Towards the end of March, Russia made a rather startling announcement that could have long term implications. It decided to set a new peg for the Rouble in terms of gold. The benchmark, to begin with, was Rouble 5,000 per gram of gold. If you consider the global price of gold in dollar terms, this amounts to a substantial overvaluation of the Rouble vis-à-vis the dollar. However, Russia has made it clear that its peg with the dollar is immaterial and what matters is the peg of Rouble to gold.
Sanctions and the aftermath
This was Putin’s first major offensive against the global financial markets, which had sought to corner Russia by imposing sanctions at multiple levels. After putting sanctions on Russian payments, the latest round of sanctions by the US decided to curb the Russian trade in gold by disallowing the citizens of the US and its allies from trading with Russian banks for gold. These would be prima facie deemed illegal and would be immediately frozen.
These sanctions by the Western world are largely an outcome of the Russian attacks on Ukraine. Russia has been unhappy with Ukraine hobnobbing with the US via NATO. They had launched a similar attack to take over Crimea from Ukraine in 2014. This time, the focus was on a much longer and deeper battle of attrition. However, the unprovoked attack and the loss to human life has resulted in the West tightening sanctions on Russia.
How has Russia reacted to these sanctions?
Russia realizes that the US is able to dictate terms to the Western powers only because of the rampant use of the dollar as a standard of payment for trade and commerce. Barry Eichengreen called it the exorbitant privilege of the dollar, which artificially made the dollar valuable. This was despite successive US governments debasing the dollar with rampant printing of dollars. That is where Russia wants to hit and Putin sees an opportunity here. Here are the 3 stages in which Russia will play out its gold standard move.
1) The first step will be to offer the domestic Russian banks a window to sell their gold to raise short-term resources. These Russian banks cannot sell gold in the international markets due to sanctions. This move will encourage the flow of gold from the Russian commercial banks into the coffers of the Central Bank of Russia. For this purpose, the Russian central bank has already set a peg of Rouble 5,000 per gram of gold.
2) The second step would be to encourage flows into the rouble. What is Russia’s biggest trump card? In this case, nearly 60% of total Russian supply of oil and gas goes to the EU region, while Russia alone supplies about 35% of the oil and gas consumption of the EU. As the second step, Russia has already started insisting that all payments for Russian oil and gas should be either made in Rouble or in gold. What does this mean? If EU chooses to pay in Rouble, they have to buy Rouble and will strengthen the Rouble. Alternatively, if they pay in gold, there will be transfer of gold reserves from the EU to Russia.
3) The third and final step would be position the Rouble into a credible gold substitute at a fixed rate. This is akin to what the US offered as a dollar-gold peg till 1971, before Nixon officially abandoned the gold peg. That process led to the rise of dollar as a global standard. Russia envisages a situation wherein the dollar would be undermined with increased payments in gold and in other bilateral currencies.
Things change pretty fast; but this appears to be the plan. As we write, Russia has already diluted its stance and is willing to accept Euros for oil supplies to the EU. Obviously, the quid pro quo would be that EU will not be party to deepening of sanctions on Russia by the West.
How the Rouble gold peg will undermine the dollar?
To understand how the Rouble gold peg will undermine the dollar, let us look at a practical illustration. For example, Russia has announced that the peg of Rouble 5,000 to 1 gram of gold would hold till June 30th. If you take that as the benchmark and compare it to the dollar equivalent, you will understand why this is an attempt to debase the value of the dollar in the international market.
If you use the current exchange rate between the Rouble and the US Dollar, then the purchase price of Rouble 5,000 per gram of gold is equivalent to about $50 per gram of gold. Considering that one troy ounce (the global standard for gold) is equivalent to 32 grams, this translates into an indicative price of $1,600/oz. However, gold is currently quoting at $1,960/oz, so this translates into 18.8% virtual debasement (360/1960) of the US dollar.
What is the bottom-line and what this could imply?
If the sharp fall in many Western currencies on the day of the announcement is any indication, it is clear that the implications for the dollar are negative. A lot will depend on whether this Russian gold peg really works. But you can envisage some interesting implications of this move.
Firstly, it is not just the dollar but even other currencies like UK Pound, Canadian Dollar and Australian Dollar that are closely pegged to the US dollar that will take a hit. This could result in a lot of volatility in the current markets.
One possibility is that there could be selling in these currencies if these currencies are not revalued lower. However, it is a Catch-22 situation as debasing the currencies would also mean importing inflation and making these economies open to a surge in prices.
Lastly, if Russia has its way, many other countries could follow suit. China has long been calling for an end to the dollar hegemony. Many Middle East countries are now willing to accept Yuan for their oil exports to China. India already has a Rupee-Rouble trade channel with Russia. Things could just about amplify.
These are early days still. A lot would depend on how Russia is able to walk the talk and the support it derives from its new-found Asian allies.