NEW YORK – Russia and India took a small but important step towards non-dollar trade finance and investment on March 25, when the Reserve Bank of India allowed Russia to invest proceeds from its sales arms to India in local currency corporate bonds.
Russia’s account with India’s central bank is small, with a reported balance of $262 million, but the potential benefits for both countries are enormous: India will pay for one of its most assets, namely Russian weapons, in local currency, and Russia will invest the proceeds in a sanctions-free financial market.
India has changed its rules on external commercial borrowing to accommodate the Russian proposal, Bloomberg News reported. The United States, the European Union (EU) and Japan seized Russian central bank reserves as well as the assets of wealthy Russian nationals after troops from Moscow invaded Ukraine in late February.
This is another small but indicative crack in the framework of the US dollar reserve system. Saudi Arabia would accept RMB as payment for oil shipments to China, its biggest customer.
This in turn implies that the Saudi kingdom will maintain a significant portion of its reserves in Chinese currency, possibly under a deal like the Indo-Russian deal for the reinvestment of arms sales proceeds.
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 United States or other Western governments can seize it. Diversification into the RMB is a logical alternative.
Russia, meanwhile, demanded payment for gas shipments to “unfriendly” countries in its own currency, forcing European gas customers to buy rubles on the open market. The ruble fell from a low of 140 rubles to the dollar on March 8 to 100 rubles to the dollar on March 25.
After the United States, Europe and Japan seized more than half of Russia’s $630 billion following the war in Ukraine, Russia has few safe places to store oil revenues and gas in dollars and rubles.
By accepting payment in rubles, Russia effectively removes some of its own currency from circulation, which retards the exchange rate of the ruble and removes the inflationary pressure that arises from currency devaluation.
‘Nuclear’ sanctions on Russia’s economy will cause a 10% contraction this year, according to Goldman Sachs economist Clemens Grafe, followed by 3-4% growth in 2023 and 2024 – which is hardly the stuff of which a regime change is made.
With oil and gas sales estimated at $1.1 billion a day, Russia is likely to post a current account surplus of $200 billion this year, slightly higher than its annualized surplus of $165 billion in the fourth quarter. 2021.
The International Monetary Fund, the international financial institution created in 1944 to manage world currencies on a combined gold and dollar standard, is worried. The gold part of the standard disappeared in 1971 when the United States unilaterally stopped paying its current account deficit in gold transfers.
But the central role of the dollar was affirmed in 1974, when Saudi Arabia and other Gulf oil producers agreed to keep oil trade denominated in dollars, in return for American security guarantees.
All of that could change, the IMF wrote on its website March 15: “War could fundamentally alter the global economic and geopolitical order if energy trade changes, supply chains reconfigure, payments were fragmenting and countries were rethinking reserve currency holdings.
Rising gold prices are an indication of doubts about the central reserve role of the dollar. Gold generally trades closely with the yields of Treasury Inflation Protected Securities (TIPS), which perform the same function. Both protect against an unexpected inflationary shock and currency depreciation.
Over the past month, the price of gold has decoupled from TIPS yields, rising instead of falling as inflation-linked interest rates soar.
Judging by the historical relationship between gold and TIPS returns, the metal is about $300 too expensive. This suggests a geopolitical risk premium.
The US Treasury said on March 24 that existing sanctions prevent Russia from selling its gold reserves, worth around $140 billion at the current market price of around $1,960 an ounce. Many news reports have reported a “freeze” of Russian gold reserves due to Western sanctions, which is totally misleading. Russia does not need to sell gold to raise funds; it earns $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 could invest the money in Indian assets, according to the new agreement with the Reserve Bank of India. Alternatively, India could transfer gold to Russia to settle the difference.
American or European sanctions are irrelevant in the case of a bilateral transfer of gold between central banks.
America’s threat to the world boils down to the possibility that it will 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 Russian central bank reserves, Washington put a question mark over the raison d’être of the existing financial system and encouraged the rest of the world to “rethink foreign exchange reserve holdings. “, as the IMF put it.
But in plain English, it means rethinking the trillion dollars a year that the rest of the world lends to the United States.
Follow David P Goldman on Twitter at @davidpgoldman