A Once in a Century Opportunity

“The era of liberal globalization is over. Before our eyes, a new world economic order is being formed”

Wow! How rapidly the wheel of fortune turns. It seems like only yesterday that a French Finance minister was touting the imminent the collapse of the Russian economy, and President Biden celebrated the Rouble being “reduced to rubble” – the collective West having seized foreign exchange reserves of the Central Bank of Russia; threatened to seize any Russian gold it could lay its hands on; as well as imposing unprecedented sanctions on Russian individuals, companies and institutions. Total fin-war!

Well, it didn’t work out that way. It scared the bejesus out of Central Bankers around the world that their reserves might be up for seizing too if they strayed from ‘the line’. Nonetheless, Team Biden’s hubristic decision to try again to collapse of the Russian economy (first ‘go’ was 2014) may yet come to be viewed as a major geo-political inflection point.

Its’ salience in geo-political terms may even ultimately equate to Nixon’s closing of the U.S. ‘gold window’ in 1971 – albeit, this time, with events pointing completely in the converse direction.

The consequences to Nixon’s abandonment of gold were nuclear. The petrodollar based trading system that was birthed from it allowed America to ‘nuke’ the world with sanctions and secondary sanctions – giving the U.S. its unipolar financial hegemony (after U.S. militarism alone, as the global order’s main support pillar, became discredited in the wake of the 2006 Gulf War).

Now, barely a month on, we see articles in the financial press that it is the Western financial system and world reserve currency that is in open decline, and not Russia’s economic system.

So what is going on?

The post-1971 system quickly evolved from being underpinned by a commodity – crude oil – to a fiat currency which is a “promise” to repay a debt obligation, and nothing more. A hard asset-backed currency is a guarantee that repayment will occur. By contrast, a one dollar of reserve capital is backed by nothing tangible – just the “full faith and credit” of the issuing entity.

What happened is that the fiat system began its demise when the Russo-phobic Washington ‘hawks’ stupidly picked a fight with the one country – Russia – that has the commodities needed to run the world, and to trigger the shift to a different monetary system – to a system that is anchored in something other than fiat money.

Well, the first ‘strike’ on the system – the sequellae to western financial war on Russia – simply was mayhem in commodity markets as prices soared astronomically. Russia is a global commodity super supplier, and it was being ring-fenced by sanctions.

Then early in March, Zoltan Pozsar, who formerly worked at the NY Fed, and was formerly an advisor at the U.S. Treasury and currently a strategist at Credit Suisse, published a research report in which he made the case that the world is heading to a monetary system in which currencies are backed by commodities, as opposed to being backed solely by a sovereign issuer’s “full faith and credit.”

As one of Wall Street’s most respected voices, Pozsar argued that this present monetary system worked so long as commodity prices oscillated predictably within a narrow band – i.e. not under extreme stress (precisely because commodities are collateral for other debt instruments). However, when the entire commodity complex is under stress – as it is now – the berserk commodity prices drive a wider ‘no-confidence’ vote in the system. And that is what we are witnessing now.

In short, the financial war on Russia gave the West an unmistakable lesson from Moscow that the hardest currencies are not USD or EUR, but rather oil, gas, wheat, and gold. Yes, energy, food and strategic resources are currencies.

Then arrived the second strike on the system: On 28 March, Russia announced that it was putting a floor under the price of gold. Its Central Bank would buy gold at a fixed price of 5,000 roubles per gramme – until at least 30 June (the 2^nd quarter end).

A price of RUB 100: 1 dollar imputes a gold price of $1550 per ounce, and a RUB/USD rate of around 75, but today a rouble exchanges at approximately RUB 84:1 dollar – (i.e. more roubles than just 75 are required to buy one dollar). Tom Luongo has noted however, that with the Central Bank buying gold at a fixed rate, this commitment gives an arbitrage incentive to Russians to hold savings in roubles, because the rouble is being ‘fixed’ at an undervalued rate relative to an over-valued open gold price (at approximately $1,936 per ounce, at time of writing).

In short, Russia’s Central Bank commitment sets in motion a dynamic to bring the Rouble back into balance with the current dollar price of gold on the open market. And ‘hey presto’, contrary to the European-U.S. effort to crash the exchange value of the rouble and cause a crisis, the rouble is already back at its pre-war level – and it is the dollar which has crashed (vs. the rouble).

