreciation of their currencies vis-à-vis the dollar; the recent depreciation of the Indian rupee is part of this process.

To counter this outflow, the central banks in all these countries are also raising interest rates (and their governments will certainly pursue policies of fiscal austerity) which would transmit the recession of the “metropolis” to these countries. But even if such interest rate hikes stabilise their exchange rates vis-à-vis the dollar for a while (until the next round of exchange rate slides begins), the fact that the dollar continues to remain at the top of the hierarchy of currencies belonging to the rest of the world (leaving aside Russia for the moment) remains indubitable.

Put differently, there are two different tendencies visible in world currency markets at the moment: one is the decline of the dollar vis-à-vis the rouble because of the sanctions against Russia that have backfired on the West; the other is the rise of the dollar vis-à-vis a host of other currencies because of the outflow of finance from countries of the third world to the U.S. The decline of the dollar on the one side is accompanied by its strengthening on the other. Paradoxically, the dollar has strengthened vis-à-vis the Chinese currency too in recent months.

I have so far discussed currency movements in purely economic terms, but the economic links are just mediations through which the underlying power relations make themselves felt. The hegemony of the pound sterling, arising proximately from the economic factors I have mentioned, such as expectations about its stability, was rooted in the reality of British colonialism which contributed to this stability in diverse ways. Likewise, the hegemony of the dollar was rooted in the reality of post-war American hegemony over the capitalist world as a whole (some have called it “American super-imperialism”).

The challenge to the position of the dollar we see today is in reality a challenge to this American hegemony over the world. In fact, the whole Ukraine war represents a major episode in this challenge, a crucial marker in the transition from a so-called “unipolar world” to a “multipolar world”. To believe that the dollar will remain forever hegemonic would be tantamount to believing that the current unipolar world will continue for ever. Democratic opinion, however, should wish not for a transition from one “pole” to just a few “poles”, but rather to a world where there are no “poles” at all, where countries come together through local, bilateral or multilateral arrangements to accept each other’s currencies for settling transactions among themselves.

Prabhat Patnaik is Professor Emeritus, Jawaharlal Nehru University.

The Crux

• The sanctions against Russia over the war in Ukraine are turning out to be counter productive for the United States and Europe.
• Among the self-goals scored by the West are Europe’s closure of factories because of the absence of Russian natural gas, not to mention Europe’s prospect of freezing in the coming winter months.
• Another self-goal is the weakening of the dollar, whose pre-eminence owed much to the stability of the dollar price of oil.
• The rouble price of oil can be kept fixed, as Russia happens to be a major oil producer, while the dollar price of oil cannot be kept fixed, and has indeed risen, as the U.S. cannot overcome the demand-supply mis-match in the world oil market caused by sanctions.
• The dollar is therefore effectively losing out to the rouble as a currency.
• One of the consequences of the sanctions against Russia has been the revival of bilateral payments arrangements between Russia and other countries, and the dollar does not enter as the medium of transaction into such trade.
• The fact that the dollar continues to remain at the top of the hierarchy of currencies belonging to the rest of the world (leaving aside Russia for the moment) remains indubitable.
• Yet, the dollar continues to remain at the top of the hierarchy of currencies belonging to much of the world.
• If the dollar has declined vis-à-vis the rouble, it has risen vis-à-vis a host of other currencies because of the outflow of finance from countries of the third world to the US.