The Breakdown - Russia’s Plan to Force the World to Use Rubles

Starting point is 00:00:04 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.io, Arculus, and FtX, and produced and distributed by CoinDesk. What's going on, guys? It is Saturday, April 9th, and that means it's time for the weekly recap. And this week, we are checking in on the Russian economy. Before that, however, if you... are enjoying the breakdown, please go subscribe to it wherever you listen to podcasts, give it a rating, leave a nice review. And if you want to dive deeper into the conversation, come join us on the

Starting point is 00:00:45 Breakers Discord. You can find a link in the show notes or go to bit.le slash breakdown pod. Also a disclosure, as always, in addition to them being a sponsor of the show, I also work with FTX. Finally, I would love to invite you to come join CoinDesk's Consensus 2020. The event is taking place this June 9th through 12th in Austin, Texas. And the thing that makes consensus such a different type of event is that it is truly a big tent event. It is highlighting all aspects of this industry from specific cryptocurrency ecosystems to Bitcoin to Web 3, to Metaverse, NFTs, etc. It's got tracks for people who are more enfranchised as well as for people who are newer. And there's great speakers like Kathy Wood, CZ, Punk 6529, SBF, and many, many more.

Starting point is 00:01:33 You can use code breakdown to get 15% off your pass if you go to coin desk.com slash consensus 2022. It should be a great time. All right, so we're doing a bit of a macro geopolitical check-in today, and quickly before I get into Russia, I wanted to flag one small thing that happened this week with the Fed. At a speech on Tuesday, Fed Governor Lail Braynard said balance sheet reduction is coming soon. Remember, balance sheet reduction is another term for quantitative tightening, and as you might guess, it's the opposite of quantitative easing. Instead of buying assets and thus putting liquidity into the markets, the Fed sells assets and thus removes liquidity from the markets. Now, they actually don't sell assets into market exactly. It's more a process of letting bonds expire.

Starting point is 00:02:18 But in either case, there have been three phases of a shift away from former monetary policy. The first was the Fed's tapering of asset purchases, aka slowing down QE, which started last November. The next was raising rates, which happened. at the last Fed meeting. In January, however, we got the December FOMC meeting notes, and that's when the market realized that we were going all the way to quantitative tightening, aka balance sheet reduction, and it was going to happen faster than anyone thought. That, much more than raised interest rates, has been the thing that radically shifted markets to risk off. Now, the way that balance sheet reduction works is also in a couple of phases. For a while,

Starting point is 00:02:54 there is a normalization phase where the Fed tries to keep its balance sheet at a consistent level. That means as bonds expire, they buy more at the same maturity, but only at the same level that they had before, rather than increasing the overall balance sheet. The next phase after that is letting bonds expire without buying more. Theoretically, they could then move to a final phase, which would be actively selling assets into market, although that hasn't really happened in the past. Brainer's speech showed a clear shift in tone. Current inflation, she said, is, quote, much too high, and getting it down is, quote, of paramount importance. The committee will continue tightening monetary policy methodically through a series of interest rate increases, and by starting to reduce the balance sheet at a rapid pace as soon as our May

Starting point is 00:03:36 meeting. Given that the recovery has been considerably stronger and faster than in the previous cycle, I expect the balance sheet to shrink considerably more rapidly than in the previous recovery, with significantly larger caps in a much shorter period to phase in the maximum caps compared with 2017 to 2019. So clearly we're seeing a strong shift. We're talking about rapid paces and considerably more rapid balance sheet normalization. Now, when that speech came out, it felt like part of the goal was to prep the market for the next day's release of last month's FOMC notes. And when we got them, it made sense. Quote, participants generally agreed that monthly caps of about $60 billion for Treasury securities and about $35 billion for agency MBS,

Starting point is 00:04:17 that's mortgage-backed securities, would likely be appropriate. So that's $95 billion a month of reduction. Now, this is worth keeping an eye on because it's obviously one of the biggest macro determinants of the economic landscape that crypto and everything else alongside it finds itself in the context of. The other big global economic context is, of course, Russia and Ukraine, and there is a lot at stake economically. First, the destruction of the Ukrainian economy, who are a key exporter of a lot of goods, but particularly foodstuffs like wheat. Second, the way sanctions are wreaking havoc with global supply chains. The most pronounced discussion already, is in terms of food, both in terms of end products like wheat, but also inputs like fertilizer.

