How the War in Ukraine Is Killing the U.S. Dollar

The law of unintended consequences... Years as the king of money... Weaponizing a global currency... China's growing economy... No one trusts the yuan... How the war in Ukraine is killing the U.S. dollar... Could a crypto be the new king?... Here's what you can do now...

Editor's note: As regular Digest readers know, we keep our eyes on what's happening in front of us in the markets each day and share it with you, but we also like to think about the long-term consequences of it all...

With this in mind, today our colleague and Stansberry Research international editor Kim Iskyan delivers an essay about one very large, possible unintended consequence of one of the big stories driving recent market action. In short, Kim will detail how the ongoing war in Ukraine could lead to the fall of the U.S. dollar as the world's reserve currency...

If this sounds like a big story, it is, to say the least. So even with the market volatility we've seen lately, we think it's an appropriate time to share Kim's ideas... analysis... and an action you can take to help protect your wealth from a potential fundamental sea change in the global economy...

Over to Kim...

The U.S. dollar might be losing its crown...

That's right... the law of unintended consequences is playing out in real time – for the biggest, most important issue facing generations of investors... the role of the U.S. dollar as king in the global economy.

Russia's invasion of Ukraine has many consequences... The death of Ukrainian citizens, the devastation of the second-largest country in Europe, and the shake-up of geopolitical relations around the world are among them.

But in time, the biggest long-term repercussion of the Russia-Ukraine conflict may be that it's a point of no return for the U.S. dollar. That is... an unintended consequence of this war is the beginning of the end of the dominance of the dollar as the world's reserve currency.

If American humorist Mark Twain were still around, he might speak for many and say... reports of the dollar's death are greatly exaggerated.

And he might be right... for now. While it's no longer as dominant as it once was, the dollar – after more than a century – is still king. In fact, as measured by the U.S. Dollar Index ("DXY"), it is up 5% over the last two months.

But as I (Kim Iskyan) will explain... an unintended consequence of the Russia-Ukraine war ‒ and (this is key) the U.S.'s response to the war ‒ might accelerate the slow shift of the global economy from the dollar, in ways that we're already seeing.

Unintended consequences are everywhere in life...

An unintended consequence is when a result of an action has ramifications that weren't part of the initial purpose of the action.

Sometimes they're good... A widespread cattle virus results in higher chicken consumption – and lower rates of heart disease, as people eat less red meat...

But typically, what might in some ways be a positive outcome also results in a negative unintended consequence... For example, one study found that seat-belt laws succeeded in protecting drivers and passengers – but pedestrian and cyclist deaths rose because strapped-in drivers, feeling more confident and secure, drove more aggressively.

Wars are superspreaders of unintended consequences...

The terms of the Treaty of Versailles that ended World War I, with the objective of creating a permanent peace, were so punishing to Germany that they led to the rise of Adolf Hitler... and subsequently World War II.

Right now, the Russia-Ukraine war is causing a flurry of unintended consequences... Poor people in Egypt, the world's biggest importer of wheat, are going hungry as bread prices rocket due to collapsing wheat production from major producers Russia and Ukraine...

But the unintended consequences of Russia's invasion of Ukraine on the dollar – and its status as a reserve currency – could trump all of these.

For more than a century, the U.S. dollar has been the world's reserve currency...

That means it's the most important medium of exchange, unit of account, and store of value... When a visitor from Chile tours China, he'll use dollars.

When a company or government spends money abroad, it will typically use U.S. dollars to buy copper or oil... sell toys or cars... or invest in hotels or factories.

As of late last year, 59% of the $12.1 trillion in allocated reserves held by central banks around the world were in U.S. dollars.

Governments use those dollars to trade goods abroad or invest in other countries... Some governments employ reserves to maintain exchange-rate levels. Eleven countries use the U.S. dollar as their official currency – while more than 65 others peg their national currencies to it.

Because the dollar is the global reserve currency, the U.S. government has enjoyed a special advantage... It's able to borrow from the rest of the world, seemingly endlessly, to create new dollars. And it has deferred repayment by constantly rolling over – and increasing – its debt.

But the dollar's role as the world's reserve currency has been slowly eroding...

The share of the U.S. dollar in the world's economic output fell from 40% in 1960 to 24% last year. The U.S. now trails the European Union and China in overall export and import volumes... That means less demand for, and use of, dollars.

Another factor is the dramatic growth of the Chinese economy... It has expanded at an average annual rate of 10.5% since 1991, while the U.S. economy has inched up by 2.5% per year over the same period.

As a result, China's market share of the global economy has increased around fourfold, to 18%, since 1960. China will likely overtake the U.S. as the world's largest economy within the next five years.

But the U.S. government hasn't been doing the dollar any favors... A paper currency is backed only by the "full faith and credit" of the issuing government.

