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.

Russia, The US, and Crude Data

Overall, I’ve been disappointed with the reporting on the US embargo against Russian oil. The AP reported that the US imports 8% of Russia’s crude oil exports. But then they and other outlets list a litany of other figures without any context for relative magnitudes. Let’s shine some more light on the crude oil data.*

First, the 8% figure is correct – or, at least it was correct as of December of 2021. The below figure charts the last 7 years of total Russian crude oil exports, US imports of Russian crude oil, and the proportion that US imports compose.  That 8% figure is by no means representative of recent history. The average US proportion in 2015-2018 was 7.8%. But the US share as since risen in level and volatility. Since 2019, the US imports compose an average of 11.9% of all Russian crude oil exports.

As an exogenous shock, the import ban on Russian crude oil might have a substantial impact on Russian exports. However, many of the world’s oil importers were already refusing Russian crude. The US ban may not have a large independent effect on Russian sales and may be a case of congress endorsing a policy that’s already in place voluntarily.

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Economics of the Russia-Ukraine Conflict

Russia launched a full invasion of Ukraine last night. Most of the discussion I’ve seen has naturally focused on the fighting itself- what is happening, what is likely to happen, how did it come to this.

Since there are plenty of better sources to follow about that, I’ll simply offer a few observations on the economics of the conflict:

  1. Russia is not only more than 3 times as populous as Ukraine, it also more than twice as well off on a per-capita basis. This means its overall economy is more than 6 times the size of Ukraine’s. This gap has been growing since the fall of the Soviet Union, as Russia’s per-capita GDP growth has been much stronger, while its population has shrunk much less than Ukraine’s. Putting this together, Ukraine’s measured real GDP is actually smaller than it was in 1990, while Russia’s is larger.

2. Russia’s much larger economy allows it to spend much more on its military. Russia spends $60 billion per year, the 4th most of any country (after the US, China and India). Ukraine spends only $6 billion per year on its military. So Russia is starting with a big economic advantage here, though Ukraine has some of its own advantages, like fighting on their own ground and receiving more foreign support.

3. War is bad for business. Russian stocks are down 33% in a day, their biggest-ever loss; Ukraine shut down trading entirely, and their bonds are being hit even worse than Russia’s. Regardless of which side “wins” the fight for territory, both countries will be economically worse off for years as a result of the war.

4. Russia, though, expected that the war would lead to sanctions from the West that would harm their economy, and prepared for this by building up hundreds of billions of dollars worth of foreign reserves over many years.

5. US markets are down only slightly, much less than they would be if traders thought the US would get involved directly in the fighting. But this slight overall decline conceals huge swings. Companies that do business in Ukraine or Russia are big losers. But those that compete with Russian exports see their value rising given the expected sanctions. Because Russia’s biggest exports are oil and natural gas, the value of US-based oil & gas companies is rising, while alternatives like solar are also up substantially.

6. There is still some hope for Ukraine to expel Russian troops, but its not looking good, and even a victory would involve huge costs. This leaves people all over the world wondering, how did it come to this? How might future conflicts like this be avoided? There is of course a lot to say about military preparedness, nuclear umbrellas, and ways the West can impose costs on Russia as a deterrent. But what stands out to me is that a stagnant economy and shrinking population make a country weak and vulnerable. Ukraine has a worse economic freedom score than Russia; this combined with its relative lack of natural resources explains much of the stagnation. Political elites often focus on grabbing a large share of the pie, rather than growing the pie and risk empowering domestic opponents. But we’re now seeing how stagnation carries its own risks. A growing economy, and especially growing energy sources that don’t depend on hostile nations, is the path to independence and survival.