17 min read

Til' The Money Runs Out

Til' The Money Runs Out

As the war in Ukraine drags on, it's fast become a talking point among various hawks on Twitter, government officials demanding more be done, and the economically illiterate to point to USD/Ruble exchange rate as proof that sanctions aren't working. This line has been pushed by a variety of voices, ranging from Robin Brooks' arguments that surging commodity export earnings are driving a 'real' appreciation in the ruble's value to political voices hoping to get more military aid for Ukraine or, perhaps, even some forms of soft military intervention. The orgy of handwringing over the value of the ruble and concerns that sanctions aren't biting hard enough has coincided with an explosion of what Adam Tooze has called "Fin-fi," a spate of pieces investigating the potential ramifications of sanctions on Russian central bank reserves and access to USD/EUR as well as its commodity exports for the global monetary system as a proliferating array of responses develop. Zoltan Pozsar is the widest-reaching private sector thinker on 'money' writ large in this imagined brave new world, with other entreaties – generally tepid in my view – to more deeply consider the multipolarity of the geopolitical order in concert with the multicentricity of the global economic order rounding out today's speculation.

If we're to take our political imaginaries seriously, it should be little surprise that we often reify the material or intellectual orders we seek to break at the very moment we imagine our escape, in much the same way it's easier for us to imagine a planet killing asteroid in apocalyptic films a la Roland Emmerich than the world after Capitalism with a capital C, unless of course we wish to refer to the politics of totalitarianism or other 19th and 20th century maladies. Multipolarity is similarly an archaic concept, not because of what it's intended to signify, but rather how it's deployed by specific states and subjects trying to articulate a notional 'order' to international politics and economic life. Central banks lack the implements to steer real economic activity in the manner necessary to address sudden shortages and gluts from huge disruptions of activity linked to the loss of or increased complexity of the purchase and transport of Russian commodity exports. Inflation and shocks within the real economy pose very different problems from a classic financial crisis as we learned collectively in 2020 and continue to digest. Yet for all of the Fin-Fi and moral panic emerging, there has been remarkably little written on Russia, its real economic fallout, or its position within a multipolar system itself. The most meaningful ideas we've gotten via Twitter are about India as a pivot state in Eurasia or similar threats to USD hegemony, something that I believe is both over-blown and a framing intended to support an extant critique rather than a scenario analysis exploring the current shock from the ground up.


Invoking Multipolarity

I've been reflecting on Andrei Kozyrev, post-Soviet Russia's first foreign minister, and the deployment of said multipolarity. Kozyrev was by far the most ardent rhetorical supporter of deep US-Russia partnership during Yeltsin's first term. Kozyrev was also despised as a dilettante by much of the diplomatic and national security apparatus left in Russia and constantly harangued at home for failing to assert Russia's national interests. Yet even Kozyrev, himself working within the foreign policy discourse shaped in large part by Yegeniy Primakov during the Gorbachev years, appealed to multipolarity and de facto spheres of influence. At the opening of his essay The Lagging Partnership, written in 1994 as an appeal to the Clinton administration to help him out, Kozyrev lays out the central thrust of his policy worldview:

"Indeed, partnership is the best strategic choice for Russia and the United States. Rejection of it would mean the loss of a historic opportunity to facilitate the formation of a democratic, open Russian state and the transformation of an unstable, post-confrontational world into a stable and democratic one."

In Kozyrev's view, the stunning absence of a strategy was disastrous with narrow interest groups pushing their own interests as national ones. Cold Warriors were adrift as a result of the 'unipolar' moment and looking for meaning and budgets. It should be no surprise that the late Charles Krauthammer's July 20, 1990 op-ed in the Washington Post titled "The Unipolar Moment" pointed to this shift on the global market for geopolitical goods:

"Unipolarity is felt all over the world, as far away as, say, Syria. This week's reconciliation of President Assad of Syria (Soviet ally) with President Hosni Mubarak of Egypt (American ally) is a direct result of the end of Cold War bipolarity. Syria cannot play East against West, East having resigned the game. Unable to rely on the Soviet bloc in its struggle with Iraq and Israel, Syria, by accommodating Egypt, is making a move toward the West, the one remaining allocator of geopolitical goods."