And Uncle Sam has been testing that faith with escalating debt, rising inflation, and towering deficits... Policymakers in Washington, D.C. have been taking advantage of the dollar's privileged status as the global reserve currency.

So it's not surprising that the global-reserve-currency holdings of the U.S. dollar, as a percentage of total stockpiles, at 59%, has fallen 12 percentage points over the last two decades and is at its lowest levels since the 1990s...

Sanctions on Russia will accelerate that decline...

After Russia's attack on Ukraine, the U.S. and a group of around 30 countries, most notably in Europe, showed unexpected unity and determination to impose drastic economic sanctions on Russia – well beyond those implemented following the 2014 Russian annexation of Crimea – to punish it for invading Ukraine and to try to encourage it to withdraw.

These sanctions have included cutting many Russian banks out of the global SWIFT (Society for Worldwide Interbank Financial Telecommunication) financial system, plus making transferring cash in and out of the country more difficult... The Russian government – as well as Russian companies – may default on its foreign debt, in some cases because payments can't make it through the financial system.

Hundreds of Western companies have suspended operations in Russia – or exited altogether. Scores of Russian politicians and business leaders have had their assets abroad frozen and are barred from traveling to Europe and other parts of the world...

But that was just the sanctions appetizer...

By far the biggest element of sanctions has been the unified effort of the world's central banks... The U.S. Federal Reserve, the European Central Bank, and the Bank of Japan impounded Russian central-bank reserves denominated in dollars, euros, and yen.

With a few keystrokes – that's all it takes to freeze funds that are in electronic book-entry form – the Russian government lost access to around two-thirds of the $630 billion of its reserve funds.

That money was supposed to be the lifeboat for the country's economy during a financial catastrophe... And now Russia can't touch it.

International pariahs Iran and Venezuela had been subject to harsh sanctions before... but never on this scale had finance been used as a weapon of mass economic destruction – and, in particular, with the world's reserve currency as the ammunition.

As the Financial Times recently explained...

This is a very new kind of war – the weaponization of the U.S. dollar and other Western currencies to punish their adversaries.

Here's where the unintended consequences appear...

The Russian invasion of Ukraine is horrific and despicable. Vladimir Putin deserves to be punished...

But by freezing Russia's reserves – suspending Russia's access to its cash – Western countries have ripped the fabric of the entire economic system by breaking some of the most basic rules of how finance works... and how those rules are enforced.

One of the key differences between emerging markets (places like Russia, Brazil, Indonesia, Turkey, and China) and developed ones (the U.S., most of Europe, and Singapore) is that developed countries have a robust legal infrastructure.

They have laws, courts, and decades of legal precedent that help ensure that investors are protected. Investors know that they'll be treated fairly under these financial systems...

Without the rule of law – or, with only the selective implementation of the rules – an investor is just one bribe-seeking bureaucrat away from being put out of business.

Or... a country is one arbitrary decision by the self-anointed global rule-makers away from losing it all... Such as, "We're suspending the rule of law for you because you've been exceptionally naughty."

That's what the U.S. is doing to Russia now.

And meanwhile, the rest of the world is taking notes...

Other big holders of dollars that aren't part of what could be loosely called the "Western team" should be concerned – countries like China, India, and Saudi Arabia... What would it take for Uncle Sam to freeze my assets? they might be asking themselves.

For example, if China were to attack Taiwan, would the Fed tap a few computer keys to restrict China's access to its U.S.-dollar reserves?... Or if the genocide of the Uyghurs in Xinjiang would become a greater concern for the rest of the world... Or if India or Saudi Arabia did something to offend the U.S. or the West?

It's a pretty good reason for these countries, and dozens of others with a lot less geopolitical and economic heft, to think twice about their holdings in U.S. dollars, euros, and yen.

As Foreign Affairs magazine explained...

Economies that feel threatened by Washington do now have an incentive to shift their reserves out of holdings in the United States. In theory, this has always been a check on Washington's overuse of financial power; if the country sanctions too frequently, it might induce other states to come up with better alternatives to the dollar and to the payments system around it.

The Pandora's box of finance as a weapon of mass destruction has been opened... Using it again will be a lot easier, too.

Right now, Russia and others are finding ways around the U.S. dollar...

Most international commerce is conducted via the U.S. dollar... But now that Russia has been locked out of the system, it's quickly finding a Plan B.

For example, with China – which has studiously avoided condemning the invasion of Ukraine and which is still a willing trade partner – Russia is leaning on the Cross-Border Interbank Payment System, China's yuan-clearing and settlement system that's similar to SWIFT.

Saudi Arabia has started discussions with China about pricing oil shipments in yuan, rather than the dollar... Earlier this month, China bought Russian oil and coal purchased in yuan. And India – hedging its geopolitical bets – quadrupled its oil imports from Russia during the early weeks of the war and suggested paying for them in rupees.

