Prisoner’s Dilemma: Russia's Fierce Economic Battle with the USA and Europe by Pegging Gold to the Ruble?
The face-off over Ukraine between Russia and the United States and its Nato allies has been dominating the headlines for a while now with tensions ratcheting up as we receive dire public warnings everyday of a Russian invasion. You may be wondering why is Putin suddenly so interested in invading Ukraine? Well, Russia is definitely interested in claiming back the territory of the former USSR. As the saying goes, “nothing happens for decades, but decades happen in weeks.” Putin has planned all his moves meticulously. He was only waiting to execute his plan over the last 10 years. So nothing is as ‘sudden’ as it seems.
Now with the USA waging an economic war by cutting off sanctions and freezing Russian assets, Putin is back with a sinister economic game plan to wipe out dollar’s clout from the world markets as his revenge for putting the country’s economy at stake.
Trump once said that Putin is a really smart leader. Well, he said this for a reason! Even before invading Ukraine, Putin had prepared himself to deal with the imminent sanctions. But the superior leaders of the West couldn’t match Putin’s shrewdness. Biden imposed, what he termed as “crippling” sanctions on Moscow and excitedly waited for the Russian economy to “blow up.”
Graph1: The USD/RUB closing value when Russian troops invaded Ukraine *Source: Bloomberg
But much to Biden’s vexation, that delusion never saw the light of the day and Putin did outsmart him with his most unpredicted economic decision to save the economy of his country by pegging gold to rubble and bringing the gold standard system back in today’s century . Now, consider Russia’s steps to shore up its currency, the Ruble. Russia, with three major steps, has effectively recovered the lost valuation of its currency. And the world markets have witnessed that after this peg the Russian Ruble is now more stable than the US dollar which is being dumped against the Ruble in the forex markets.
Let's look at how Russia’s unpredictable economic decision to save its economy from blowing out unfolds: The three major steps it has taken to unleash this are as follows.
Russian central bank puts the Ruble on the gold standard
Recently, the Russian central bank announced that it will put the ruble on a gold standard. The bank pegged 1 gram of gold to 5,000 rubles. Now that means, one troy ounce of gold or 32 grams of Gold would now cost 1,60,000 rubles in Russia. At the current exchange rate, 32 grams of gold would cost roughly $1,600 in Russia.
Confused as to why Putin made this decision and what was his motto behind it? By making this decision Russia just wiped out about thirty percent (30%) of the value of the US Dollar worldwide, when it comes to Gold Bullion. This is worse for the other economies especially for USA as Russia will only sell its oil and gas in Rubles, and Rubles are now fixed at 5,000 Rubles per gram, anyone wishing to buy Oil or Gas will need to either pay in Rubles or pay in Gold, and they won’t get the US Dollar value for the gold they tender as payment which will in turn dump the value of the US dollar and make it more volatile.
But wait, in the US the same quantity of gold would cost you $1,928. That means Russia has effectively ratcheted up its currency’s value against the dollar by pegging it to gold. If 1 gram of gold is bound to 5000 rubles, then according to Western standards, the ruble must be valued at 70-75 units against 1 dollar.
This move to encourage domestic gold inflows to the Russian Central Bank?
Since the West has banned Russian gold under sanctions, Russian banks would be more than happy to sell whatever gold they possess to the Russian central bank. They will sell even on discounts since they can’t find buyers in the West due to sanctions. More domestic gold flows to the Central bank would mean the ruble will get stronger with each passing day.
How has Russia weaponized its gas trade with Europe to strengthen its currency?
Russia has asked “unfriendly” nations to pay in gold or the ruble for their gas trade with Russia. That would encourage international gold flows to the Russian bank. European countries would either have to buy rubles using gold or simply trade through gold. Basically, as Putin has pegged the Russian oil and gas to gold using paper rubles as a proxy so if Europe needs oil and gas it will need to either buy Rubles from Putin in gold or they will have to buy directly in gold. Which means, there will soon be a lot more demand for rubles and by applying simple economics we know that when the demand for a currency increases its value will gradually increase. The same applies to rubles.
Graph 2: The current value of ruble post it was pegged to gold *Source: TradingView
In both ways, the EU will end up helping Russia deepen its gold reserve. That would mean that the ruble's value would get even more strengthened.
Russia declared the ruble as a substitute for Gold
Now, under the third step, Russia will simply put its currency on the gold standard. It can simply declare the Ruble a hard gold substitute at a fixed exchange rate. Now, when a currency is backed by gold rather than the US dollar, it becomes more stable and stronger. With a strong ruble backed by gold, Russia would simply be in a position to insist on payment for Russian commodities in rubles. So, each time any European country pays Russia in the rubble or gold, it will simply end up strengthening the ruble’s position even more.
Let's look at what they exactly wanted do, They had thought that by devaluing Russian gold and by sanctioning it, they would reduce the amount of stuff Russia could buy using that gold. Instead, the ruble’s binding with gold and ensuing decision of forcing EU nations to pay in ruble or gold for their gas trade with Russia have simply turned the table on the West.
- With 5,000 Rubles now equaling one gram of Gold, and oil being priced directly in Gold, we are going to see a Massive price disruption in FOREX markets, in terms of how much Gold a Dollar can still buy.
- Foreign countries holding our Dollar Debt Notes in Reserve, will see an immediate, and far less use for them and will want to start dumping them in favor of something more stable; something which holds its value.
- Any currency pegged to gold will be affected. Which means countries like Japan will start dumping their dollar debt as fast as they can. They do not want to sink with the ship like others and want to move in a stable zone like the ruble.
- This will have a Deflationary effect on the ruble, making it valuable over time. Putin can repeg the ruble any time he wants depending upon the prevailing economic situation the country will be in the coming years.
- The consequence of this in the long term is that all those foreign countries dumping their Dollar Reserves will cause all those excess Dollars to start coming home, triggering worse hyper-inflation than we already have now in the USA.
- And as we know, When the US sneezes, the whole world catches a cold. With that the inflation may spread to other economies as well slamming the world economy into darkness.
Effects on the aftermath of this decision on the world economy
In closing
Russia has put both Europe and the USA in a Prisoners dilemma where it's not possible for both countries to work together and outsmart the Russian leader. In days to come, this peg of ruble to gold may stumble the world economy and its progress towards recovery amid the approaching fourth wave of the Covid’19 pandemic.