Kozyrev grasped the problem. In the absence of competition, there was no meaningful political constraint on interest groups lobbying because there was no view towards the longer-term. He wasn't fighting material imbalances of power, but material imbalances of interests within the West and Russia. He grokked that those convinced Russia was doomed to confrontation with the West would render any way forward impossible. At the same time, he recognized that public opinion was now an important factor in the construction of Russian foreign policy, even if he himself was terrible at managing it, ineffectual as a bureaucrat in Yeltsin's government, and a smooth-talking blowhard in the eyes of many Russian civil servants and politicos. But the most interesting core belief animating Kozyrev's insistence that partnership was compatible with disagreement on core national interests lay in the language he used to describe the world of the 21st century just a few years after the advent of the 'unipolar' world amid considerable uncertainty:

"One thing is sufficiently clear: the international order in the 21st century will not be a Pax Americana or any other version of unipolar or bipolar dominance. The United States does not have the capability to rule alone. Russia, while in a period of transitional difficulties, retains the inherent characteristics of a great power (technology, resources, weaponry). And other rising centers of influence strive for a greater role in international affairs. The nature of modern international problems calls for solutions on a multilateral basis."

Unipolarity was a window in time, not a permanent reality, and one that has since warped observers' capacity to assess relative changes in power. And while Kozyrev clearly omitted the evolution of the Eurodollar system and West's financial and economic dominance as capital flows were globally liberalized along with trade, he understood that Russia retained a leading role in the newly minted post-Soviet space. That meant on security grounds – Russian troops were pulled into various peacekeeping capacities, though there were clearly intentions to maintain influence through said operations – and also economic grounds. Russia would have to be the engine of economic reform and centripetal force that could, in theory in my view at least, pull in demand and support diversification and specialization in former republics unable to compete effectively for European markets outside of raw material exports. In his own words, why would there be a problem with Russia retaining its leading role in Eurasia on a voluntary basis among neighbors and partner states?

My own takeaway is that multipolarity was already a fact of multiple non-western states having nuclear arsenals and the capacity to deliver them at distance. Yet these constraints did not map neatly onto the relative increase in strength of the Eurodollar system with which the evolution of commodity markets since the 1970s was intimately linked or the shift in commodities consumption and trade growth to China, the global south, and south-south trading relationships. The result is to now turn to multipolarity in a haphazard fashion as an understandable appeal for fairness without necessarily deploying a useful heuristic to unpack the current shock. Multipolarity isn't new, the comparative power of the United States to compel outcomes even at peak unipolarity was always exaggerated, and the significance of today's changes far from clear in defining a turn away from Eurodollar dominance.


Ruble Tuesday

Since the default of 1998, the Russian state's relationship with the US dollar has always been testy. Yes, it provided the petro-windfalls that provided the state a huge influx of financial resources which it could redistribute, lifting incomes, consumption, and funding for state needs while being sterilized. But it also poses an underlying risk for the nation's banking sector. The surge of ruble-denominated rents created from dollar-denominated fiscal revenues and export earnings, sterilization policies, and improvements to basic institutional governance and functions for the banking sector and businesses allowed Russia to effectively de-dollarize most domestic transactions and economic activity by roughly 2005. Dollars remained a safe asset households would move to in times of duress or, when possible, in the informal sector since provided a more stable and safe place to stash savings/earnings for those with fresh memories of the 98' financial crisis. De-dollarization since the annexation of Crimea has been a function of state banks and state institutions taking on additional FX risk for geopolitical purposes, not households' own perception of safety. It's also been unsuccessful at achieving anything.

