In Part I we discussed how the fallout from the Russian invasion of Ukraine will lead to inflation, but not in the way most people think. In Part II we discuss the possibility of Russia repudiating the dollar and going on a gold standard. Can they do it? How would the world react? Why not enact a Bitcoin Standard instead?
The Russian central bank reportedly has over 2,000 tonnes of gold. We have seen three arguments repeated many times, both in finance/economic articles and on social media.
One is that Russia can pay gold for goods, to work around being locked out of the SWIFT payments system.
Two is that Russia could use this to declare a gold standard, which would really piss off the Western powers.
Three is that a number of other countries will see the now-revealed threat of being locked out of SWIFT, and switch from the dollar to rubles/yuan/rupees/real or to gold.
Let’s address these in order.
Russia Paying in Gold
The Russian central bank has over 2,000 tonnes of gold, worth around $130B. Perhaps, but Russian GDP was $1.5T in 2020. Russia imported $247B in 2019. So its imports are nearly double its gold reserves, or to put it the other way, its gold would last less than half a year. That is, unless Russia was paid gold for its exports. This is dubious, as Russia is having to increasingly incentivize buyers of its oil, a vital economic good. Russia is currently being paid about $18 a barrel under the market price. This indicates a lack of appetite for Russian oil. This is the environment in which we are to suppose that buyers will be so hungry for Russian exports they will pay in gold?!
But there is a deeper issue. Central bank reserves are not like a wage earner’s savings. If you save $100,000 and have that deposited in the bank, you can spend it at any time. You may call it your “reserves
””, but it is not analogous to a central bank’s reserves.
A better way to think of it is that you have a $400,000 house and owe a $399,000 mortgage. The house is your asset, and the mortgage is your liability. You cannot spend (i.e. sell and spend the proceeds) of your house. You must pay off the mortgage first! And in this example, that leaves you with just $1,000.
A central bank is in the same position. It has assets, gold in this case. And it has liabilities. Its assets are not available for spending.
Could Russia Impose a Retroactive Gold Standard?
Does Russia have enough gold to declare a gold standard?
First, let’s address the question of would they even want to do so. To begin, a dictator would not want a gold standard. The gold standard is the monetary system of a free market, and Russia is no free market. Putin orders production as he wills and gives the rights to profiteer to his cronies (“oligarchs”). A dictator does not want a free market in money, as it would work against his purposes.
That minor issue aside, a gold standard cannot be understood in terms of a ratio of gold reserves to currency. It must be understood as the creation of gold-redeemable credit (including bank notes) by the individual depositors who willingly bring their gold to the banks. Each deposit creates a gold asset on the bank’s balance sheet and creates a corresponding gold liability to return the metal under the terms of the deposit contract (which is on demand, for a bank note).
It should go without saying, that no rubles exist today which were created by a deposit of gold. We don’t know how many Russians would trust their gold to a bank run by a crony of Putin. We only know that they did not get the chance, and so none have done so. We can look to China, where the wealthy evade the government’s capital controls, and take their yuan out of the country, where they dump it for dollars. That is, those who best understand China’s financial system are fleeing it, even at risk to their lives. We have little reason to think that Russia’s financial system is better than China’s. And therefore, little reason to think that non-Russians would send their gold to Russia in exchange for a bank note or bank account.
This leads us to ponder what would it mean, for Russia (or any country with an irredeemable currency) to retroactively declare that it has a quantity of gold and now wishes to have a “gold standard”? It can mean one of two things.
The government could promise to set aside gold in a vault, at a ratio of X units of currency per ounce. “Trust us, we will never print more currency than allowed by our reserves,” but the people have no means of enforcing or even testing it. We could call this a “jawboning gold standard”. It would be talk only, not a gold standard.
Or else the government could promise to redeem its paper notes at the official exchange rate of its declared gold standard. None of these bank notes were created by depositing gold. There was not the kind of trust and rule of law conducive to people bringing gold to a bank. These bank notes were all created as irredeemable promises—i.e. promises to pay, which promise not to pay. And one day, the government would declare that they are redeemable, backed by gold deposits? We would quickly find out how the people would respond to this turn of events. It would be totally unworkable.