Starting point is 00:04:58 Three, the way that energy security is wrestling up against principles and causing a total re-evaluation of previously assumed things. Four, the viability of the weaponization of the dollar system, and five, the potential fallout of that weaponization, and the possible move to a new monetary order. So today we're doing a quick review of the state of the Russian economy, starting with the rubble. The rubble plunged when sanctions first went into place. In late February, the exchange rate was $85 rubles to the dollar, but it got as low as $130 to the dollar at the peak of the impact of sanctions. The ruble is now theoretically almost completely recovered to its pre-war pricing against the U.S. dollar. The question is, how is that possible? Well, it's a couple

Starting point is 00:05:39 of things. The first is seriously strict policies from the central bank, requiring exporting firms to convert 80% of their foreign currency earnings into rubles, suspending new conversion to USD for private citizens until September, with a withdrawal limit of $10,000 from existing U.S.D accounts. As a Wall Street Journal put it, the rubble is in a central bank-induced coma. The second reason the rubble might be coming back, however, has to do with energy. Robin Brooks, the chief economist at the Institute for International Finance, said much of the rubal recovery is fake, because capital controls prevent Russians from taking their money out of Russia. But some of the recovery is genuine and reflects Western Europe continuing to import energy

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Starting point is 00:08:15 After capital controls were imposed, no Russian citizen or business can sell rubles to buy USD or euro at this quote-unquote official rate, not even close. Anyone who believes this, try and exchange ruble for USD at this rate and enjoy the experience. Carl Shemada, the chief market strategist at Corpay, adds, quote, the black market is quoting anywhere between 110 and 140 on dollar-to-ruble transactions. So citizens who are looking to purchase dollars or euro are paying a much higher cost than we're seeing on the interbank market. Yet, of course, there is a whole chorus of squawkers on Twitter who are so intent to hate the U.S. government or the U.S. dollar that they're taking the number seriously as a sign of

Starting point is 00:08:50 the failure of sanctions. The same crowd, many of whom are goldbugs, are absolutely losing their mind around another fact as well. The central bank of Russia has started buying gold from local banks but has set a price of $5,000 rubles or $52 per gram until June 30th. This is a 23% discount on the current market value of $68. This appears to be in response to a Biden White House executive order last week, prohibiting U.S. persons from transactions in Russian gold. Yet the headlines we're seeing are things like Zero Hedges' A Paradigm

Starting point is 00:09:19 Shift Western media hasn't grasped yet. Russian ruble relaunched, linked to gold and commodities. So the gold bugs are trying to draw this line to the end of the dollar, saying that this is going to cause massive disruption in Forex markets, which will lead countries to dump dollar debt notes to get in something more stable, which means necessarily anything pegged to gold. And someone actually wrote the line, quote, countries like Japan will be dumping their dollar debt as fast as they can. They will move into more stable currencies like the ruble. This is all so ludicrous that it beggars belief.

Starting point is 00:09:49 The idea that countries will just all of a sudden ditch the dollar because the Russian central bank started buying all the gold it could get because it was the only reserve available to it is just wrong. Remember, they're just out here acquiring. Dubeberg writes, there's a big difference between setting a fixed exchange rate to buy gold at 5,000 roubles per gram, than committing to sell gold at that price. Russia has not yet backed the ruble with gold, critical distinction. And quote. Let's also talk about the fact that this is effectively confiscation. The central bank is allowing themselves to buy gold at a 23% market discount. On top of that, the idea that the ruble is somehow going to be stable, compared to other currencies is insane. None of this commentary takes any account of the relative

Starting point is 00:10:28 percentage of trade that is denominated in dollars in the sheer inertia of the offshore dollar system. In fact, I think almost the exact opposite analysis is true than what most of these folks are saying. Russia is playing the only card it has left. It can't transact in any other type of currency. This is the action of an economy that is completely backed into a corner. Look, if you'll give me a moment, I'm going to climb up on a soapbox. You are likely, by virtue of being in Bitcoin and listening to this podcast, someone who doesn't just tow the standard MSM party line on economic issues, and that is a good thing. You're also probably someone who has a long-term view of things, and because of that, you likely have more of a sense of both the

Starting point is 00:11:06 unintended consequences of the dollar-led monetary system, as well as a better understanding of the cracks in that system that could make it calcify and be ripe for disruption. But that doesn't mean that we need to blindly accept and amplify every loudmouth Twitter and gajor who has made their reputation screaming that the end of the dollar is nigh. You can have an appreciation of just how many factors go into the weird complexity of global trade and geopolitical consideration, including ones that point firmly in the direction of the continued dominance of the dollar, and still take your long-term view of the global monetary system's trajectory and inevitability of change. There are great debates to be had around these topics, but zero hedge ain't it.

Starting point is 00:11:45 These things are peak dumerism and a waste of good brain selves, and I think the world is full of so many important discussions to have that I have very little patience for the stupid ones. All right, rant over. And if we're going to really look at the most interesting monetary dimension of all of this, it is not the random gold accumulation, but the latest in how Putin is trying to use energy as the wedge to force Europe into propping up his currency. About a week ago, Putin started signaling that Russia would only be accepting rubles for energy payments from then on. He has now signed a decree stating that buyers must open ruble accounts in Russian banks from Friday, April 1st. The Russian president said, nobody sells us anything for free and we are not going

Starting point is 00:12:20 to do charity either. That is, existing contracts will be stopped. His decree means foreign buyers of Russian gas will have to open an account at Russia's Gazprom bank and transfer euros or US dollars into it. Gasprom bank will then convert this into rubles, which will then be used to make payments for the gas or oil. Simon McKelovich explains a little more in a Twitter thread. Quote, pre-April first, gas buyers could satisfy their contractual obligations via payments to Gazprom accounts held at Western banks. Post-April 1st to meet contractual payment obligations, buyers must wire payments directly to Gazprom Bank in Moscow and convert their USD-slash-Euro into rubles. Since funds in Gasprom's Western accounts could be frozen after being deposited by buyers, it was possible for the buyers

