The Breakdown - The True Implications of Seizing Russia’s Foreign Reserves

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 nexo.io, Arculus, and FtX, and produced and distributed by CoinDesk. What's going on, guys? It is Sunday, March 13th, and that means it's time for Long Reads Sunday. Today, we have a good one for you, but before we get into that, if you were enjoying the breakdown, please go subscribe, give it a rating, give it a review, or if you want to dig deeper into that juicy, juicy conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit. Bit.le slash breakdown pod. Also a disclosure as always, in addition to them being a sponsor of the show,

Starting point is 00:00:52 I also work with FTX. Now, Long Read Sunday has but one rule, and that rule is pretty simple. When Nick Carter writes a new piece for CoinDesk, we read that piece. I'm not even going to give you any more context than that. We are just going to jump right in reading America's quiet default. Seizing Russia's holdings of American debt, risks the role of the U.S. in the international system, and opens the door to gold and Bitcoin. Amid the dying embers of World War II, in an ornate ballroom in a New Hampshire resort in July 1944, America gathered the imminent victors of the war and designed a new monetary system. global currencies would be various weights of the dollar, redeemable for gold held with the U.S.

Starting point is 00:01:37 At the time, a British economist spoke up and suggested instead a neutral international settlement medium consisting of a basket of sovereign currencies. This bank-or idea, proposed by a certain John Maynard Keynes, was overruled by the American delegation, which favored the more U.S.-centric dollar-gold standard. From 1944 to 1971, sovereign currencies were simply different weights of the dollar, redeemable, albeit infrequently, by the governments themselves for actual gold at a rate of $35 an ounce. The tether was tenuous, however. The entire system depended on the beneficence of the U.S. government and its willingness to not overspend, increasing the ratio of dollars to underlying gold.

Starting point is 00:02:18 Things came to a head when the U.S. spent extravagantly on President Lyndon Johnson's Great Society and the Vietnam War, and sovereigns began to doubt the veracity of America's promise to redeem currency for gold on demand. In August 1971, France called America's bluff and dispatched a battleship to retrieve their gold. President Richard Nixon knew the U.S. could not honor its commitments and defaulted on the promise that had held since 1944. The U.S. would no longer honor the peg. A decade of ruinous inflation followed, and the U.S. was only able to stabilize the dollar through enormous rate hikes in combination with the inventive petrodollar scheme.

Starting point is 00:02:55 This latter device saw the U.S. ally with the oil producers like the Saudis, guaranteeing the military protection in exchange for the exclusive pricing of oil and dollars, combined with the recycling of profits into U.S. treasuries. With a reliable treasury bid secured, faith in the dollar that was lost in Nixon's default was restored. Other tools facilitated the re-entrenchment of the dollar in overseas commerce. The U.S. funneled its cheap debt into military spending and became the de facto guarantor of markets globally, ensuring energy and food security for the globe by protecting trade routes with its blue-water navy. The U.S. set the rules of the game through their control of the international financial institutions,

Starting point is 00:03:32 the International Monetary Fund, or IMF, for short-term lending to sovereigns, and the World Bank for Long-Term Development Finance. The U.S. maintained an open capital account and allowed their securities market to become a global piggy bank for savers worldwide. Today, the size of publicly traded securities in the U.S. relative to public markets worldwide vastly outweighs its share of global gross domestic product. U.S. dollars denominate most international trade, even for exchange, changes occurring outside of the country. U.S. Treasuries came to be considered the global risk-free savings device for sovereigns, as the U.S. was presumed to have no default risk whatsoever. The Federal Reserve became the lender of last resort for central banks, willing to

Starting point is 00:04:10 create unlimited liquidity to support markets worldwide during times of stress. Even absent the tethered gold, the U.S. dollar thrived as the dominant medium of settlements internationally, and U.S. Treasury served as the default savings device globally. Around 2014, however, something began to turn. Foreign government purchases of U.S. debt began to stagnate. Even though foreign purchases of treasuries eventually picked up in absolute terms in 2018, they did not remotely keep up with the expanding scale of U.S. debt. Nexo is the go-to platform for all things crypto. Invest in the hottest coins out there and start earning risk-free interest of up to 20% APR, paid out daily. Need cash, ASAP, but don't want to sell? Use your crypto as collateral and receive a credit line at

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Starting point is 00:06:01 fees, no ACH transaction fees, and no withdrawal fees. One of the large, exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTX, you pay no gas fees. Download the FTCX app today and use referral code breakdown to support the show. In short, foreigners who had long supported America's large S by eagerly buying its debt were buying less and less of our new debt issuance. Foreign ownership of U.S. debt declined from 34% in 2015 to 24% at the end of 2021. China's ownership declined from $1.25 trillion in 2015 to under $1.1.1 trillion in 2021. To compensate for this diminished outside interest, the U.S. looked inward for new creditors.