And what is the right price? Every creditor wants the lowest possible price because it results in the highest amount of gold they would be paid. Every debtor wants the lowest possible because they can get out of debt for a minimal amount of gold.
Assuming they set a price somehow, then their so called “gold standard” is just a price-fixing scheme. Sooner or later, the market will demand the gold. And when that happens, that is the end. Every price fixing scheme inevitably fails.
To summarize, a dictator does not want a gold standard, there is no way to set the right price, no teeth to enforce his promises, and no economics mechanism to retroactively declare a heretofore-irredeemable currency to be gold-redeemable. There is a path to a genuine free market in money, i.e. gold standard. But that path is not a fiat decree.
The Threat of Foreign De-dollarization
Getting back to the economic sanctions imposed on Russia, the most serious concern is that other countries will see what happened to Russia, and proactively withdraw from the dollar and SWIFT system lest they be removed at a time inconvenient for them (e.g. when they are invading a neighboring country). We will leave aside that most countries are not planning to invade a neighbor (we hope!)
It has long been understood that the US freezes or seizes any assets they can get, from rogue nations. For example, Iran. So, this is nothing new in the calculus of governments.
Further, when a country displays strength, confident that it uses its power righteously, it tends to gain the respect of other countries. The US is the ultimate example of this. Though it has been in decline for a long time, the post-World War II Pax Americana continues to hold, for precisely this reason.
Leaving this argument aside also, how should one respond to the concern?
It is well-understood (notwithstanding that MMT advocates claim it to be an important new revelation) that if a country borrows in its own currency, then it can always service its debts. The value of the currency it pays may be dubious, but the ability to pay the number of currency units owed is not in doubt. But most countries are not in a position to borrow their own currencies. There is an elephant in this room.
Few people want to lend kina to Papua New Guinea. Even a much-larger economy such as Turkey, there is not so great a willingness to lend lira to Turkey. About half of its debt is denominated in foreign currencies. We would expect the foreign portion to grow as a percentage. The lira has dropped so much—almost 50% in the last year—that anyone outside would think twice about holding lira-denominated assets.
The point is that countries don’t borrow dollars (or pounds, etc.) out of ignorance of the dangers. They do it because that’s the only way to get capital investment. Even within Papua New Guinea or Turkey, those with wealth know that they have a choice. Dollar holdings are ubiquitous, even in stronger countries.
And note that there is no kind of benevolent reciprocity. It is not that Turkish pension fund managers will lend shilling to the Kenyan government in some sort of quid pro quo with Kenyan banks who will lend lira to the Turkish government. The world does not work that way. Each is looking to protect its own interests—which does not include incurring the risk that a foreign currency will fall significantly relative to the domestic currency and the dollar. One wonders how often, when institutional investors buy domestic debt denominated in domestic currency, that they do so under pressure from the domestic government.
Competitors to the Dollar World Reserve Currency
In order to seriously entertain the idea that there will arise an irredeemable fiat currency which replaces the dollar, we would first have to hear which currency could step up. It won’t be a plethora of currencies, as we discussed why the lira or shilling could never work.
In the years following the last financial crisis, there was an expression “the BRICs” meaning Brazil, Russia, India, China. These countries were believed to be economic powerhouses, that could help pull the world out of a major recession. And some held out hope that their currencies could become reserve currencies.
We think that it’s easy to see why it did not and could not happen with the Indian rupee and Brazilian real. Which leaves Russia’s ruble and China’s yuan.
Russia and the Ruble
If the picture of Russia unable to sell its oil even as the world desperately craves it, does not debunk the idea of the ruble as any kind of global reserve currency, then nothing will. Russia is struggling to give away its oil. It will not attract creditors to lend to it. Much less creditors happy to denominate debts in rubles.
Not to mention it has instigated a war of aggression, destroyed the lives and properties of thousands, and has threatened much worse. The optics of doing business with Russia have gone from bad to worse. It’s not clear if or when that would begin to change.
