IMF Warns Countries May Cut Dollar Reserves In Response To US Sanctions Against Russia

Did the IMF just parrot one of Russian President Vladimir Putin’s favorite criticisms of Western sanctions?

During an interview with Foreign Policy, the IMF’s first deputy managing director, Gita Gopinath, warned that Western sanctions on Russia, and more specifically, the confiscation of dollar- and euro-denominated reserves held by the Russian Central Bank, could backfire by making other foreign central banks more reluctant to hold such a large amount of their own foreign reserves in dollars and euros.

For decades now, the international dollar-based financial system has been underpinned by free market principles. Unfortunately, when western institutions effectively confiscate reserves belonging to an independent central bank, they cut against this notion, and prompt other nations to ponder the possibility – however remote – that they could be next.

Ultimately, it’s likely that some countries will “reconsider” the wisdom of so heavily relying on Washington.

“We are likely to see some countries reconsidering how much they hold of certain currencies in their reserves,” she told Foreign Policy.

While Russia accuses the West of trying to engineer a default on Russia’s foreign-currency bonds by restricting its access to euros and dollars, Gopinath pointed out that the sanctions imposed over the past month have effectively cut Russia’s ties to the global financial system, and a default (however technical in nature) would likely lock Russia out of said system for years.

“When you’ve defaulted, reentry into the market is not easy. And that can take a long time.”

The IMF is already seeing an “increasing fragmentation” in global payments systems. On Thursday morning, it was reported that Russia and Iran are working on a global financial messaging system that could act as an alternative to SWIFT.

Of course, the IMF isn’t the only institution to highlight this trend. Just the other day, Goldman Sachs released a note warning that the twilight of the US dollar’s global hegemony could be at hand – citing the possibility of Saudi Arabia accepting yuan for oil instead of dollars (leading to deep fissures in the edifice of the petrodollar) – as evidence.

Since the annexation of Crimea in 2014, Russia’s central bank had steadily divested its reserves of most U.S. dollar assets. But the dollar, euro and sterling still account for more than 50% of its holdings, located in France, Germany, Japan, Britain, the United States, Canada and Australia.

Russia isn’t alone in this: Increasingly, Latin American nations are diversifying their reserves away from the dollar, including larger percentages of alternatives like the Chinese yuan.

And Russia isn’t alone in this. As Credit Suisse’s Zoltan Poszar recently pointed out, western sanctions could help spark a larger move away from holding reserves in the form of “inside” (aka fiat) money, and instead see a movement toward a new system where crypto, or perhaps a hybrid of gold and other commodities like oil, serve as the new reserve asset of choice. Of course, the Fed – which is pushing the adoption of a central bank digital currency to seize the last bit of financial autonomy Americans have left – will likely push back with force. We’re already seeing it today as the US and its G7 allies seek to halt purchases of gold by the Russian Central Bank.