Thursday, December 4, 2014

Alisdair Macleod: Russia's Monetary Solution

Here is an interesting and thought provoking article by Alisdair Macleod. Mr. Macleod has a background as a stock broker, banker, and economist. In this article he suggests that Russia should consider going to a gold backing for the ruble. If that really happened, how would the west react to that? Let's look at it. First a number of quotes from his article, then some comments. Be sure to read the whole article.


"The successful remonetisation of gold by a major power such as Russia would draw attention to the fault-lines between fiat currencies issued by governments unable or unwilling to do the same and those that can follow in due course. It would be a schism in the world's dollar-based monetary order."

"Russia has made plain her overriding monetary objective: to do away with the US dollar for all her trade, an ambition she shares with China and their Asian partners. Furthermore, in the short-term the rouble's weakness is undermining the Russian economy by forcing the Central Bank of Russia (CBR) to impose high interest rates to defend the currency and by increasing the burden of foreign currency debt. There is little doubt that one objective of NATO's economic sanctions is to harm the Russian economy by undermining the currency, and this policy is working with the rouble having fallen 30% against the US dollar this year so far with the prospect of further falls to come."

"Russia faces the reality that pricing the rouble in US dollars through the foreign exchanges leaves her a certain loser in a currency war against America and her NATO allies. There is a solution which was suggested in a recent paper by John Butler of Atom Capital, and that is for Russia to link the rouble to gold, or more correctly put it on a gold exchange standard*. The proposal at first sight is so left-field that it takes a lateral thinker such as Butler to think of it. Separately, Professor Steve Hanke of John Hopkins University has alternatively proposed that Russia sets up a currency board to stabilise the rouble. Professor Hanke points out that Northern Russia tied the rouble to the British pound with great success in 1918 after the Bolshevik revolution when Britain and other allied nations invaded and briefly controlled the region. What he didn't say is that sterling would most likely have been accepted as a gold substitute in the region at that time, so running a currency board was the equivalent of putting the rouble in Russia's occupied lands onto a gold exchange standard."

"Professor Hanke has successfully advised several governments to introduce currency boards over the years, but we can probably rule it out as an option for Russia because of her desire to ditch US dollar relationships. However, on further examination Butler's idea of fixing the rouble to gold is certainly feasible. Russia's public sector external debt is the equivalent of only $378bn in a $2 trillion economy, her foreign exchange reserves total $429bn of which over $45bn is in physical gold, and the budget deficit this year is likely to be roughly $10bn, considerably less than 1% of GDP. These relationships suggest that a rouble to gold exchange standard could work so long as fiscal discipline is maintained and credit expansion moderated."

. . . .  .

"The greatest threat to a rouble-gold parity would probably arise from bullion banks in London and New York buying roubles to submit to the CBR in return for bullion to cover their short positions in the gold market. This would be eliminated by regulations restricting gold for rouble exchanges to legitimate import-export business, but also permitting the issue of roubles against bullion for non-trade related deals and not the other way round."

"So we can see that the management of a gold-exchange standard is certainly possible. That being the case, the rate of exchange could be set at close to current prices, say 60,000 roubles per ounce. Instead of intervention in currency markets, the CBR should use its foreign currency reserves to build and maintain sufficient gold to comfortably manage the rouble-gold exchange rate."

 . . . . . .

"Western economists schooled in demand management will think it madness for the central bank to impose a gold exchange standard and to give up the facility to expand the quantity of fiat currency at will, but they are ignoring the empirical evidence of a highly successful Britain which similarly imposed a gold standard in 1844. They simply don't understand that monetary inflation creates uncertainty for capital investment, and destroys the genuine savings necessary to fund it. Instead they have bought into the fallacy that economic progress can be managed by debauching the currency and ignoring the destruction of savings."

. .  . . . 

"That in a nutshell is the domestic case for Russia to consider such a step; but if Russia takes this window of opportunity to establish a gold exchange standard there will be ramifications for her economic relationships with the rest of the world, as well as geopolitical considerations to take into account.

An important advantage of adopting a gold exchange standard is that it will be difficult for western nations to accuse Russia of a desire to undermine the dollar-based global monetary system. After all, President Putin was more or less told at the Brisbane G20 meeting, from which he departed early, that Russia was not welcome as a participant in international affairs, and the official Fed line is that gold no longer plays a role in monetary policy."

"However, by adopting a gold exchange standard Russia is almost certain to raise fundamental questions about the other G20 nations' approach to gold, and to set back western central banks' long-standing attempts to demonetise it. It could mark the beginning of the end of the dollar-based international monetary system by driving currencies into two camps: those that can follow Russia onto a gold standard and those that cannot or will not."

"It is beyond the scope of this article to examine the case for other countries, but likely candidates would include China, which is working towards a similar objective. Of course, Russia might not be actively contemplating a gold standard, but Vladimir Putin is showing every sign of rapidly consolidating Russia's political and economic control over the Eurasian region, while turning away from America and Western Europe."

My added comments:

This article is pretty long and contains a lot of meat to chew on. I won't try to cover it all. But here are the key points for me from this article. 

-Russia might respond to western sanctions by actually doing this (people under pressure sometimes do unexpected things)

-the article explains how it is feasible for Russia to back the ruble with gold if they wanted to

-the article correctly notes that Russia (and all the BRICS) are already working on ways to bypass the US dollar around the world

-the article points out that if Russia were to really do this (back the ruble with gold) it would setup a major confrontation in the global monetary system. Almost like firing off a nuclear weapon if this were a military conflict

I don't know if Russia would really take this step or not. It would likely start a global financial war with the west with no turning back. The western financial and banking system would not just sit by and watch this happen with no response. For sure, if this did happen, we would see major monetary system change move to the global stage front and center which is what we follow here. We might also see a cold war turn into a hot war as well (its happened before).

I think it is more likely that the BRICS will just continue to steadily chip away at the dollar over time rather than to try a sudden full major offensive against it like this. But it is something to keep in mind and worth considering as this interesting article points out.

Update: Putin State of the Union speech - Enemies trying to "dismember Russia"

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