War in Ukraine has sparked a scramble for dollars
London (CNN Business) The US dollar serves as the backbone of the global economy and is considered the safest currency to hold. So in times of uncertainty, investors like to stock up.
What's happening: The dollar rose to its highest level since spring 2020 last week as fears grew about how Russia's war in Ukraine would ricochet through the global economy and financial markets.
One reason for its sharp rise: Investors decided they didn't want to hold euros anymore given Europe's proximity to the conflict. They dumped the bloc's common currency and bought dollars instead.
"European markets are simply not attractive in this moment simply because of their geographical exposure to Ukraine and Russia," ING strategist Francesco Pesole told me.
Remember: US stocks have been doing way better than European shares since Russia's invasion because America's economy is more insulated from the war and its consequences.
Natural gas prices in Europe hit record highs last week because of concerns about what will happen to energy exports from Russia. The United States, which is a major producer of energy itself, is getting slammed by higher costs, but to a lesser degree.
The US economy also looks healthy despite high inflation: 678,000 jobs were added in February, data released Friday showed, smashing forecasts.
Plus, the dollar got a boost after Federal Reserve Chair Jerome Powell said that the central bank aims to start raising interest rates later this month, even though the situation in Ukraine has clouded the outlook. Higher interest rates should help attract capital from abroad, especially if policymakers in Europe are forced to delay their own hikes for longer.
One more thing: In times of crisis, there's no currency investors and policymakers would rather hold. The dollar accounted for 60% of global reserves in 2021.
"Markets and central banks want to hold the dollar because it's a very liquid currency. It's highly tradable," Pesole said. "It's backed by a very strong and solid economy."
A stronger dollar can hurt profits for companies that earn money abroad, but a larger concern is how the dollar's ascent will affect emerging economies, which often have to service their debts in dollars.
There's already been some anxiety about whether Russia's economic implosion will also cause investors to ditch riskier markets such as Brazil, Turkey or Mexico. The dollar's climb could add pressure.
Watch this space: There's been some chatter about whether Russia's war in Ukraine could shake up the dollar's dominance, strengthening Moscow's resolve — along with Beijing's — to develop alternative financing mechanisms that will make Western sanctions less effective over time. Yet the end of King Dollar has been called many times before.
"There's no indication really that the dollar's dominance is shrinking," Pesole said. "This is a [storyline] that can only be for the very long term."
Russia's war has already transformed the global economy
Barely a week of war in Ukraine has rocked the global economy, as quick-fire Western sanctions isolated Russia, collapsed its currency and financial assets and sent energy and food prices soaring.
Quick rewind: Russia's $1.5 trillion economy is the world's 11th largest, according to World Bank data. One month ago, the country was doing a bumper trade in energy, exporting millions of barrels of crude a day with help from major oil companies. Western brands were doing brisk business in Russia, and investors were lending to its companies.
Now, a barrage of sanctions have made Russia's biggest banks radioactive, traders are shunning barrels of Urals crude oil, and Western companies are fleeing the country or closing up shop, my CNN Business colleague Charles Riley reports. Russian stocks have been kicked out of global indexes, and trade in some Russian companies has been halted in New York and London.
Big picture: Russian President Vladimir Putin's invasion of Ukraine has been met with an unprecedented response from the United States, the United Kingdom, the European Union, Canada, Japan, Australia and other nations. Even Switzerland, famous for its neutrality and banking secrecy, has pledged to impose sanctions on Russia.
Sanctions have cut off Russia's two largest banks, Sberbank and VTB, from dealing in US dollars. The West has also removed many Russian banks — including VTB — from SWIFT, a global messaging service that connects financial institutions and facilitates rapid and secure payments.
The coalition is trying to prevent Russia's central bank from selling dollars and other foreign currencies to defend the ruble and its economy. In total, nearly $1 trillion worth of Russian assets have now been frozen by sanctions, according to French finance minister Bruno Le Maire.
"Western democracies have surprised many by pursuing a strategy of exerting intense economic pressure on Russia through effectively cutting it off from global financial markets," Oliver Allen, markets economist at Capital Economics, said in a research note.
"If Russia continues on its current path, it is quite easy to see how the latest sanctions could be just the first steps in a severe and enduring severing of Russia's financial and economic ties with the rest of the world."