China and the Yuan
This leaves China. China is run by the same government that ran over the peaceful students reading Thomas Jefferson in Tiananmen Square. With tanks. And shot many in the back, as they fled. China has strict capital controls, which is an obstacle to adoption of its currency as a reserve, the way a locked two-ton steel door is an obstacle to entering a vault. Its own people, who presumably know what they can trust their government for, risk their lives to evade their capital controls and acquire dollar-denominated assets. There is a constant stream of wealthy Chinese businessmen, athletes, and entertainment stars who disappear from view. And, though we would not call it “communist” today, it still imposes pervasive top-down planning which has created empty buildings and empty cities on a stupefying scale.
Is there a serious case that the currency of this dictatorship, with who knows how many trillions worth of malinvestment yet to be written off, will attract happy and willing lenders all around the globe?
The issue is not whether people hate America (many do). It is not whether they hate the dollar (they may, though they all accept it and often prefer it to the local scrip). It is not simply that the dollar is the “cleanest dirty shirt” (though it is).
There are two issues. One, the other currencies are all dollar-derivatives. Their issuers own dollar assets, to back their liabilities which are their local currencies. Or they own foreign currencies such as the pound and yuan, which are backed by dollars. The dollar is backing every central bank balance sheet. And every major financial institution balance sheet. And every major nonfinancial corporate balance sheet. The dollar is also a liability on all those balance sheets.
Two, no other currency can handle the flows. China’s currency is so small that routine dollar transactions would cause a major move in the yuan. The dollar is the biggest currency, by far. No one wants to move the market up when they buy, only to move it down when they sell.
The dollar is destructive both to America, and to the other countries. That does not mean that any other currency would be better. Or that any other currency could fill the shoes left by the dollar. Or that there is a path to get to another currency.
That leaves bitcoin and gold.
A Bitcoin Standard?
Bitcoin proponents assert that bitcoin is the future of finance. It’s just that bitcoin has yet to show up on the finance field at all. It’s a popular speculation, a bet on the price. But it does not finance anything. No one borrows bitcoin to pay the costs of planting and harvesting a crop, to buy a warehouse, or to build a new factory. All production of real things in the economy is financed in irredeemable currency. Which means all producers owe irredeemable currency. Which means they must produce sufficient goods to sell to get sufficient irredeemable currency to service their debts.
This is why manufacturers of TVs, operators of copper mines, and farmers of wheat are not keen for bitcoins. They need dollars (or local currency). If they fail to service their debts, the lender will seize their assets. This, by the way, is what supports the value of fiat currencies. Purchasing power is strong, if the companies that produce all the things one might want to purchase, are desperate for currency.
Bitcoin proponents will say that bitcoin can be used for finance. They can pledge their bitcoin and get a cheap dollar loan. OK, but that is not how farming, copper mining, or flat screen manufacturing works. These producers do not start with enough capital to pay for their production. And anyways, this is dollar borrowing. Bitcoin is not being borrowed—it is being pledged as collateral. The way a home buyer is not borrowing the house. He is borrowing dollars to buy the house.
If bitcoin were stable, or at least had a fixed exchange rate with the dollar, then it could be used to finance production. But that would defeat the whole point. Bitcoin is not good at being stable. It is good at skyrocketing (also crashing). Its proponents believe it will go up 1,000 times. To a borrower, that would be a death sentence. No one would want their home mortgage to go from $300,000 to $300,000,000.
So bitcoin is not used to finance production. And cannot be used.
That leaves gold. Gold has not been used in finance since the 1930’s. The world—at least its leading economists—have long abandoned gold as a relic of a barbarous age. Though something happened that they did not foresee. Gold continued to be used in long-term wealth planning, intergenerational trusts, and the like. Gold is an asset on a billion balance sheets globally. Perhaps not the balance sheets of banks, and other institutional investors. But a surprising (to the barbarous economists!) number of wealthy families, and a billion not-so-wealthy people too.
In other words, despite its banishment from the government-controlled monetary system, gold has not had a decline in global demand. Despite accumulating gold from mining over thousands of years, gold miners are quite active today. And the market readily absorbs all they can produce, with no sign of a glut.
Gold not only can be borrowed to finance production, it has been. Monetary Metals issued the first gold bond in 87 years. The path to the gold standard is paved by voluntary lending and borrowing, by individuals and corporations pursuing their own self-interest. Individuals and corporations who understand that earning interest on gold, and thereby compounding their holdings over time, is superior to earning interest on dollars over the long term.
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