A month after the decision was taken to fully de-dollarize the National Welfare Fund – the primary vehicle used to sterilize US dollar inflows and accumulate FX for domestic investment – the fund lost a reported $2 billion in value to shifts in gold prices and yuan. In fact, Russian authorities almost always lost out when buying yuan either to a sudden fall in the exchange rate after the initial swap of USD for the currency or else smaller fluctuations that showed up as ruble-denominated losses. The decision to move 15% of the liquid reserves of the NWF into yuan in February 2021 was, overall, a loss-making decision that did nothing to ease investment or protect the regime from USD hegemony. Freezing central bank reserves and the ability to settle in USD and Euros with counterpart central banks changed the game. All it did was take losses in ruble-terms on what was available to be invested, a reserve of currency that had to be held instead of spent once the economic shock of sanctions hit since FX liquidity is massively strained. These challenges are compounded by regulations governing the NWF that restrict its ability to invest into foreign financial assets, forcing the purchase of ruble-denominated assets traded on Russian financial markets that offered terrible returns and yields before financial sanctions crushed financial markets. Capital controls and limits on selling can generate artificial balance sheet value for the NWF, but do nothing for spending on the already inadequate levels of investment now deferred for the foreseeable future. The requirement that 10% of GDP be held in liquid assets further starves the economy of financial resources it desperately needs under sanctions.

The ruble's current strength has nothing to do with positive indicators buttressing the regime and everything to do with the comparative success of sanctions. As Elina Ribakova has noted, the liquidity of market trades for rubles – already frequently thin since 2014 – has evaporated with the intensity of capital controls, sanctions, and self-sanctioning:

Imports have fallen dramatically, leading to a ramp up in the economy's current account surplus. Oil exports have continued at huge discounts that are now frequently exceeding $30 a barrel relative to Brent crude prices, Europe is now shunning Russian coal imports as is China, and gas revenues have surged high but politics have sowed the seeds of current and future demand destruction on European markets. When capital controls are this strict, the external exchange rate for the ruble does little to contextualize what Russians themselves are actually paying domestically for goods and services, especially those affected by export restrictions and corporate self-sanctioning. It's positive ostensibly that the Central Bank has eased the key rate down to 17% from 20% due to better than expected inflation data partially reflecting the recovery in the value of the ruble. But that's overstating the case. Annualized inflation has already hit 16.7% at the same time the economy is facing a contraction in GDP that seems likely to reach 10%, quite likely even more as oil wells are shut, factory orders vanish, coal exports shrink, substitutes for various inputs become more expensive and harder to source, and the space for Russia Inc. to work with firms abroad shrinks and shrinks. Inflation is proving better than expected because demand is beginning to fall significantly, with the strengthening of the ruble offering limited relief for basics like food or medication. Surveys from VTsIOM as of March 18 already show 60% of Russians saying sanctions are affecting their lives to varying degress. That figure is undoubtedly higher now.

There is also no evidence exports can salvage this situation. Look at the Central Bank's data on incoming payments for exporting industries amid increased earnings for oil & gas exports from rising prices:

Growth Rate For Volume of Average Incoming Payments vs. Previous Quarter in Exporting Sectors Blue = 2021 Red = 2022 Dark Blue = Quarterly Avg.

The Ministry of Finance is now proposing that the Federal Customs Service (FTS) be granted policing powers to expropriate foreign currency and return it. This specific proposal has been in the works since 2019 but taken on considerable urgency. That points to growing stress domestically even as high oil & gas prices are currently cushioning the currency and current account. No one wants to hold rubles abroad, most incoming foreign currency is being forcibly converted into rubles, and those rubles are beginning to buy less domestically whether that's due to inflation or because households are pulling back their spending as productive capacity of various kinds is idled and demand for housing falls. March data hid the intensification of the pressure as self-sanctioning effects took root:

Volumes of cargoes with unknown destinations can only rise for so long until Russian firms can't find floating storage capacity or buyers. April is going to look a lot uglier for Russia's domestic economic data than March, and I expect an intensification of the enforcement of capital controls rather than the legal imposition of additional controls to take root.