These are just small steps away from the dollar... But they're steps nonetheless.

But if not the dollar...

The real problem for those countries that might want to reduce their reliance on the dollar is that diversification of foreign-currency reserves might not help as much as they'd like.

As Foreign Affairs recently explained...

Russia demonstrates that diversifying into euros, yuan, and even gold will not help states if other market participants are themselves afraid of being shut out of the dollar system, because there will be no other party for them to sell their reserves to.

In other words, countries who abandon the dollar risk hurting their relations with countries who are still all in with the greenback.

The obvious counterbalance to the U.S. dollar is the currency of the world's second-largest economy.

But China's currency isn't a viable option as a foreign-reserve currency...

The first and most important prerequisite of a foreign-reserve currency is that buying and selling it should be quick, easy, cheap, and virtually frictionless.

But the yuan is a controlled currency and is not freely convertible... What's more, there's a trade-off between political control and the economic openness that's a prerequisite for a reserve currency.

China's government values control over everything else... even at the expense of its own economy.

So the Chinese government isn't prepared to make the changes necessary for the yuan to become a genuine foreign-reserve-currency threat.

And history wouldn't favor China taking a bigger foreign-reserve-currency role. As economic historian Barry Eichengreen wrote last month...

Every leading international and reserve currency in history has been the currency of a political democracy or republic where there are credible institutional limits on arbitrary action by the executive. Under President Xi Jinping, China has of course been moving in the opposite direction – away from such limits.

In other words... there's nothing to stop China from doing just what the U.S. and friends have done – preventing a major holder of its currency from accessing it.

Central banks that use the yuan as a reserve currency would just be swapping Washington's sanction threats for those of the Chinese government.

And in recent years, China hasn't been winning the hearts and minds – or investment dollars – of central bankers looking to diversify their foreign reserves...

Of the share of total foreign-currency reserves that the U.S. dollar has lost over the past few decades, only about a quarter of that has been shifted into the renminbi... what the yuan in currency form is called.

The rest was moved into second-tier currencies like the Australian dollar, the Swiss franc, the Swedish krona, and the Canadian dollar... Today, the yuan makes up less than 3% of the global total of central-bank reserve holdings.

Seeking out alternatives to the U.S. dollar...

We've ruled out the yuan...

The euro, the yen, and a number of the smaller reserve currencies all sided with the U.S. in freezing Russia's reserves... So as far as reserve currencies go, they are not strong alternatives.

There are of course the cryptos... Bitcoin – or Ethereum or another cryptocurrency – is also an alternative for central banks searching for safety and anonymity.

But the volatility of most cryptocurrencies, and the challenges of buying or selling large volumes without moving the price, means that it's not a realistic option for the amount of money central banks need to move around.

And then there's gold... the one asset that has held its value over time – and that will continue to do so, regardless of the Fed, China, war, or anything else... The value of gold held in a vault can't be compromised by outside powers.

But while gold can retain value, selling it in a time of need – if you're a country that has been cut off from the global financial system, for example – presents a new set of challenges... It's just not as liquid as existing reserve currencies.

After that rundown, it seems the U.S. dollar is the least-bad option... But that doesn't mean that some of the other currencies mentioned above – as well as the smaller-country options that have taken foreign-reserve currency market share – won't continue to gain ground.

Even Fed Chair Jerome Powell seems to be thinking this way... In testimony before Congress on March 2, he said... "It's possible to have more than one large reserve currency."

And in the meantime, globalization will continue to reverse...

The answer for many countries may be to increase capital controls and limit the need for foreign capital in the first place... that is, keep more cash at home that's out of reach of others.

That would be part of a broader trend of deglobalization... reducing the interdependencies between countries and economies... less investment in other markets... "onshoring" and bringing supply chains back home... and making it more difficult for outsiders to get access to your markets and opportunities.

The presidency of Donald Trump was a big exercise in deglobalization. So was Brexit... the U.K.'s exit from the European Union in 2020. COVID-19 – closed borders, quarantines, and the every-country-for-itself scramble for a vaccine – was an accelerant of deglobalization. Supply-chain challenges of recent months added friction to world trade... And now, the weaponization of finance marks another step in the process.

Another kind of deglobalization is splitting the global economy into big pieces... as the Financial Times suggested...

By explicitly weaponizing the dollar in this way, the U.S. and its allies risk provoking a backlash that could undermine the U.S. currency and sunder the global financial system into rival blocks.

Deglobalization means that a global reserve currency matters less. The dollar is not being dethroned tomorrow... but in time, one of the biggest unintended consequences of the Russia-Ukraine war will be the acceleration of the decline of the U.S. dollar as king.

You're not a central banker with trillions to worry about...

What can you do to protect your wealth against the eroding value of the dollar?

One option... gold.