Starting point is 00:12:59 to fulfill their side and for Russia to owe the gas but never get the proceeds. With payments being made in Moscow, this is no longer a risk factor. So this seems a lot more significant than the gold thing, but even this has a lot of questions. On the one hand, you have this type of commentary exemplified by Laurie Milverta, the lead analyst at the Center for Research on Energy and Clean Air, who said, it would be unbelievable if it wasn't so predictable. Germany and Italy have apparently agreed to open accounts at Gazprom Bank to pay for gas and rubles, while spinning it as a compromise. They're compromised, all right. On the other hand, you have the rhetoric coming out of those European nations.

Starting point is 00:13:33 After Putin's first comments about forcing Europe to pay for energy and rubles, the German economy ministry Robert Haybeck said that his country was prepared for all scenarios, including a stoppage of Russian gas flows to Europe, including getting out of bed with Russian energy entirely. He said, quote, it is important for us not to give a signal that we will be blackmailed by Putin. French finance minister Bruno Lemaire said something similar, saying that they and Germany were both rejecting Russia's demands and were, quote, preparing for the possibility that Russia would halt deliveries. Then this story from yesterday, Germany has seized control of a local unit of Russian natural gas giant gas prom, saying it will do what is necessary to maintain energy supply in the country.

Starting point is 00:14:11 Nominally, this is about some acquisition gone wrong or that didn't have German government approval, but clearly there is more going on here. Again, economy minister Robert Hayback says the federal government is doing what is necessary to uphold security of supply in Germany. This also includes not exposing energy infrastructure in Germany to arbitrary decisions by the Kremlin. The proper conduct of business in Germany must be insured. Indeed, I could be wrong, but the Gazprom account news came out after the first wave of responses to the pay us and rubles thing. The difference I believe is that they're not actually forcing contracts to be fulfilled. in rubles, which would be a breach of contract. They're just converting it automatically into rubles at the time the euro or USD payments hits the accounts. It's a nationalized confiscation

Starting point is 00:14:50 of those harder currencies. Now, ultimately, there is a real challenge here. It wouldn't surprise me at all to see a combination of tough talk and at least some amount of capitulation. It's nearly impossible for countries to change their energy mix overnight, so there is going to be some leakage. To some extent, it will be a game of chicken. It's definitely a strong move from the Kremlin, but can they afford to not sell their energy either? For as much as we talk about how Europe can't afford to not take Russia's energy, can Russia really afford not to sell their energy either? I'm not sure. On that question, Alina Rybakova, the Deputy Chief Economist at the Institute of International Finance, says, energy embargo not only would wipe out Russia's all-time high current accounts

Starting point is 00:15:30 surplus of $250 billion, but would also drive the fiscal position deep into deficits. Oil accounts for 30% of revenues. With a 15% recession in 2022, it could be as much as 50% of revenues. We expect Russia's oil and gas production to contract this year by 20 to 30%. Once closed, some fields will never be able to be reopened. Apart from the significant indirect effects on Russia's economy, the energy embargo would directly hit nearly 10% of Russia's economy. On top of all this, there is even more increasing pressure on further sanctions as Russia gets accused of war crimes in Boucher. The tone is shifting to actually forego Russian oil and natural gas entirely. Javier Blas, the Energy and Commodities columnist at Bloomberg said,

Starting point is 00:16:09 can Europe keep buying Russian oil and natural gas? As the Kremlin's war crimes in Ukraine come to light? Public opinion will continue to harden as more and more horrific pictures emerge. So these are the really interesting conversations, of course. And not to end on a Bitcoin fixes this note, but one thing you do sort of have to see here is the difficulty of using sovereign currencies as trade currencies in times of conflict.

Starting point is 00:16:32 This is sort of what John Maynard Keynes was worried about when he proposed the bank or at Bretton Woods. Does the world need a neutral intermediary currency? And even if it does need it, does it want it? Something to ponder on. For now, I want to say thanks again to my sponsors, nexus.io, Arculus, and FTX. And thanks to you guys for listening.

Starting point is 00:16:51 Until tomorrow, be safe and take care of each other. Peace. Hey, breakdown listeners. Come join CoinDesk's Consensus 2020, the festival for the decentralized world this June 9th through the 12th in Austin, Texas. This is the only festival showcasing and celebrating all sides of blockchain, crypto ecosystems, Web3, and the Metaverse, and is designed for crypto-newbies, investors, entrepreneurs, developers, and creators. Don't miss speakers like Kathy Wood, SBF, C-Z, Punk 6529, and Joe Lubin to name just a few. Use code breakdown to get 15% off your pass at coindesk.com slash consensus 2022.

The Breakdown - Russia’s Plan to Force the World to Use Rubles

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