The Consequences of Financial Autarky

I've been thinking about this a bit more after Pozsar's last note that I'm still digesting because I'm still relatively new to thinking about money in this way. The most important point to reflect on is that Central Banks broadly lack the capacity to directly intervene and address issues across real economies that come in contact with, conflict with, or consonance with their power to affect nominal prices for goods and services. These gaps arise for the import of foreign cargoes – note that most international commodities trade is conducted in US dollars or de facto dollar-backed currencies – shipping cargoes, and protection for the money at risk in the world of traded goods and services. This last point is one Pozsar hit home about thinking through the implications of Central Banks confronting liquidity crunches for commodity traders, making the obvious but crucial point that the infinite capacity to print money or create assets has precious little to do with the physical capacity of economic actors to produce the molecules of various kinds we consume for energy, for food, and so on. Since commodity traders aren't themselves lenders, instead just taking money out from banks and financial institutions, any attempt to backstop liquidity has to look more like direct purchases of commodities or financial backstops for said purchases and planning of purchases to coordinate supply and demand. Central Banks need new institutional arrangements to deal with real economic shocks like the current one. The original bit of news prompting a rash of speculation came from India seeking to create a rupee-ruble settlements mechanism to facilitate commodity imports from Russia at a time when everyone else was either abandoning ship with self-sanctions or quietly continuing purchases without any plans to increase them. Here's a good visualization from @policytensor of the "Bretton Woods III" system Pozsar's note traces compared to the current system with China at its core:

In March, foreign investors cut their holdings of Chinese sovereign bonds by $15 billion. So much for China as provider of safe assets. What I find so surprising about the debate around the potential rise of the RMB as the global reserve currency is the notion that China's commodity consumption provides an avenue to monetary dominance. On its face, it makes sense. US dollar dominance is intimately linked to the persistence of the US trade deficit and its twin – the American provision of financial assets for foreign investors and trade partners. That's not just US Treasuries as schematically laid out here, but also a story about US stocks after the 98' financial crisis:

Setting aside the huge political obstacles obstructing a full liberalization of China's capital account that would be necessary for any "Bretton Woods III" to emerge, the commodity consumption piece of the latest round of "Fin-fi" from Pozsar requires more context. China consumes anywhere between 30-50+% of most of the world's major minerals and is now the world's largest oil importer though it still consumes considerably less oil than the United States. There's no doubt that China will remain the world's preeminent commodity consumer writ large for several decades to come. But a huge portion of its weight on global commodity markets comes from the uneven pattern of industrial export-led development that hit a wall with the Global Financial Crisis. The country massively overbuilt structures and homes it didn't need or that created little if any economic value. Since 2008, industry has increasingly served domestic demand but the insane waste of resources in the construction/real estate sector has continued. Any liberalization of the capital account would pose serious problems for China's exporters and also run into trouble with real estate. The instability currently pervading the sector would rightly scare off investors for a long time, and it's also worth noting connects to problems with developers borrowing in FX, namely US dollars. What's more, the flow of petrodollars globally has changed with the shale boom and shifts in marginal production. The following is an approximation using BP data and my own assumptions, including all producers covered by the Monroe Doctrine with the exception of Venezuela in the Allies/Eurodollar system category. Iran falls under the Middle East:

The fact is that Middle East producers are not looking to China for their security any time soon, nor has Russia ever been a credible security provider in the region. Rather it's intervened in its limited capacity when in its interests, namely in Syria and Libya. That's roughly 80% of global production taking place explicitly within economies linked via the Eurodollar system, US alliances, or US security guarantees, sanctions, and its military presence.

I'm also surprised at how quickly the effects of US stimulus from 2021 have been memory-holed. There was a good chunk of time in 2-3Q 2021 that the United States appeared to be the consumer driving a lot of marginal commodities demand because of the comparatively austere approach to the crisis China took economically. We now live in a world where neither American party believes in fiscal discipline, even with the current inflation scare in mind. The American fiscal state has the power to upset expectations, nor should we assume that America's comparative decline is writ in stone even if its absolute decline is unavoidable. China has moutains to climb turning its commodity consumption into monetary leverage because of the links between said consumption and its completely skewed and problematic growth model. These imbalances are then compounded by the "our commodity, your problem" framework Pozsar points to. To imagine India has the leverage to affect these dynamics is almost farcical by comparison given its struggles with deindustrialization, inequality, regional imbalances at the domestic level, and approach to trade. Anti-fragile its political system may be, India is even further behind in the race to topple dollar hegemony or project power. Buying heavily discounted commodity imports of oil or coal from Russia priced in US dollars and settled through a mechanism bypassing exposure to the US financial system is well and good, but India isn't anything like the export powerhouse China is for industrial inputs and they can't buy much with rubles outside of those transactions. Russia's export infrastructure in the Far East needs considerable investment as we now see the specter of a slow-burning commercial blockade in Europe begin to set in with Finland turning away all Russian commercial vehicles at the border:

World Bank data, GDP data in 2017 constant USD and is PPP adjusted

It's also worth noting that China has caught up to the world average in terms of spending power per person. We're never going to see another 2000s commodity demand boom unless China is willing to move more of those factories offshore to even cheaper markets, let the RMB appreciate more, and dispense with capital controls. India's declining trade share looks a lot different. India applies an average tariff rate of about 10.2% across all products. China applies a rate of about 5.4%. That's just a snapshot to remind us of differing approaches to trade as well as the influence that commodity prices have on India's exchange rate and GDP per capita on a PPP basis since low oil prices from 2014/15-2020/21 provided a bit of a boost for consumers in emerging markets as does a weaker US dollar.

These shortcomings collide against the real economy implications of detachment from the dollar. For a particularly useful example, Russia's Federal Anti-Monopoly Service (FAS) is pushing an idea to ban all domestic agreements and contracts pegged to prices set in foreign currency or price indices for goods that are set in foreign currencies. A followup clarification limited the idea to a "temporary" measure that would last up to 2024, at least from what I saw but I might have misread the details. Either way, the net effect of adopting such a policy would be to force Russian firms to trade everything domestically at spot prices set in rubles. Long-term contracts require price stability for calculations, which is simply not possible in an environment where the exchange rate value of the ruble is steadily decoupling from its domestic purchasing power, inflation is high, and the economy is contracting. Pozsar's research notes and concerns about multipolarity are fascinating thought experiments. Spend a minute thinking about what's actually happening in Russia and with its trade partners and they don't cohere well. Russia's response to the current sanctions regime is to recreate the financial autarky it failed to achieve after Crimea and, in effect, to create two parallel economies over time between domestic consumption and its exporting sectors to a degree not seen since the late Soviet system with the added caveat that the Soviets had an easier time trading with people and had more ready trade partners to import higher-end technology. Spot trading in a currency whose value businesses will struggle to manage and track will end up distorting purchasing patterns, bidding up prices, make it more difficult to manage supply and demand or allocate resources through state interventions, and justify further expansions of state management over economic activity.

Financial autarky requires politically managed trade to function in the Russian context, and that political management is impossible with the current climate surrounding Russian actions in Ukraine or the current construction of the regime. Even if you take seriously the notion that non-aligned states are refusing to take sides, Russia is not a major international investor outside of Eurasia with limited exception, these countries are often themselves commodity exporters, and they face varying degrees of dollarization or reliance on foreign currency earnings dominated by the Eurodollar system. China's retreat from capital account liberalization faces different institutional and real economic constraints, but points back to the same problem: the politics of currency internationalization and challenges to monetary and financial hegemony preclude regimes incapable of bearing adjustment costs from doing so. India is not a monetary pivot for Eurasia, nor should we expect a sea-change from the invocation of a multipolarity that had already existed and been relevant to varying degrees for decades despite the combined military and financial/economic dominance of the United States as seen from the vantage points of 1945 and 1991. At some point, traditional hedging behavior that was commonplace in a bipolar world should not be seen as some new development. It has taken place in a comparatively unipolar world as well. The context is certainly new. Sanctions and self-sanctions imposed on Russia are novel in their scope and intensity on an economy of its size and importance to commodity markets. Responses to this new context, however, are not. Sometimes it pays to take realism seriously as much as it pays to dive deeper into the material underpinnings of financial, economic, and military power in international affairs.


Like what you read? Pass it around to your friends! If anyone you know is a student or professor and is interested, hit me up at @ntrickett16 on Twitter or email me at nbtrickett@gmail.com. I no longer write daily content, but post occasionally and want to engage more with Russia, Eurasia, and its political economy.

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