Taps Coogan – April 6th, 2022

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For the last couple weeks, there has been a lot of discussion of Russia’s demand that ‘unfriendly’ countries pay for natural gas in Russian Rubles. A lot of people are declaring it to be a major blow to the US Dollar reserve system or even the start of Brenton Woods III.

Striping away the hyperbole, the demand really doesn’t change much.

Here’s why:

Anticipating the sorts of sanctions that it currently faces, Russia liquidated its US Treasury holdings and remaining US Dollar reserves in 2018. In other words, Russia had already stopped holding US dollars prior to the Ukraine invasion.

The US dollars that Russia accumulated through trade were thus sold or lent in FX markets, typically in Germany or Japan, resulting in the accumulation of Euro and Yen reserves abroad.

A transaction to buy Russian gas post 2018 might have looked like this: A Western company sends US Dollars to a Russian company with an account at a German bank in exchange for gas. The Russian company then sells/lends those US Dollars for Rubles, Euros, Yen, etc… in the FX markets.

At the end of the day, the Western company gets Russian gas, the US Dollars wind up back in Western markets, and Russia gets whatever currency they wanted. Much-if-not-all of the transaction happens outside Russia’s borders.

Fast forward to today and here is what changes based on Russia’s Ruble demand. Instead of the US dollars being converted to Rubles (or Euro, Yen, etc…) after the gas transaction, they will be converted before the transaction. Instead of the transaction happening in Germany, Japan, South Korea, etc… it will happen in Russia.

Here is how it might work: The Western company exchanges its US Dollars for Rubles at a bank in Russia and then uses them to buy Russian gas. The Russian gas company gets Rubles and the Russian bank gets US Dollars. The Russian bank will presumably then try to sell/lend the US Dollars in the FX market.

At the end of the day, the Western company gets Russian gas, the US Dollars wind up back in Western markets, and Russia gets whatever currency they wanted (assuming it can access FX markets). In other words, nothing has changed expect the order and location of the transaction.

While this does provide Russia protection from sanctions on the Western-company-selling-Dollars-to-buy-Rubles part of the transaction, if Russia is blocked from FX markets, they will have a hard time reselling the US dollars they accumulate. Paradoxically, that means that if the Ruble payment demand ends up changing anything, it might be to cause a renewed accumulation of Dollar reserves in Russia. That may actually be the point and, paradoxically again, probably part of why the Ruble has strengthened.

The various petrodollar theories have done great damage to the understanding of how reserve currencies actually work and why the US has one.

In 2022, India doesn’t use US Dollars to import TVs from China because Henry Kissinger struck a deal with the Saudis to sell oil in 1974. The US Dollar is the predominant reserve currency because of numerous factors that we have discussed in more detail elsewhere.

Suffice it to say that one gets a reserve currency by having the currency that other countries want to hold in reserve. Countries, people, and companies hold US dollars in reserve because they are plentiful due to our trade deficits and the size of the US economy, tradable (no capital controls expect in the exceptional case of sanctions), tied into the deepest pool of financial assets, and part of an adequately dependable legal system that recognizes property rights.

The US Dollar Reserve currency will live and die by our ability to ensure those various qualities. The only long term threat that Russia poses to the US Dollar is by providing an endless impetus for US sanctions that undermine the reliability of the US dollar in the eyes of other foreign countries.

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