De-dollarisation

The unintended consequences of sanctions

If you weren’t sure about what a little volatility can do then you do now; that was the quarter that was. US equities had their worst quarter for two years, not as bad as 2020 although do we know for certain that the downdraft has finished yet?

Bonds were taken out behind the shed and had their worst period since the US Civil War in 1865! The rest of the world pretty much followed suit with the exception of the Asia Pacific region excluding Japan and the UK. Both of which produced positive returns.

In a volatile and inflationary environment, it was perhaps unsurprising that gold continues to do well in sterling terms, matching US equities over one year. The attraction of the barbarous relic has been enhanced by western sanctions against Russia. By confiscating Russia’s foreign reserves, it has sent a message to other nations, not on the friendliest terms with the US and Europe, that their reserves are potentially in the same category.

Russia’s request, thus far ignored, for all shipments of oil and gas to “unfriendly” countries, will have to be paid for in rubles. Ignoring the actual mechanics of converting euros or yen to the Russian currency, what would they do with it? Simple answer is that they would buy more gold. They produce enough of it to satisfy their own demand and would allow them to store it on their soil and not with European banks.

China, and perhaps India, seems to be siding with Russia, not overtly but enough to get the big guns out to “persuade” them otherwise. Such rhetoric doesn’t tend to go down well with the Chinese, and we are looking at the beginnings of a new east west bifurcation.

Bloomberg argues: “Unless the US and its allies mobilize to save it, the second great age of globalization is coming to a catastrophic close…. Unless something is done quickly and decisively, the world will divide into hostile camps, regardless of what happens in Ukraine. And this divided world will not suit the West.”

The Atlantic concurs: “...what could emerge are two semi-distinct spheres, with tighter economic ties within than between them. Each will use different technology and operate on different political, social, and economic norms. Each will likely point their nuclear missiles at the other and compete in a zero-sum game for power and influence. This is not the world anyone wanted. But it may be the world we’ll get anyway.”

The question being asked is, “is this the end of dollar hegemony”? Probably, but in the manner of Churchill’s “this is not the end, nor the beginning of the end, but the end of the beginning.” The first chart below shows that whilst the dollars share of global reserves is declining it still accounts for some 60% and the euro in second place has 20%. The “others” at the bottom of the chart hardly figure at all so the dollar will still hold sway for a while yet especially in the major economies ex China.

The second chart shows the “also rans” with the renminbi picking up speed, but not yet a threat at 2.75% of global reserves. Where both Russia and China are leading the way is in gold reserves. Both have been accumulating and both are keeping all the gold mined in their respective countries at home.

Compared with the size of their economy China’s reserves are very small, certainly at the current gold price. If the petrodollar is on its way out, then one of the obvious replacements would be gold, again not at the current price.

Very quietly (aka not reported in the mainstream media) the Russian central bank by offering to buy gold from Russian banks at a fixed price of 5000 rubles per gram, the Bank of Russia has both linked the ruble to gold and, since gold trades in US dollars, set a floor price for the ruble in terms of the US dollar, which is now back to where it was pre-invasion.

What does this imply for the price of gold? The ruble now has a floor to the US dollars, in terms of gold. But gold also has a floor, so to speak, because 5000 rubles per gram is 155,500 rubles per troy ounce of gold, and with a RUB / USD floor of about 80, that’s a gold price of around $1940, not far from the current price of $1925.

It is highly unlikely that the Bank of Russia will get away with this without some serious push back, but, again, the effects of the unintended consequences of sanctions are being felt.