The Gold Standard
To understand what Russia is attempting to do with the ruble and USD, it is important to first understand what the concept of the gold standard in economics and finance is. The gold standard was first introduced in the United Kingdom in 1821, as a method of attempting to fix the value of British currency to the value of gold. By expressing gold in terms of currency, a country’s central bank dictates that it will sell – and buy – gold at a fixed rate.
By doing so, a country is able to ensure stability in its economy – and the international economy – by mandating a fixed value for its currency, that is, that one gram of gold is equal to exactly ten units of its currency. Whether the central bank is selling or buying gold, it will do so at this same exchange rate.
However, dwindling gold supplies have led the world to slowly ease off the gold standard over time, instead choosing to “peg” their currencies to gold rather than “fixing.” Pegging a currency means instituting a minimum price for gold, and allowing the free conversion of currency into gold.
Since 1973, even this practice has been abandoned, as President Nixon of the United States ended the American dollar’s free convertibility to gold in 1971, leading to the collapse of the Bretton Woods Agreement – that had ensured a world system of gold convertibility – two years later.
The Dogged Dollar
Since then, most of the international trade and currency exchange has had the USD as its standard, with almost every country in the world carrying out its payments in dollars. 60% of the world’s countries’ foreign reserves are in USD, meaning that most countries choose to buy dollars, leading to the actual strength of the USD in the world. As long as there is demand for the dollar, it will remain strong.
However, this means that there is no economic check on the US Federal Reserve’s ability to print money. The gold standard helped limit how much a central bank could print money, and thereby cause inflation, as the value of money is fixed to a standard amount of gold. Since the abandonment of the gold standard, the US has printed dollars at an alarming rate, in order to keep up with growing demand.
From 2008 to 2018, the value of the US Federal Reserve’s balance sheet (of its assets and liabilities) grew from $800 billion to roughly $8.5 trillion! The rising money supply contributes to inflation, as the value of money itself falls. We have seen this happen, as inflation rates in America have recently skyrocketed to a 40-year high of 8.5% – though this is in part due to the ongoing economic shocks generated by the Russian invasion of Ukraine.
This brings us to the question at hand; the Russian economy in the midst of the country’s war on Ukraine. Facing an unprecedentedly comprehensive set of sanctions, Russia finds almost half of its foreign exchange (forex) and gold reserves frozen, with $300 billion out of $640 billion rendered unusable currently. It is not just Russia that is feeling the heat of the sanctions.
Seeing as it is the world’s largest exporter of oil and petroleum-based products, many countries in Europe have been forced into paying much higher prices for the oil they import from Russia, because of the very sanctions they are imposing. While they would like not to, they have no choice but to continue buying oil from Russia, as not doing so would end up hurting themselves.
Global oil supply has fallen too, as not just Russia, but other countries such as Libya have reduced oil production for one reason or the other. The price for Brent crude, the standard by which we generally measure oil prices, had risen to over $120 a barrel on March 7th, a historic high. It stands at around $108 as of April 19th.
The price of gold has risen too, to over $2000 an ounce – or $64 a gram, up from $57 a gram in late January, before the Russian invasion! The price of gold in Pakistan currently stands at a little over Rs. 11,400 per gram, roughly the same as the world price.
The Rumbling Ruble
Sanctions, while also raising commodity prices in Russia by as much as 17.5% from last year, have raised international prices of oil and gas by so much that Russia has managed to achieve a record current account surplus (exports minus imports) of $58.2 billion in the first quarter of 2022.
However, the value of the Russian ruble took a hit when sanctions first hit, falling to a low of 132 rubles per USD on March 7th, more than one and a half times the most recent high of 79 rubles per USD on January 26th, before the invasion.
However, since then, the ruble has managed to fight its way back up, managing to hit 78 rubles per USD, an impressive regaining of value. Just how did Russia’s economy manage to push the ruble back up so much? The answer is less impressive. The most impactful policy that orchestrated the rise of the ruble since the invasion was simply the severe restrictions imposed on currency trading.
By raising the interest rate to 20%, Russia aimed to mitigate the borrowing of money to buy foreign currency, on which it imposed a further 30% commission. By artificially reducing the demand for foreign currency, Russia ensured that the value of its own currency would rise. Amongst other policies, Russia has also implemented the pegging of its ruble to gold.
Enter the Gold Russ-h
Russia is the world’s sixth-largest exporter of gold and holds over 50% of its forex in gold. As mentioned earlier, global prices of gold skyrocketed to over $2000 an ounce as people rushed to buy the precious metal, seen as tried-and-tested protection against economic fallout. The sharp rise in the value of gold opened another avenue for the Russian economy to protect its ruble from the worst effects of global sanctions.
Therefore, the Russian central bank on March 25th announced that it would begin buying gold for 5000 rubles a gram, which was below the market price at the time of $62.8 per gram (on March 25th, 5000 rubles were equal to $52). By fixing a below-market exchange rate, Russia managed to enforce the rise of the ruble’s value till it reflected global gold prices.
By April 7th, global gold prices were still at just over $62, but the change in exchange rates meant that the ruble was now equal to roughly $65. Since April 7th, however, Russia has announced the removal of the mandated 5000 rubles to a gram of gold and said that it will instead buy and sell gold at negotiated prices with the central bank.
The causes of the removal of the peg to gold after just two weeks were dictated by the fear of over-reliance on gold, and also perhaps because the objective of bringing the ruble back up had been achieved. The ruble has managed to maintain its relative strength since then, not exceeding an exchange rate of 83 rubles to a USD.
Shifts in the Financial Markets
So far, the policies that have brought the ruble back up have been ones that the government cannot implement indefinitely. Already, the commission on purchases of foreign currency has been removed, and the interest rate has been brought down to 17% from 20%. One major policy that Russia is implementing is the replacement of the USD with the ruble as the medium of international exchange.
It has tried to pressure “hostile” countries, namely the US, the EU member countries, and many more, into paying for Russian gas in rubles instead of dollars. While some – undeclared – countries have agreed, many more are resilient in their refusal to do so. However, if such a system were to be instituted, it would provide a huge boost to the demand for rubles; Russian gas exports in 2019 were worth over $26 billion.
This would significantly raise the value of the ruble, especially relative to the USD, which would see an equivalent fall in its demand. For every unit of Russian gas paid for with rubles, there would be less and less demand for dollars. Whilst the policy to peg the ruble to gold was only temporary, the strength with which the ruble bounced back up reflected the power of gold in the international economic system.
It is a power which, while created by low supply relative to demand, is also dependent on enough supply to sustain itself. Hence, the temporary nature of the policy. Nevertheless, it has shown that the dollar is not impervious to shifts in economic policy in major countries and markets. Whilst the legitimacy of Russia’s current military actions is highly questionable, it will undoubtedly use its clout and power to force agreements on payments for its exports in rubles.
This trend might be followed by other growing countries, most notably China, which in 2018 made agreements with Pakistan to conduct its bilateral trade in Chinese yuan instead of the dollar. Some see this as a new phase in international politics; an attempt as part of a growing paradigm shift to shift the world away from its dependency – some say over-dependency – on the dollar as the medium of international trade.
However, there is no telling whether the same will hold true in the shifting tides of the global future. Saudi Arabia and China have reportedly entered talks to begin pricing oil sales to China in yuan, a report that led to the value of the yuan appreciating. The role of Saudi Arabia and the Gulf countries in maintaining the power of the dollar through the concept of petrodollars could mean that any such agreement could seriously threaten the power of the dollar, but that is a discussion for another time.
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