š® Did Putin Just Kill the Dollar?
Russia's latest move could have major repercussions for the US. Here's how. (Reading Time: 4 mins)
Russia just detonated the economic equivalent of a nuclear bomb.
No, we are not being overdramatic.
Putin has directed the Russian Central Bank to start buying gold and may peg its currency to Gold.
5,000 rubles = 1 gram of gold.
"Peg? What? ReadOn, what the heck is happening?"
Let's go a little back in time, and understand how this whole currency-gold thing works.
How Money Works
Money enables trust.Ā
A rupee in any State in India is a rupee. No questions asked.
In the 1900s, when the world was low on trust, gold was that one thing that everybody trusted humans to assign value to. Gold was the default currency.
But transacting in physical Gold was very difficult (and dangerous). So, countries found a way around it - they made their currency a derivative of Gold.
And so began the era of the Gold Standard.Ā
The amount of gold you had determined the value of your currency.
Eg: Assume the US has a total of $100 printed, backed by 50 tonnes of gold.Ā
Similarly, the UK has ļæ”1,000 printed, backed by 50 tonnes of gold.
Hence, $100 = ļæ”1,000, or, $1 = ļæ”10
Thatās how exchange rates were determined.
After World War II, the US owned 75% of the worldās gold. And its economy was growing super fast. It did not have enough gold in its reserves to print more dollars (without gold in your reserves, you couldnāt print money - it was against the agreement signed by the top 10 nations of the world).
The US became the worldās gold mafia.
As an economy grows, the number of transactions grows, and the country needs more money in circulation. As gold couldnāt be mined fast enough (takes approx 10 years), the US called for all nations to de-link currency and gold, and mutually decide on a standard. It wasnāt in the US' favour anymore to link gold and other currencies.
What were the other currencies linked to, then? Obviously, the US Dollars.Ā
Today, the scenario is such that gold is denominated in terms of US Dollars, not the other way around.
Also, the US had convinced Saudi Arabia to price oil in US dollars, which marked the beginning of the rise of the USD as the go-to currency for global trade.Ā
Since you needed US dollars now to buy oil (something which every country needs, and only a very few have), most countries held US foreign exchange reserves.
And since they had faith in the dollar (how could they not when every currency was linked to it?), they kept buying US government debt in the form of bonds.
Right now approximately, 30% of the US debt is held by foreign governments and more so by foreign individuals.
But Russia's move has the potential to change this whole game.
How?
Russia's Move
Like we said earlier, Russia's central bank is buying gold from other Russian banks at 5,000 rubles per gram of gold.
Why?
Because of the US sanctions that have frozen Russia's dollar cash reserves in foreign banks, and cut Russia off from the world economy.
It cannot use dollars now to trade with the rest of the world. So, it has found a new way.
And Russian banks are happy to give the central bank this gold as they cannot sell their $140 billion gold reserves for love or money, again because of the US sanctions.
But this whole system has the potential to mess with the entire foreign exchange and commodities market.
You see, Russia has set its own rate to buy gold. This rate pays no heed to the exchange rate that is prevalent around the world.
Right now, according to traditional dollar-based exchange rates, you need 82 rubles to buy $1. Also, the price of Gold in USD is $67/gm.
To buy 1 gm of Gold, Russia would earlier need Rubles 82 x $67 = rubles 5,494/gm of gold
But now it has fixed the rate at 5,000 rubles/gm of Gold.
So, by pegging its currency to Gold, Russia has made the effective ruble-USD exchange rate as:
5,000 rubles (1 gm Gold) = $67 (1 gm Gold).
Or, 74 Russian ruble = $1
What this essentially means is that the countries buying stuff from Russia may have to shell out only 74 Russian rubles in exchange for $1 (instead of 82 rubles).
And this is just the beginning.Ā
Russia has announced that it considers dollars to be "candy wrappers."
So, if a country wants to import stuff from Russia, it may have to pay in gold rubles or maybe even Bitcoin (Russia is considering this option)!
Which means oil, at least Russian oil, may now be priced either in rubles or gold which backs rubles.
If European countries choose to import oil, natural gas, palladium (metal used to make semiconductor chips), wheat or anything from Russia, they may have to probably pay in gold.
This will increase Russia's gold reserves, increasing the power of its gold-backed currency further. And keep on making it stronger against the dollar.
Note: Russiaās Central Bank has only announced that they will be buying Gold at a certain price point, it hasnāt fixed a selling price. So, itās not really going back to a āGold Standardā yet. But it could.
If it does, it could shake the faith of the world in the dollar.
To be fair, the US is kind of responsible for already having shaken this faith.
By imposing sanctions on countries like Afghanistan and Russia, it has made countries wary of having US foreign exchange reserves as they could be frozen any time the US is displeased with them.
Russia's move could further deepen this dislike, causing countries to dump the US bonds they hold because of the declining value of the US dollar.Ā
The US cannot function without debt (here's why).
So, it may have to raise interest rates to find buyers for its debt. This increase in interest rates will slow down the US' growth as the flow of money in the economy will reduce.
Plus, thanks to countries dumping US dollar bonds, the price of the dollar will also decline, because of an excess supply of dollars in the market.
This could lead to hyperinflation in the US (we know, long shot, but it is possible! P.S. hereās our write-up on how inflation works).
Also, Russia's move could convince the world to delink their currencies from the dollar.
What would happen in such a scenario? If USD would no longer be the default currency of the world?
Stay tuned to find out. Afraid you will miss the next piece? Join us on WhatsApp.
P.S. All rates mentioned in the article were recorded on April 1, 12:30 pm. They might have changed significantly since then.
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This helps to stabilize the ruble from its free fall due to sanctions but I think a dollar doomsday is unlikely
Who will the countries having US bonds sell to ?
Dollar was anyway on decline but it's still the only possible reserve currency for world trade unless people start buying oil in currency other than dollar along with other major commodities
Hye Team,
I really appreciate the effort you took to provide such quality news in simplified way to the audience,
Being a professional we can go through it in a minutes and understanding the whole story, only because of your consistent efforts.
Thanks for the News
All the Best Keep it up