Equities markets are slightly up today while gold and oil are down as investors digest news of progress in peace talks between Ukraine and Russia. While a deal between the countries would most importantly end the bloodshed and, secondarily, ease the immediate economic pressure the war is causing, it would not end the economic war I wrote about last week.
That war was declared by the United States when it banished Russia from its SWIFT system, seized its FOREX assets, and demanded the whole world boycott Russian exports (something even many NATO allies were unable to do).
Russia’s first response was to announce it would only accept rubles in payment for its natural gas exports to “unfriendly countries.” Over the weekend, it made another move. It put the ruble back on the gold standard domestically, allowing its central bank to buy gold at a fixed price of 5,000 rubles per gram (approximately 155,550 per troy ounce).
This immediately strengthened the ruble against the U.S. dollar. On Friday, RUB/USD was over 102. As of this writing, it had dropped to just under 88.
As Tom Luongo explains, this effectively sets up an opportunity for Russia to sell oil, natural gas, and its myriad other natural resource exports at a discount for gold. This will eventually bring the ruble back to its pre-war value in USD of 75.
Washington obtusely seeks to prevent Russia from selling its gold while Russia has no plans to do so. It is buying gold at a discount based on the demand for its exports.
Even if a treaty is secured and the U.S. offers to readmit Russia to SWIFT, releases its frozen assets, and end the boycotts, it’s hard to imagine Russia accepting the offer. Why put itself in the same position again when it is holding all the cards as an exporter of vital resources with a positive trade balance?
Not only Russia but every country in the world is now on notice that any reserves it has in dollars could be rendered worthless at the whim of the U.S. government. This provides tremendous incentive for most of the world to find a store of wealth and medium of exchange other than the U.S. dollar.
Americans are not ready for the reality that will be imposed if the dollar loses its world reserve currency status.
This isn’t immediately apparent to them because they believe they have the world’s most productive economy, based on having the largest GDP. It is true that U.S. GDP priced in dollars was the largest in the world at approximately $22 trillion in 2021. China was second at $16 trillion.
The problem with GDP is it merely measures total money spent in the economy. It does not measure the value of things that were produced. Since value is subjective, it is a matter of how much an economy produces for which people would truly be willing to give up something of value in return. This willingness depends upon what is produced having what economists call “utility,” a product’s usefulness in fulfilling some purpose for the consumer, whether a need like food or a luxury like a fancy car.
A large percentage of what the U.S. economy produces has no real market value.
Rising prices are not the only negative consequence of monetary inflation. Inflation also misdirects capital towards nonproductive use. That is why at the end of a business cycle, when the economy crashes, there is high unemployment. All of the people misdirected into unprofitable enterprises must be let go and redirected towards productive work – towards producing products whose value to others exceeds their cost of production.
The U.S. dollar’s status as the world’s reserve currency has allowed its central bank to inflate the currency far beyond what it would be able to get away with otherwise. This has caused huge distortions in the U.S. economy. In other words, it has directed capital towards producing products whose value does not exceed their cost of production.
What value have Americans received in return for spending more on their military establishment than the next ten countries combined? How were they better off for the military spending 20 years and trillions of dollars in Afghanistan? How do they benefit from maintaining a global standing army that will never be used against a nuclear power, as was just confirmed after Russia invaded Ukraine?
What additional value have they received for paying the highest prices in the world for healthcare and education?
What these and other malinvestments have in common is they are not funded voluntarily. The military is 100 percent tax funded. Half of all healthcare spending is government spending. College education is largely underwritten by government-guaranteed loans, meaning taxpayers guarantee them whether they want to or not.
Even outside of government-funded enterprises, capital is misdirected towards nonprofitable use by monetary inflation. Houses and automobiles, for example, are bid up beyond their true market value because of the artificially low interest rates of the loans that make their inflated prices affordable.
Like taxation, monetary inflation transfers purchasing power involuntarily from holders of dollars to those receiving the loans. That means there is no market discipline acting upon the borrowers and lenders. No one was asked to voluntarily give up something of value to underwrite the loan. Therefore, capital is much more likely to be invested unprofitably.
Yes, all countries in the world have fiat currencies that they inflate, but no other country has been able to do it on the scale and with the impunity the U.S. has while enjoying reserve currency status. This has directed huge amounts of people and resources towards unproductive ends.
Foreigners have paid Americans to waste resources and collect salaries for non-value producing jobs in government, health care and education bureaucracies, finance, and other bubble industries by accepting American exports of dollars in return for imports of valuable products.
Removing this privilege will cause an enormous deflation of some economic sectors and the complete disappearance of others. Millions of people employed unproductively, as well as millions of others who sell to them, will be devastated. The result will be a sharp reduction in living standards for virtually all Americans outside of the very wealthiest strata.
While this cleansing of waste in the economy might be beneficial at some point in the future, it will be unimaginably painful for most Americans in the present. For a country already near a political boiling point, the economic reality on its way could blow the lid.
America is not ready.