Will paying for Russian Oil and Gas in roubles result in the
fall of the dollar as global reserve currency?
Background on Russia's invasion of Ukraine
For various reasons related to geopolitics, last February,
Russia invaded Ukraine. To avoid
potential escalation into World War 3, the United States and its western allies
decided to pinch Russia where it hurts, while avoiding launching an outright
war with Russia, a nuclear power – its economic lifeline. They launched economic and financial
sanctions with the stated aim of crippling Russian capacity for a protracted
war, and to depower Putin and his billionaire supporters.
The sanctions regime included sanctions on Russia’s largest
banks, and freezing of their dollar assets held in western banks. This resulted
in Russia being unable to access its vast hoard of dollar and Euro reserves,
which it had accumulated through sales of its commodities to the West, and
which it had counted on to prop up its economy, its currency, and fund its
military campaign. The goal was precisely
that, to cut the source of funds to further its campaign in Ukraine.
Sanctions however stopped short of fully cutting off all
trade and economic ties with Russia. Russia after all supplied much of Europe’s
oil and gas requirements. Which gave Russia the loophole it needed to get
around the sanctions on its banks.
Russia could therefore continue to earn hard currency while
it continues to sell its oil and commodities to Europe. However, as long as
these continued to be transacted in dollars and euros, these will be coursed
through Western controlled banks and clearing bodies, which are subject to US
and European laws and policies, of which the escalating bank sanctions on
Russian banks are part. By transacting the sales in roubles, buyers are forced
to source roubles to pay for their oil and gas, and roubles can only be sourced in quantity at Russian banks. By
effectively transferring the venue of exchange from western controlled to
Russian-controlled banks, Russia effectively limited the potency of the bank
sanctions. The West cannot now further escalate
the sanctions to all Russian banks, as this would effectively cut Europe’s
ability to source these needed commodities from Russia. They can, but at great risk tom causing
prolonged recession in their home economies, and potentially weakening their
domestic political clout.
By transacting sales in roubles going forward, this will create
new greater demand for roubles that was not there before. Whereas before,
Russia was content to just accumulate dollars and euros, occasionally
converting them to roubles as domestic transactions required it, while hoarding
the rest as global reserve, now it’s the western nations who will need to
accumulate roubles, so that they can continue buying Russian commodities.
This can be viewed as an increase in international value of
the rouble, and decline in the use of the dollar and euro.
Background on dollar’s rise as global reserve currency
The dollars rise to global reserve status is widely accepted
to start from the end of World War 2, when due to the widespread destruction of
European economies and industry during the war, only US manufacturing prowess remained intact, and the
US had the financial capability to supply much of Europe’s and the world’s,
needs. This resulted in countries’
increased demand for the currency, demand which continued to rise even as
Europe started to become resilient again.
Much of the world’s trade was done in dollars, or were
quoted in dollars, because for a long time, the US was the only country with a
stable enough financial system, that it became a self-reinforcing condition to conduct
international trade in dollars. As more trade was done in dollars, this created
more demand for dollars, which resulted in the dollar being preferred for more
Because the dollar was the default currency for most global
trade, it then logically also became the default reserve currency preference of
most nations. In lieu of accumulating
gold, as the global consensus for acquiring wealth, acquiring dollars became
the norm for many countries that started to accumulate surpluses from trade.
The most serious threat to the global acceptance of the US
dollar as default reserve currency was during the 2008 crisis, as widely
covered at the time on this blog. When
large financial institutions in the US started blowing up, the US had to
respond by propping up measures such as quantitative easing and the fall of
interest rate to the zero bound. This
resulted in a lot of people speculating that the US will print the dollar til
it loses all value. I argued, against
such, assertions on this blog, and so far, until now, 14 years later, the dollar
has not yet to lose value like Zimbabwe’s currency, despite rolling out the
largest stimulus ever in history in 2020.
Since 2008 however, this widespread speculation contributed
to many trends, including the rise of Bitcoin and cryptocurrencies; the hunt
for alternative currencies that can diversify central banks’ reserve baskets;
and greater speculation in ‘scarce’ assets that will increase in value when
valued in the dollar losing value.
Many speculated that the Chinese yuan could take the place
of the dollar as the default standard, given China’s meteoric rise in global
trade. But since China continues to
control the supply of yuan, and maintains its peg to the dollar, the yuan has
not been the threat to the dollar as some have thought.
Where China and Russia still fall short
This is I believe is the quagmire Russia will find itself in. Will they allow the rouble to be freely
available anywhere in the world, and allow it to feely float, as the US does
the dollar? What happens when a rising
rouble makes their exports more expensive, or a falling rouble makes imports too
costly for local consumers? Will they allow market forces to dictate, or will
they intervene heavily, as China does?
A further competitive advantage the US has, that allows them
to freely float the dollar globally, is that the US had a large domestic
market, which decreases their reliance on exports, lower than other countries’ level
of reliance to theirs. The US has also always
been an innovative economy, that always had a lot of things to sell, and by the
time a rising dollar was making the exports of yesteryear highly expensive,
they were already on to their next exporting star, and gladly outsourced production
of expensive goods elsewhere.
So what’s next?
Businesses will continue to adapt. This recent spate of sanctions is a test case
whether the dollar will fall as default reserve currency. However, since there
has been no difference in the economic preferences and bargaining positions of
countries with regard to global trade and investment since a decade ago, my bet
is on the US dollar to continue its reign for the foreseeable time.