Starting point is 00:06:49 The Federal Reserve held around 4% of U.S. debt in 2009. That figure has climbed to 19% today. These purchases, made with dollars summoned out of thin air, come with a giant asterisk. They do not derive from organic demand for our debt. They are only sustainable as long as inflation is tolerably low, which it no longer is. In February, it hit a 40-year high of 7.9%. The exact explanation for the lost appetite among foreigners for U.S. dollars in U.S. debt is hard to pin down. It may have been a delayed reaction from the 2008 crisis, when the Fed made it clear it had the ability to print unlimited dollars to support domestic markets at the expense of foreigners.

Starting point is 00:07:27 It might have been the aggressive sanctions the U.S. instituted against Russian banks after Russia's invasion of Crimea in 2014, the most economically powerful nation the U.S. had ever targeted in such a manner. Previously, sanctions had been reserved for small, economically unimportant nations. At the time, the U.S. threatened to exclude Russia from the swift international transfer system entirely, but backed down due to the severity of the measure. Russia took the threat to heart, and its central bank divested most of its U.S. Treasury exposure and set up a swift alternative called SPFS. Even as the Russians took steps to free themselves from dependence on the dollar system, the U.S. wisely walked back from the brink, realizing that American and European banks were

Starting point is 00:08:05 hopelessly intertwined with Russian ones. At the time, President Obama laid out a prescient warning regarding the risk to the dollar system that arbitrary exclusions could pose. In 2015, he cautioned in the context of unilateral Iran sanctions, we cannot dictate the foreign economic and energy policies of every major power in the world. We'd have to cut off countries like China from the American financial system. And since they happen to be major purchasers of our debt, such actions could trigger severe disruptions in our own economy, and by the way, raise questions internationally about the dollar's role as the world's reserve currency. Joe Biden did not heed the warning of his former boss.

Starting point is 00:08:40 First, the U.S. seized Afghan central bank assets held in New York and bizarrely handed a large portion over to the plaintiffs in a 9-11 lawsuit. While the seizure may have been predictable, expropriating the savings of ordinary Afghans and distributing them to Americans affected by 9-11, an attack perpetrated by Saudis, is deeply unusual. Partly as a consequence, the Afghan banking system is kneeling over, worsening a humanitarian crisis. Not content with that, Biden then dropped a fire for a government. financial nuke on Russia with the seizure of her reserves. It's important to untangle the perceived

Starting point is 00:09:09 morality of this action, a reaction to an unjust invasion, and its prudence. While seizing Afghan or Russian reserves may feel righteous and just, the immediate effect of such actions is to completely undermine the credibility of dollar debt as an international savings device. The U.S. wants to have its cake and eat it, too. We need foreigners to buy our debt, so the government can finance its structurally high levels of spending. But we increasingly seek to impose moral conditions on who can hold that debt. The U.S. will find that their creditors are increasingly unwilling to pass these purity tests, and will choose to hold a money that doesn't require the owner to comport with Washington's latest political fashions. Author Luke Groman pulled no punches, asserting that the Fed and

Starting point is 00:09:47 European Central Bank, quote, completely discredited sovereign debt as an FX reserve completely, adding that, quote, the multi-currency, multipolar world was likely fully born on Wednesday night. Fed blogger Joseph Wang calls the freezes of FX reserves financial WMDs, adding that, quote, foreign sovereigns must now diversify as a matter of national security, and some citizens must now diversify as a matter of self-preservation. Wang points out that India and China, both of whom voted abstain on the United Nations motion to condemn Russia's invasion of Ukraine, maintain heavily FX-based sovereign reserves that they will now be eyeing uneasily. Russia made the fundamental miscalculation of not realizing all of their foreign fiat reserves were at risk. Other nation-states

