While much ink has been spilled over the sanctions imposed on Russia by the West, there’s been noticeably less coverage of Russia’s response: an attack on the dollar as the world’s reserve currency. With all the deficit spending since the pandemic, the dollar is the most vulnerable it’s ever been. But don’t start writing its eulogy; the dollar isn’t going down just yet.
When the U.S. left the gold standard in 1971, Austrian economists howled over the impending collapse of the dollar. Over half a century later, they’re still howling. Fiat currencies, argued the disciples of Ludwig von Mises, amount to nothing more than a Ponzi scheme. With no real assets backing the currency, politicians were free to pass all the pork projects they desired with impunity. The only consequence was the slow devaluation of the dollar over time.
Don’t worry, the frogs in this pot won’t notice another two degrees.
After Nixon’s “temporary suspension” of the gold standard, the dollar remained the world’s reserve currency for two reasons. First, the rest of the world’s currencies were valued against the dollar anyway thanks to the Bretton Woods agreement of 1944. Other nations could exchange their currencies for dollars and exchange those dollars for gold. Once the dollar’s tie to gold was severed, so were the currencies of other nations. Even untethered, the dollar was still the biggest game in town.
Oil is the second reason the dollar has remained the world’s reserve currency. In exchange for weapons and military protection, Saudi Arabia agreed to price all its oil exports exclusively in dollars. This agreement created what is known as the petrodollar. In place of a gold standard, we now had an oil standard. By 1975, all OPEC countries signed on to the petrodollar system.
Will the dollar remain the world’s reserve currency forever if we stay on this path? Probably not. None of the currencies of the world’s past hegemonic powers have survived their devaluations. However, Russia’s recent monetary reactions aren’t nearly strong enough to become the dollar’s coup d’grâce.
The American and European response to Russia’s invasion of Ukraine has been mostly economic, as you would expect. Sanctions are the go-to strategy to punish states for bad behavior. However, since Russia’s actions were particularly heinous, a heavier hand was required.
As part of the sanctions, Russian banks were expelled from SWIFT, the communication network between banks that facilitates secure messaging and payment orders. Disconnected from SWIFT, Russian banks would be unable to send or receive money from outside their borders, essentially isolating them from the rest of the world. It would cause a flight of international capital from Russia, cut off much of the country’s commodity revenues, and send their currency into a tailspin.
However, there was one more economic sanction levied against Russia that could potentially cause the most reverberations across the global economic system: the freeze of Russia’s foreign exchange reserves. On February 26th, the U.S., Japan, and the E.U. cut off Russia’s access to over $600 billion in asset reserves that Moscow had stored in their banks. Some economists referred to this as the “nuclear option”.
The seizure of foreign exchanges assets and expulsion from SWIFT were intended to crater the value of the ruble. A devalued ruble and a lack of foreign capital inflows would decimate the Russian economy. In fact, after these sanctions were implemented, the exchange rate increased from 87 to 102 rubles per dollar.
While there were some carve-outs for Russia to use its foreign reserves for energy payments, things were working as intended. Russia came awfully close to defaulting on some of its sovereign debt in March and continues to struggle to make payments now in April.
Russia’s counterpunches were aimed straight at the heart of U.S. power: our currency. Make no mistake, we are in a monetary war with Russia that could change the balance of world power.
To keep the ruble from collapsing, Russia quickly moved to link its value to both gold and natural gas, its biggest energy export to Europe, which, not coincidentally, was excluded from sanctions.
To do this, the Russian central bank began offering to buy gold from Russian private banks at the rate of 5,000 rubles per gram. In effect, this sets a floor for the ruble versus the dollar since gold trades in dollars. Arbitrage traders could potentially buy gold with a devalued ruble, then turn around and sell it for U.S. dollars at a profit.
For example, if a gram of gold costs $62 outside Russia and 5,000 rubles inside Russia, then the gold-based exchange rate would be 5,000 rubles ÷ $62 = 80.7 rubles per dollar. If the ruble devalued more than this, someone could make a profit buying and selling gold, assuming they could make these transactions happen given the sanctions.
Next, Russia started demanding payment for its natural gas exports in rubles. Remember, Europe, particularly Germany, depends on Russia’s natural gas for energy. Of course, this is why Germany has been dragging their feet on Russian sanctions all along.
By forcing buyers of natural gas to pay in rubles, Russia also ties the value of the ruble to natural gas. Because the Russian central bank is still buying gold, it has the secondary effect of linking the price of Russian natural gas to the price of gold. This allows Russia to just accept gold for its natural gas or any commodity that they’re still able to export.
The unfortunate effect of all of this is that it stabilizes the ruble against the dollar. If other countries start paying Russia in gold for its exports, it also has the potential to strengthen Russia’s balance sheet.
Threats to the Dollar
While the economic and monetary sanctions have certainly hurt Russia, direct trade with China and India outside the SWIFT system could represent a threat to the dollar as the world’s reserve currency. While these sanctions have forced Russia’s hand, it’s unclear how opportunistic these countries will be now that they could have access to discounted Russian exports.
Additionally, the seizure of Russian foreign reserve assets certainly can’t imbue other nations with confidence that their foreign reserves will not be frozen should they run afoul of the desires of the U.S. and her allies. The double-edged sword of this nuclear option is that it undermines trust between trading partners.
If you were India, would you start thinking about hedging your foreign reserves with something other than dollars?
To complicate things further, the Saudis see the progression of the Iran nuclear deal as a rebuke of the original petrodollar arrangement. If OPEC nations decide to settle oil transactions in currencies, the dollar could face additional challenges in the near future.
Kiss the Dollar Goodbye? Not So Much
While Russia may be doing its best to get revenge, it will need more than ruble machinations to bring down the dollar as the world’s reserve currency. It certainly won’t be the ruble that replaces it. The E.U. is in worse shape than the U.S., so cross the euro off the list too. There’s no other currency with enough scale to replace the dollar, including the yuan.
Outside of the question of scale, there’s a much simpler issue at play: all other currencies are fiat. Even with Russia’s attempt to soft-peg the ruble to gold, the ruble still has no convertibility to gold. You can’t go to the bank in Russia and exchange your rubles for gold. If that were the case, they would end up with a run on gold, just like the events that caused Nixon to close the gold window for the U.S. in 1971.
Outside of central bank currencies, gold still has its portability and storage problems. While Bitcoin does solve some of gold’s problems, it still hasn’t been widely adopted to come anywhere near challenging the dollar soon. However, we have started to see more and more use cases for Bitcoin recently.
How This Affects You
The dollar has its problems. After fifty years of being untethered to gold, politicians find it easier than ever to stuff budgets with pork projects and extend our military interests further across the globe by printing money. This overextension and currency devaluation marks the decline of every single global power in human history. This means price inflation for us in the near term.
The BRICs countries (Brazil, Russia, India, and China) will likely continue pursuing trade arrangements outside of the dollar system. This will only add to the inflationary pressures we expect to see in commodities over the coming years. Accordingly, we can prepare for higher prices for everyday goods here in the U.S.
While price inflation will be a problem, rumors of the dollar’s death have been greatly exaggerated. For the dollar to lose its reserve currency status, something must exist to take its place. Right now, nothing else fits the bill.
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