But note this: Should the value of the rouble rise further vs the dollar, (say from 100 to 96:1) – as a result of Russia’s commodity trade strength – then the imputed price of gold becomes $1610 per oz. Or, in other words the value of gold rises.

But there is another wrinkle to this: Europeans are loudly protesting that Putin has insisted that ‘unfriendly states’ pay for their gas imports in Roubles (rather than dollars or euros) from 31 March, but Putin added the rider that the Europeans alternatively could pay in gold. (And other states have a further option to pay in Bitcoin.)

And here is the point: If fewer than 75 roubles equate to one dollar, buyers are getting oil at a discount when paying in gold. Maybe the big European energy majors will not be interested, but Asian traders will be keen to arbitrage and profit from the implied price differentials. And that, in itself, is likely to force the physical gold markets into a supply shortage situation, which again will feed through into further increasing the price of physical gold.

One less evident component therefore to European cries of pain (‘We won’t pay in roubles’), is that Central Bankers try to keep gold trading in a tight pattern (through manipulating the paper gold market as so not to rock the foundation of the global financial system).

But what the Russian Central Bank has just done is to wrest the gold ‘price-maker’ role away from the West, and its price manipulation. Between them, Russia and China can therefore effectively control the gold and oil price. Luongo concludes: ‘They are about to change the denominator in the global foreign exchange markets from the USD to gold/oil (commodity currency)’.

“Putin let the world down easy with this announcement. He could have walked right in and said 8000 roubles to the gram or $2575/oz and that would have broken the markets Friday going into the weekend, by selling his oil and gas at a steep discount” – thus forcing a rise in the gold price.

Neat, hey?

Ok, ok: bring on the chorus with usual tropes: Oh no; not another ‘de-dollarisation narrative! TINA – “There is no alternative to the dollar as a reserve currency”.

Fine. We all know that all gold at current valuation is far too small in total value to underpin a fully gold-backed trading currency or global trade. And, by the way, this is not about ending the dollar as an instrument of trade. No, it is about signalling a new direction of travel.

Pozsar’s argument is more subtle: A crisis is unfolding. A crisis of commodities. Commodities are collateral, and collateral is money, and this crisis is about the rising allure of ‘commodity-linked currency’ over fiat money. In periods of banking crises, banks are reluctant to play the inside game because they don’t trust fiat currency as a real collateral. They then refuse to lend money to their banking peers. Every time this occurs, the Central Banks have to print more money to “lubricate” the system enough so that it functions. This in turn, further devalues the fiat money, on which the system is predicated.

But if currency issued by Governments and printed by Central Banks is backed by hard assets, this problem is avoided. In this system, the counter-party to trade or financing transactions would have the option of demanding payment in the hard asset or assets backing the currency – most likely gold or possibly a pre-agreed upon commodity asset. Recall, fiat currency is nothing more than an unsecured debt instrument of the issuing entity – one which we have seen can be ‘cancelled’ at whim by the issuer – the U.S. Treasury.

This makes the ‘pay in roubles’ scheme more understandable too: Any workable “pay in roubles” scheme will have gas buyers going to Russian banks to sell dollars or euros or sterling to the bank, to have it buy roubles to tender to Gazprom. This will have the effect both of increasing the value of the rouble as a means of trade but may mitigate exposure to further financial sanctions by making Russian institutions the locus for payment operations.

As for the ‘direction of travel’? “After the current history of confiscation of dollar reserves”, Sergei Glazyev – supervising Eurasian Economic Commission’s planning for the monetary future – has said  bluntly: “I don’t think any country will want to use another country’s currency as a reserve currency. So, we need some new tool”. “We (the EEC) are currently working on a such a tool, which can first become a weighted average component of these national currencies”, he said. “Well, to this we must add, from my point of view, exchange-traded commodities: not only gold, but also oil, metal, grain, and water: A sort of commodity bundle – with a payment system based on modern digital blockchain technologies”.

“In other words, the era of liberal globalization is over. Before our eyes, a new world economic order is being formed — an integral one, in which some states and private banks lose their private monopoly on the issue of money”.

A Once in a Century Opportunity