Starting point is 00:10:27 falling afoul of the U.S. will not repeat that mistake. Most notably, the celebrated credit Swiss interest rate strategist, Zoltan Pozar, declared an end to Bretton Woods 2, the post-1971 pure fiat period based on the petro dollar and treasury recycling. Quote, Breton Woods 2 was built on inside money, and its foundations crumbled a week ago when the G7 seized Russia's FX reserves. While the reach of gold bugs and Fed critics might extend only to narrow echo chambers on Twitter, Pozar's words reverberate around the financial community. For once, the difference between gold and dollars is starkly clear. Outside of James Bond novels,

Starting point is 00:11:00 gold cannot be immobilized at a distance. Dollars and dollar assets can. While not as dramatic as the Nixon shock, the Biden sanction was just as genuine a default. U.S. Treasuries in the post-1971 era were global risk-free assets, used by friends and enemies alike to reliably store value. Rug pulling the Russians, even if warranted, introduced for the first time genuine doubt into the quality of the commitment the U.S. can maintain towards foreign creditors. The prospect of total asset invalidation is an unacceptable tail risk, and any need of the need of the cost of the cost of nation-state wary of falling a foul of U.S. sensibilities, especially as the U.S. becomes ever more capricious and less interested in the well-being of the international sphere it used to

Starting point is 00:11:39 govern, will consider diversifying out of U.S. treasuries and other freezable assets. In 2022, Pozar's outside money is king. For now, that's gold, but even the former skeptic has some time for its digital analog, concluding, Bitcoin, if it still exists after the war, will probably benefit from all of this. Back to NLW here. I think one of the things that's hard about this moment and about distilling insight from the noise is how rhetorically valuable in the context of social media and readerships and digital publications is to propose the end of one era and the beginning of another.

Starting point is 00:12:17 This is the type of proclamation that makes for immensely good reading and immensely good pondering and immensely good content. It's also something that humans are biased to think about themselves in their time. We all like to imagine ourselves as living through significant eras of being a part of something larger. It's why, for example, so many generations throughout history have seen themselves as the last and the end of times. And so perhaps because of that, it's easy to be skeptical when someone declares something so huge as the closing of this monetary era. However, in those moments, it's worth doing a few things. First, asking about the source of those proclamations, and what their biases are to fall trap to that great moment of history sort of fallacy.

Starting point is 00:13:04 In this case, for example, Nick isn't trying to get clicks outside of sharing what he thinks. It's not his business. He's also written enough that we know that he doesn't fall prey to hyperbole. So Nick becomes a more interesting, more valid source, at least for me. When it comes to this sort of big picture power shift, is not to say, is there a clean break from history, but have the recent actions of leaders made a sufficient crack on the face of history for new forces to seep in. And that's, I think, what someone like Nick in this piece and others beyond him in other pieces are arguing about the seizure of Russia's central bank reserves. It's not so much that this definitely means the end of U.S. dollar hegemony.

Starting point is 00:13:50 It means that there's a new crack in a once largely impervious pillar of the global financial. financial order. That pillar was the neutrality and imperviousness of U.S. Treasuries and the U.S. dollar as a way to store global wealth, and that crack is the idea that it could be made political. Now, of course, this is an extreme circumstance. It's a belligerent nation making an unwarranted, unjustified attack on a smaller nation, largely for the sake of its own economic or political or nationalistic or even individual reasons. And to perhaps that will temper, just how many forces slide into that crack, but it doesn't change that crack in the pillar is now there.

Starting point is 00:14:32 What that means and how that will play out will be the story of the decade to come. For now, I want to say thanks again to my sponsors, nexus.io, Arculus and FTX. Thanks to Nick Carter for another excellent piece. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

Starting point is 00:14:52 Hey, breakdown listeners. Come join CoinDesk's Consensus 2020, The Festival for the Decentralized World this June 9th through June 12th in Austin, Texas. This is the only festival showcasing and celebrating all sides of blockchain, crypto ecosystems, Web 3, and the Metaverse, and is designed for crypto-newbies, investors, entrepreneurs, developers, and creators. Don't miss speakers, Kathy Wood, SBF, CZ, Punk 6529, and Joe Lubin, just to name a few.

Starting point is 00:15:23 Use code breakdown to get 15% off your pass at CoinDesk.com. com slash consensus 222. See you there.

The Breakdown - The True Implications of Seizing Russia’s Foreign Reserves

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