West’s Seizing of Russian Foreign Reserves May Lead to Rise of Commodities as Money

Some eighteen months ago, I wrote here on “Money as a Social Construct“. Most civilizations over the millennia have found it expeditious to move from simple, immediate barter of physical objects like cows to some system involving “money”. But what is money? Wikipedia gives the following standard definition:

Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given socio-economic context or country. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value.

For convenience, the “thing” used as money is best if it is portable and durable and of limited amount. Gold and silver have historically served these purposes. Even though these are physical objects, their actual value in usage (e.g. how much gold does it take to buy a cow) is arbitrary. Its value in usage is whatever is agreed upon by the users.

For this system of money to work, the key players all have to believe in the value of the gold coins. Thus, money is a mainly social construct, an article of mutual faith. If people lose faith in the value of some form of non-commodity money, it will in fact become valueless.

We have moved from useful commodities like cows, to gold coins and bars, to printed dollar bills redeemable in gold,  and now to fiat currencies not formally tied to any physical objects. And in the twenty-first century, most “money” is not even tangible printed bills, but is in the form of digital entries in accounts “somewhere”.

Trillions of dollars’ worth of transactions take place every year, on the supposition that the dollar you deposit in a major bank will be there next week or next year. At my own personal level, nearly all of my life savings exists in the form of investments in stocks or bonds of corporate entities, which are held in accounts that I only ever access from my computer. Thus, I rely on on-going functional, reasonably honest government to enforce rules on the stewardship of those funds at multiple levels. So I am betting everything on the supposition that law and order prevail.

Well, in war sometimes “law and order” do break down and the normal rules of stewardship are over-ridden. Such has been the case with Russian foreign reserves. The central banks of major nations hold assets in the form of accounts at other central banks. Russia, as a big net exporter, has accumulated reserves of dollars and other currencies at the central banks of various nations in the West. In the wake of Russia’s invasion of Ukraine, the Western banks froze some 630 million of Russian assets held in these banks. There has even been discussion of redeploying these assets to pay for assistance to Ukraine.

(Sadly, as I noted in How Overzealous Green Policies Force Europe to Bankroll Putin’s Military, these seemingly dramatic fund seizures and SWIFT sanctions are annoying but not crippling for Russia. Europe is still funneling billions of euros a month to Russia, because Europe has made itself utterly dependent on Russian natural gas due to prematurely chopping its own nuclear and coal power generation and banning the fracking process that has unlocked such enormous oil and gas production in the U.S.)

It is understandable why the West has taken such a step, in view of the unjustified Russian attack on Ukraine, and the ongoing atrocities such as the bombing of a maternity hospital and a clearly-marked children’s shelter. However, this action may lead to worldwide reappraisals of what is money and how net export nations choose to store their monetary surpluses.

The Wall Street Journal ran a piece called, “If Russian Currency Reserves Aren’t Really Money, the World Is in For a Shock.” It is suggested that central banks may be motivated to accumulate more of their reserves in the form of physical gold, held in their own countries, which cannot be confiscated by some outside forces. Or we may even go back to using “cows” as a store of value, with central banks gaining title to piles of useful commodities such as wheat or nickel or palladium.

Good hockey players skate to where the puck is heading. I bought into a fund of corn futures yesterday. After posting this article, I think I will log into my brokerage account and buy some shares in a fund holding physical gold.

Let’s Talk About Inflation

You’ve probably seen the headlines. Corn prices are double what they were a year ago. Lumber prices are triple. You can find all kinds of other scary examples. Is runaway inflation just around the corner? Is it already here?

And yet, measures of prices that consumers pay are much more stable. The most widely tracked measure, the CPI-U, is up 4.2% over the past year. That’s through April — and keep in mind that it’s starting from a low base since March-May 2020 saw falling prices). The Personal Consumption Expenditures index, often preferred by economists, is up just 2.3% (though that’s only through March).

So what gives? Do these consumer measures understate inflation in some way? Or is the increase in commodity prices telling us that consumer prices will increase soon?

Let’s take that second question first. Do higher commodity prices necessarily lead to higher consumer prices? The answer is a clear no. First, we can see that in the data. The producer price index for all commodities (such as corn and lumber) is up 12% over the year (through March, with April data coming out tomorrow). That’s a big increase. But as the chart below suggests, that probably will not lead to 12% increases in consumer prices. It probably won’t even lead to a 5% increase in consumer prices.

Notice two things about this chart. First, commodity prices (the red line) are much more volatile than consumer prices, both on the upside and downside. Second, there really isn’t much of a lag, if any. The direction of change is similar in both indexes, almost to the month. When producer commodity prices go up, consumer prices also go up, that very same month, but not by the same amount. So all of that 12% increase in producer prices is probably already reflected in consumer prices.

Why might this be? Simple supply and demand analysis (hello Econ 101 critics!) can tell us why.

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