NEW YORK – Russia and India took a small but important step towards non-dollar trade financing and investment on March 25, when the Reserve Bank of India allowed Russia to invest the proceeds of its arms sales to India in local-currency corporate bonds.
Russia’s account with India’s central bank is small, with a reported balance of US$262 million, but the prospective advantages to both countries are enormous: India will pay for one of its most important import items, namely Russian weapons, in local currency, and Russia will invest the proceeds in a financial market safe from sanctions.
India changed its rules on external commercial borrowing to accommodate the Russian proposal, Bloomberg News reported. The US, European Union (EU) and Japan seized Russian central bank reserves as well as the assets of wealthy Russian nationals after Moscow’s troops invaded Ukraine in late February.
That is another small but indicative crack in the framework of the US dollar reserve system. Saudi Arabia reportedly will accept RMB in payment for oil shipments to China, its largest customer.
That implies in turn that the Saudi kingdom will maintain a significant portion of its reserves in Chinese currency, possibly in an arrangement like the Indian-Russian agreement for reinvestment of the proceeds of arms sales.
Human rights organizations have denounced Saudi Arabia for “longstanding human rights abuses,” as Human Rights Watch wrote on its website. After the seizure of Russian reserves, the Saudis are reluctant to keep their wealth where the US or other Western governments can grab it. Diversification into RMB is a logical alternative.
Russia, meanwhile, has demanded payment for gas shipments to “unfriendly” countries in its own currency, forcing European gas customers to purchase rubles on the open market. The ruble rallied from a low point of 140 rubles to the dollar on March 8 to 100 rubles to the dollar on March 25.
After the US, Europe and Japan seized more than half of Russia’s $630 billion in the wake of the Ukraine war, Russia has few safe places to park oil and gas earnings in dollars and rubles.
By accepting payment in rubles, Russia effectively removes some of its own currency from circulation, holding up the ruble’s exchange rate and suppressing inflationary pressure that arises from currency devaluation.
The “nuclear” sanctions against the Russian economy will cause a 10% contraction this year, according to Goldman Sachs economist Clemens Grafe, followed by 3-4% growth in 2023 and 2024 – hardly the stuff that regime change is made of.
With oil and gas sales running at an estimated $1.1 billion a day, Russia probably will show a current account surplus of $200 billion this year, slightly higher than its $165 billion annualized surplus during the fourth quarter of 2021.
The International Monetary Fund, the international financial Institution created in 1944 to manage the world’s currencies on a combined gold and dollar standard, is worried. The gold part of the standard disappeared in 1971 when the United States unilaterally ceased paying for its current-account deficit in gold transfers.
But the dollar’s central role was affirmed in 1974, when Saudi Arabia and other Gulf oil producers agreed to keep oil trade denominated in dollars, in return for US security guarantees.
All that might change, the IMF wrote on its website on March 15: “The war may fundamentally alter the global economic and geopolitical order should energy trade shift, supply chains reconfigure, payment networks fragment, and countries rethink reserve currency holdings.”
One indication of doubts about the dollar’s central reserve role is the rise in gold prices. Gold typically trades closely with the yields on Treasury inflation-protected securities (TIPS), which serve the same function. Both hedge against an unexpected inflation shock and currency depreciation.
During the past month, the gold price has decoupled from TIPS yields, rising instead of falling as inflation-indexed interest rates shot up.
Judging from gold’s historic relationship to TIPS yields, the metal is about $300 too expensive. That suggests a geopolitical risk premium.
The US Treasury said on March 24 that existing sanctions prevent Russia from selling its gold reserves, worth about $140 billion at the present market price of about $1,960 an ounce. Numerous news reports have reported a “freeze” on Russia’s gold reserves due to Western sanctions, which is entirely misleading. Russia doesn’t need to sell gold to raise cash; it is taking in $1.1 billion a day from energy sales.
Central banks that trade outside the dollar system, for example, Russia and India, could use gold to settle balances. If Russia exports more to India than India exports to Russia under the local currency arrangement, Russia might invest the money in Indian assets, per the new agreement with the Reserve Bank of India. Alternately, India might transfer gold to Russia to settle the difference.
American or European sanctions are irrelevant in the case of a bilateral gold transfer between central banks.
America’s threat to the world comes down to the possibility that it might stop borrowing money from the rest of the world (its net foreign investment position is now negative $14 trillion) to buy goods from the rest of the world. America, that is, runs a trillion-dollar-a-year current account deficit, and finances the deficit by selling reserve assets to the rest of the world.
By seizing several hundred billion dollars of Russia’s central bank reserves, Washington has put a question mark over the rationale for the existing financial system, and encouraged the rest of the world to “rethink currency reserve holdings,” as the IMF put it.
But in plain English, that means to rethink the trillion dollars a year that the rest of the world lends to the United States.
Follow David P Goldman on Twitter at @davidpgoldman