And just because gold won't help central banks subject to sanctions, it can help you and the diversification of your portfolio.

In Module 1 of Stansberry's Financial Survival Program, a new seven-part course designed specifically for the volatile market environment we are in today, Dr. David "Doc" Eifrig writes...

Gold's value is the closest thing we have to permanent in this world. And that's the No. 1 reason you want to own gold during a crisis. Whether you're worried about inflation or a deflationary debt collapse... gold will remain unchanged in value. Sure, the price of gold might change, but its value won't. Remember, price is a ratio, in this case comparing gold with dollars. So, when the price of gold changes, what's really happening is that the value of the dollar is changing. Just remember: Gold is the scale. Its value won't change.

Doc goes on in Module 1 to explain specifically how to buy and hold gold... from gold coins to gold funds to gold stocks. And he recommends one stock in particular among the many to choose from... He even, perhaps tongue-in-cheek, suggests owning a one-pound bar of gold as a conversation piece to place on your coffee table.

And in Module 3 of the Financial Survival Program, released on Friday, analyst Alan Gula shares specifically how to use a low-volatility strategy that earns a high risk-adjusted return... These are exactly the kinds of strategies that can bolster your portfolio in times like today.

Bear markets don't need to scare you. But in order to profit during a bear market, you need to set yourself up properly.

Existing subscribers and Stansberry Alliance members can find that research here. And if you are interested in getting access to Stansberry's Financial Survival Program, click here for more details and get started today.

What You Need to Know About Bitcoin

Whether you already own bitcoin, are interested in the leading cryptocurrency, or are maybe a crypto naysayer... this is an all-new and special educational episode of Making Money With Matt McCall focusing on crypto.

Click here to watch this video podcast right now. For more free video content, subscribe to our Stansberry Research YouTube channel... and don't forget to follow us on Facebook, Instagram, LinkedIn, and Twitter.

New 52-week highs (as of 4/26/22): None.

In today's mailbag, feedback on yesterday's Digest... and some subscribers are fired up over a comment about inflation in yesterday's mailbag. The subscriber said we've been "spoiled" by relatively low inflation for decades... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com...

"You write: 'First, let's say this... The Fed is about a year behind in tackling high inflation by raising interest rates.'

"No!... The Fed is 14 years behind in tackling economic problems. It concluded, mistakenly, in 2008 that large banks were too big to fail. We have endured 14 years of government forced liquidity and abysmal interest rates... a heinous crime against savers and retirees." – Paid-up subscriber Kendrick M.

Corey McLaughlin comment: True. I was referring to the recent history tied to this rate "cycle," but you're right, of course. The era of rock-bottom rates in general has been in place for much longer and has been a major factor leading us here...

"I had to comment about H.U.'s note regarding inflation. His note made it sound like we should all be fat and happy and accept the fact that our government has been spending what it doesn't have since 'forever,' and especially 1971.

"Some of us are old enough to remember that our moms stayed home and took care of the house and children. Not very many young moms get to do that today. Currency is no different than anything else in that it reacts to demand and supply. When dollars are printed, those dollars have to go 'somewhere' and that, my friends, is what inflation is – the printing of currency.

"None of us are old enough to remember this, but before around the year 1900, the word 'inflation' commonly meant 'the amount of currency the government is printing.' Ever since 1971 when the Nixon administration abolished the gold standard, our politicians have been steadily stealing from us via 'inflation.'

"I personally am fine, and my kids will be fine because of my earlier actions – I spent 17 years after high school earning degrees and studying things like the history of money. I very well understand the true value of gold and silver. If there were no value, our silver coins would not have disappeared from circulation.

"Think about this – Does anyone out there know why tokens (they stopped being true coins once silver was removed) have reeded edges? It dates all the way back to the Roman Empire where they would clip off the edges of circulating coins and then melt them down to create new coins. This was the beginning of inflation by governments. It went on then and it's been going on ever since.

"I could go on and on... but H.U.'s note touched a hot button for me. I hate seeing these career politicians continuing to kick the can down the road and stealing from hard working families. A day of reckoning is coming... perhaps not in my lifetime but surely in my children's.

"So, no! I am not happy or content or satisfied about the past 30 years of inflation. Some people need to wake up." – Paid-up subscriber Rob W.

"I happen to be in my 90th year having been born in 1931.

"I still trade actively in the markets and am a Stansberry Alliance member.

"Inflation is a fact of life foisted upon us by our incompetent government and the Federal Reserve. We have no choice under the circumstances but to live with it. Its devastating effect on each of us makes life extremely difficult and ever more costly.

"My heartfelt sympathies go to the average family who are struggling to keep their life together and have less to spend each day.

"I can't change it... neither can you... We can only do our best to make ends meet." – Stansberry Alliance member Paul M.

Kim Iskyan
Olney, Maryland
April 27, 2022