An escalation in geopolitical conflicts stands as the paramount risk to the global economy, a concern echoed by central bank reserve managers who nonetheless maintain a generally positive outlook. This perspective is detailed in an annual survey released on Thursday by UBS Asset Management. The survey, encompassing insights from 40 leading central banks managing over $15 trillion, which represents about half of the world’s foreign exchange (FX) reserves, reveals a cautious optimism. According to reporters, two-thirds of these managers anticipate a return to moderate economic growth and inflation over the next five years.
Gold Surges as Hedge Amid Rising Geopolitical Tensions, Survey Shows
The survey highlighted that 71% of respondents foresee US headline consumer inflation stabilizing between 2% and 3% within the next year, aligning closely with the Federal Reserve’s 2% target. However, this optimistic projection is tempered by significant concerns: 87% of reserve managers flagged the potential escalation of geopolitical conflicts as the greatest threat to this favorable outcome. Notably, 41% indicated they are diversifying their investments across different regions and currencies due to fears of intensifying tensions between the US and China.
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Gold has emerged as a major beneficiary of this diversification strategy, with its price reaching unprecedented highs. The survey indicates that 24% of respondents increased their gold holdings over the past year, and 30% plan to further augment their gold exposure in the coming year. This shift, however, does not come at the expense of bonds, as many managers also plan to raise their bond allocations.
Massimiliano Castelli, head of strategy and advice at UBS Asset Management, underscored the gravity of the geopolitical risks, particularly highlighting the recent political decision to use profits from Russia’s frozen central bank assets to finance Ukraine. This move, he warned, amplifies the perception that FX reserves may no longer be the untouchable safe havens they once were. Castelli elaborated, “Gold, an asset held by central banks largely for historical reasons linked to the time when it was a pillar of the global financial system, risks being brought back to life by ongoing geopolitical trends.”
This scenario paints a complex picture where historical financial instruments like gold are resurrected amid modern geopolitical tumult, signaling a potential reconfiguration of global economic stability strategies.
Geopolitical Frictions Fail to Dethrone US Dollar
Approximately 260 billion euros ($281.40 billion) of Russian central bank funds remain frozen globally, predominantly within the EU. This financial impasse underscores the broader geopolitical frictions impacting global economic stability. The imminent US election could exacerbate these tensions further, with 94% of surveyed central bank reserve managers anticipating a victory for Donald Trump would deteriorate US-China relations significantly.
Despite these geopolitical strains, the survey indicates that the US dollar’s hegemony in foreign exchange (FX) reserves remains unchallenged. The average proportion of dollar holdings reported by participants stood at 55%, showing virtually no change from the previous year. This steadfast confidence in the dollar’s stability contrasts with shifting attitudes towards other currencies, notably China’s yuan. While five institutions reported introducing the yuan as a new addition to their reserves, two have recently divested from it.
Post-Ukraine Impact on Inter-Bloc Trade and FDI
In a world divided into U.S.-leaning, China-leaning, and nonaligned blocs, trade growth between U.S.-leaning and China-leaning countries declined by nearly 5 percentage points from Q2 2022 to Q3 2023 compared to the previous five years. Meanwhile, intra-bloc trade saw a 2-percentage point decrease. Since Russia’s invasion of Ukraine, inter-bloc trade and FDI have fallen approximately 12% and 20% more than intra-bloc flows, reflecting broader economic realignment.
The future trajectory hinges on policymakers’ choices. They may redirect trade and FDI to preserve integration gains or escalate barriers, further disrupting links between politically distant countries. Today’s trade fragmentation, while less severe than during the Cold War’s early years, is costlier due to a higher goods trade-to-GDP ratio (45% vs. 16%) and rising global protectionism.
Nonaligned countries now play a pivotal role as connectors between blocs, unlike in the Cold War, despite historically smaller economic footprints. Their enhanced economic and diplomatic influence helps mitigate fragmentation costs in today’s global economy.
Impact on China-Leaning Countries:
- USD share of trade finance payments within the China bloc declined since early 2022.
- RMB share more than doubled, from around 4% to 8%.
- RMB now accounts for 50% of all cross-border transactions by Chinese non-bank entities.
- USD share decreased from 80% in 2010 to 50% in 2023.
Regarding currency composition in cross-border payments and FX reserves, despite limited data, the U.S. dollar remains dominant. SWIFT reports it accounts for over 80% of trade finance, driven by dollar-denominated commodity trade, and comprises nearly 60% of FX reserves. As reserves diversify into currencies like the Australian and Canadian dollars, the dollar maintains its entrenched role amidst evolving geopolitical and economic landscapes.
During 2022-23, reshaped trade relations have notably impacted China-leaning countries. The USD share of trade finance payments within the China bloc declined since early 2022, while the RMB share more than doubled, rising from around 4% to 8%. This shift persists independently of Russia’s influence. China’s RMB now accounts for approximately 50% of all cross-border transactions by non-bank entities, up from nearly zero 15 years ago, while the USD share decreased from about 80% in 2010 to 50% in 2023.
Russian Central Bank Funds Frozen:
- Total Amount: €260 billion ($281.40 billion)
- Location: Predominantly within the EU
Financial fragmentation would compound these costs by curbing capital accumulation, reducing foreign direct investment (FDI), and disrupting capital allocation, asset prices, and the international payment system. Weaker international risk sharing could heighten macro-financial volatility. A fragmented global payment system along geopolitical lines could emerge, with non-interoperable platforms undermining efficiency and regulatory coherence.
Furthermore, FX reserves might realign amid new economic and geopolitical dynamics. While a multi-currency reserve system could offer benefits such as broader safe asset pools and enhanced diversification, its stability hinges on robust policy coordination among reserve currency-issuing nations. Yet, such coordination faces challenges in a geopolitically divided world, posing risks to global economic stability and financial resilience.
