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From an economic perspective some of the most interesting things to have happened since the onset of the Ukraine crisis are the least reported. On February 28 the NATO Alliance froze (stole) $300Bn of Dollar denominated assets of the Russian Federation. This was a bad move for the NATO partners. Russia now, and others in time will stop using Dollars. We have already witnessed the opening salvos in the currency war.
From an economic perspective some of the most interesting things to have happened since the onset of the Ukraine crisis are the least reported. On February 28 the NATO Alliance froze (stole) $300Bn of Dollar denominated assets of the Russian Federation. This was a bad move for the NATO partners. Russia now, and others in time will stop using Dollars. We have already witnessed the opening salvos in the currency war.
On March 25 the Central Bank of Russia issued the following statement:
“Bank of Russia will buy gold from credit institutions at a fixed price starting from 28 March 2022. The price will be 5,000 Russian rubles per 1 gram from 28 March 2022 through 30 June 2022”
On March 28 Gold was trading at $1,944 per ounce. Moscow’s bid for Gold was equivalent to a paltry $1,733. Obviously, nobody would be willing to sell Gold to the Russians at an 11% discount. However, in a little over one week the Russian Central Bank found itself paying 6% over the prevailing international price. The chart below shows the evolution of the Russian Gold price.
By April 7 selling Gold to the Russians looked like a great deal. On March 28 the Russian were paying ₽155,517 per troy ounce of Gold. In the foreign exchange market, the USD.RUB rate was 89.75. This meant that the Russians were bidding $1,733. The FX rate on April 7 strengthened to USD.RUB = 75.75. Therefore, the Russians were paying $2,053 for Gold. This was a 6% premium above the $1,937 rate in western bullion markets. The Ruble’s appreciation in FX markets had thrust the Russian bid for Gold into the spotlight.
We do not know why, but the Russians changed their mind and withdrew the 5,000 Ruble per gram bid. Moscow put out a new press release on April 7.
“Due to a significant change in market conditions, the Bank of Russia is adjusting its pricing policy when buying gold from credit institutions. From 8 April 2022, the Bank of Russia will buy gold at a negotiated price.”
In my view this withdrawal of the Ruble/Gold scheme is a bad move for the Russians. I will explain why in a moment. But first let us take a look at the evolution of the USD.RUB FX rate since the beginning of the war.
There are a number of reasons for the Ruble’s rise in value against the Dollar. Initially Russia tried to protect the external purchasing power of the Ruble by implementing some currency controls and jacking interest rates up to 20%. These initial measures pale into insignificance compared to Russia’s latest move to request payment for Gas and Oil in Rubles. Or to put it more accurately, the Russians wish to be paid for their Gas and Oil. The NATO alliance has made Dollars and Euros inoperable for Russians. Moscow cannot use Dollars/Euros, so they don’t want them. They say they want Rubles for oil. The problem now is, how do the Europeans get Rubles?
In theory there should be a virtually inexhaustible supply of Rubles available for purchase from Russian banks. But they will not exchange Rubles for Dollars or Euros. Remember they cannot use them. Therefore European energy buyers will need to purchase third party instruments to use in exchange for Rubles. For example, a German Gas buyer might be able to purchase Indonesian Rupiah and then exchange it for Rubles with a Russian bank. However, there is only so much Rupiah a Russian bank will want. Russian demand for Rupiah is limited by the demand within Russia for goods and services denominated in Rupiah. Russian demand for Gold should be unlimited. Gold can be used anywhere on the planet to buy anything. It is a permanent store of value.
The Russian Mistake
Asking for payment in Rubles is reasonable. However, it is unreasonable to ask for payment in Rubles without providing sufficient Ruble liquidity to the market. If a German gas buyer cannot exchange Euros for Rubles, what can he do? Moscow needs to give Oil and Gas buyers an option to buy Rubles in bulk. If it is unable to accept Dollars or Euros for Ruble, it must provide the market with an alternative. Gold is such an alternative.
While western sanctions persist, the Ruble cannot become a major currency. Presently Russia cannot effectively exchange Rubles for western goods. Equally Americans and Europeans cannot buy Russian produce (energy) with their Dollars / Euros. Gold can act as a bridge between the two sides. Gold solves the riddle. Convert Euros to Gold and then exchange the Gold for Rubles.
There is more than enough Gold in international markets to facilitate this trade. Although it will have to be revalued higher. Perhaps several fold higher. Europe spends over €100Bn per annum on Russian energy. This would install a permanent bid for Gold and an equally consistent offer on Dollars and Euros diminishing their value and use.
Political and Economic Logic.
Vladimir Putin is regarded by many as an intelligent or sophisticated player in terms of the great geopolitical game. This may or may not be true. It certainly appears as though his political and military calculations were flawed when the tanks rolled into Ukraine. As an autocrat he has more room to make mistakes and change his mind. His approach to this conflict could be sympathetically described as trial and error. He eventually recognises mistakes and changes his strategy and tactics. In the realm of economics, I suspect he will out-play his European / Western counterparties. Russia is an abundantly wealthy country and the nation state’s finances are in rude health. He is holding a good hand.
NATO alliance countries are bust (all of them). Their debts are unpayable and unserviceable above a 5% interest rate. Many states are importers of food and energy and thus vulnerable to shortages. Nevertheless, much of the leadership in Europe appears to be unable to grasp the very basics of economics. Consider how the European political elite appear to be somewhat taken aback at what they perceive to be the gall of Putin to demand payment for energy. Do they seriously expect the Russians to give them gas and oil for nothing? Apparently, the answer to that question is yes! They seriously think that the Russians should sell oil for Dollars / Euros which can be frozen / stolen at a moments notice.
The Russians are not alone in doubting the Dollar. Joe Biden has called Saudi Arabia a “pariah state” with no “redeeming value”. Will the NATO alliance one day decide to freeze (steal) Saudi Dollar/Euro denominated assets? Or Chinese Dollar/Euro denominated assets? The Saudis and Chinese would be foolish not to consider alternative payment mechanisms for their goods. I believe that gold is one such alternative and probably the best.
The aborted Russian Ruble/Gold strategy is probably a good indication of where things are going. Nobody wins an economic war, but you can be reasonably certain that the suppliers of essential basic goods are holding a good hand.
