On Tuesday, CEO of JPMorgan Chase Jamie Dimon warned the world that cutting Russia out of the SWIFT system would yield “unintended consequences.”
That’s a monumental understatement.
In short, SWIFT is a system banks use to securely and quickly communicate transfer instructions across international borders. Cutting off an entire nation and its people from this system will have steep consequences across the globe.
We could be looking at the potential demise of the US dollar as the world’s reserve currency, another likely Lehman moment, and the acceleration of China’s progress from third-world nation to global power.
Here’s how the US’s influence on this apolitical system could hasten China’s ascent to global power.
No More Business as Usual
Here’s a quick overview of SWIFT…
The Society for Worldwide Interbank Financial Telecommunications (SWIFT) is an apolitical Belgium-based consortium. It’s run by select officials from the US Federal Reserve, the Bank of Japan, the European Central Bank, the Bank of England, and other private bankers.
SWIFT isn’t a payment processing facility, it’s a secure modern messaging system connecting more than 11,000 banks and financial institutions in 200 countries. These messages include instructions to start, track, and/or confirm money transfers between member institutions. Thanks to its speed, it replaced slower communication methods like the telegraph or fax machine. Last year, this system averaged 42.5 million messages sent per day.
It wasn’t up to the US to cut off Russian banks from SWIFT. It was, however, the country’s indirect influence over SWIFT that led western nations to kick Russian banks off the system.
SWIFT is just a communication system. The actual transfer of payments, foreign currency exchange, and other transaction chores are handled by the banks involved through regional and central clearinghouse offices. 40% of all global monetary transactions involving US dollars (USD) instigated through SWIFT are routed through the New York Clearinghouse Interbank Payment System (CHIPS). Every transaction going through CHIPS is overseen by the state’s Federal Reserve branch, which, as I mentioned before, has representatives at SWIFT.
Due to the role the US plays for the SWIFT messaging system, any effort to sanction Russia in this way would require the nation’s support – which it gave. Without it, we may not even be talking about SWIFT today.
Kicking Russian banks off of SWIFT sent the country’s global trading partners a stark message: if you are doing business with Russian companies, getting paid or paying counterparties will not be easy. That’s intentional.
This sanction was put in place to hammer the ruble, Russia’s currency. If no one is able to use rubles for international transactions, parties involved may sell the ruble for other acceptable currencies—resulting in the diminishing value of the ruble. As a currency’s value drops, it makes purchases of everything more expensive. That increases domestic inflation, which further weakens the currency.
SWIFT but Blunt
But good intentions sometimes yield “unintended consequences,” as Dimon put it. The primary fear of hammering Russia with such a blunt instrument is, with the ruble decimated, Russia could default on interest and principal payments on its sovereign debt.
Russia partially defaulted on its debt in 1998, triggering the collapse of Long Term Capital Management (LTCM), a multi-billion dollar hedge fund run by ex-Solomon Brothers executives and a couple of Nobel laureates in economics and finance. LTCM’s collapse almost led to a market meltdown that was only averted when the New York Fed forced the fund’s counterparties to shore it up long enough to be liquidated.
There may be several LTCMs out there now.
Even if Russia doesn’t default on its sovereign obligations, impeding payment of tens-of-billions-of-dollars Russian companies owe global entities, including financial institutions and trading houses, could trigger any number of Lehman moments that cascade through global markets and impact economies.
Then there’s the issue of the US dollar and a more rapid ascent of China to the top of the world order.
It’s an academic fact that USD is the world’s reserve currency. Most global commerce is conducted in USD, and most important commodities are priced in USD. On top of that, the US Federal Reserve System is the most powerful financial player on the planet.
That means the dollar is the go-to currency for three reasons…
- Safety, as it isn’t likely to be confiscated by any American government,
- Stability in terms of its exchange value relative to other currencies,
- And its widespread acceptance in paper transactions and as cash.
China, second only to the US in terms of its economic output and global reach, has been pushing its own currency, the yuan, as an alternative reserve currency to USD. And China has its own interbank messaging system that competes with SWIFT.
China’s Cross-border Interbank Payment system (CIP) isn’t nearly as big or widely used as SWIFT, but it serves the same functions and is an option for countries who get kicked off SWIFT, like Iran and Russia.
Now that the US and its allies have formally weaponized SWIFT, it’s not unreasonable to expect many, if not most SWIFT users to sign up with CIP in case they run afoul of political adversaries, so they can message and make payments, settled mostly in yuan, in the future.
China is well on its way to developing a digital yuan, which will further facilitate its use as a global currency, one that can facilitate easy payments via open-ledger blockchain.
The seemingly devastating weaponization of SWIFT, while superficially and immediately impacting Russia, may not have the longer-term consequences hoped for. Russia could use CIP for its international payments, and use its more than $120 billion in gold reserves as collateral against yuan swaps with China, which could then be swapped into dollars and used for dollar-denominated payments globally.
Longer-term, the unintended consequences of weaponizing SWIFT could precipitate a Lehman moment, the demise of the dollar as the world’s only reserve currency, and propel China to the top of the mountain in a new world order.