The Great Restructuring

Economic History and Effects of the Russia/NATO Conflict on the Global Economy

This article explores an alternative viewpoint on the present conflict between NATO/US and Russia. A conflict that has culminated at its climax as a combination of warfare in Ukraine and worldwide financial sanctions from both parties. I will attempt to explore a wider perspective that takes into account the events that led up to this moment, a perspective rooted in economic reality. Rather than approaching the situation from a fairytale, tunnel vision, good vs. bad point of view, I will analyze the situation in the light of the broader economic picture which has been developing for the past half century.

The Mainstream Narrative¹

Without going into extensive details on the narrative which is being promoted by media and politicians, it is necessary for the sake of this article to mention it briefly. The mainstream perception of this conflict is that Russia has wrongfully invaded Ukraine in February of 2022, triggering an influx of financial sanctions from the West which intend to harm Russia. The sanctions are intended as a weapon to fight Russia, and to help Ukraine win the war against Russia. The sanctions are numerous, too many to be named here, but their effects, which have triggered my initial interest, will be the focus of this article.

The general story being sold to western citizens is that the sanctions are a weapon used to help Ukraine in their battle with the Russians. However, I am of the view that the sanctions actually hurt the Ukrainian forces and civilians by placing more pressure on Russia’s army, an army much larger and more capable than the Ukrainian army. The sanctions are an escalation process which places extreme pressure on Russian military, adding gas to the fire. This is all very logical. As the West, led by the US and NATO, applies more and more financial sanctions on the Russians, they cause two things to happen. First and most important, the Russians will act in a way to untangle their financial ties with the West by restructuring their economy in ways to bypass the sanctions. Second, the Russians may apply more military force on the Ukrainian army, as to finish the conflict as soon as possible, allowing them to focus on the first part, economic restructuring.

The sanctions have triggered Russia and the West to sever their economic ties almost completely. A development which if it continues to occur will have drastic and serious consequences for the whole world. Reality then becomes quite different than what is promoted by media. We are not watching a conflict between two countries, but may be witnessing the restructuring of the whole global economic system before our very eyes. This restructuring has been in process long before this conflict, but is being accelerated quite rapidly through this catalyst, and is by no means just a struggle over European land or a conflict between Russians and Ukrainians. In order to fully comprehend the situation, it’s necessary to step back and look at the last 50 years of global economic history. Only then can we see that the economic restructuring which is unfolding now has been a process in the making for decades. As far as local events around Russia, the 2008 war in Georgia, the annexation of Crimea and the Maidan coup d'état in 2014 are key milestones of this conflict, but what is going on is much larger, with much deeper roots that may effect the entirety of the world going forward.²

To understand the present, we will cover the following critical events in history:

1. (1971)- The end of the worldwide Gold Standard

2. (1974)- The beginning of the Petrodollar system

3. (2008)- Global Financial Crisis, government bailouts, and Quantitative Easing QE

4. (2013-Present)- The possible decline of the Petrodollar system

I am of the view that the Kremlin is in full awareness and acting in Ukraine for two main reasons.

1. To stop eastern expansion of NATO into Ukraine as they have stated in numerous examples, and to not allow NATO the development of nuclear weapons in Ukraine (on Russia’s borders). This is something that is well accepted and understood in world politics, and its counterpart is the Monroe Doctrine for the US. The US would not allow any state or union to expand and build nuclear weapons near its borders as we witnessed during the Cuban missile crisis.

But more importantly for our analysis…

1. Russia is interested in proactively cutting its economic dependency on the US Dollar and creating a bloc with the China, India, Saudi Arabia, Brazil and other countries.

Russia has been preparing for these sanctions for more than a decade, and it possibly even welcomes them as an opportunity to finally reconstruct their economic standing to be more self sufficient and less reliant on the western world. It does this strategically at a time when the West is ultra reliant on Russian, Chinese, and foreign imports of natural resources, and has been destroying its ability to produce or mine these resources locally due to ESG politics. Russia not only has the upper hand economically, but is acting in cooperation with China and other countries to undermine the West’s power and influence while simultaneously creating a powerful partnership and economic bloc together. These are allegations I cannot prove, but stem from an assumptions that the Kremlin has weighed its actions meticulously, and has found buyers for their resources before they engaged in a war they knew would invoke economic consequences and sanctions.

Why Sever Ties to the US Dollar?

Russia has been interested in cutting its dependency on the US Dollar for decades, and so have other countries such as China, Iraq, and Libya just to name a few. Under the current global financial system, sometimes called the Petrodollar System, the world must use Dollars for purchasing the most important natural resource, petroleum. This is a replacement for the previous Brenton Woods system which pegged the Dollar to gold, and ended in 1971. When the Petrodollar system was established in the summer of 1974, the global economic landscape was very different. The US GDP was close to 40% of world GDP, something that has changed significantly. The US also maintained a monetary policy much different than today’s. It showed the world with Volker as chair of the Fed, that it was willing to suffocate its domestic economy for the strength of the Dollar. Something that proved to be very valuable in maintaining it as the world reserve currency.

Let’s go through the important points in history briefly.

The End of the Gold Standard

Money for a large part of history has been physical gold and silver. The global economic system has evolved in the last several hundred years persistently in a devaluation of the means of exchange (money) into what we have now, a system of pure FIAT currencies, paper and digital money.

The Gold Standard went through several evolutions of which the last was the Brenton Woods system (1944-1971), where gold ownership was illegal to US citizens, but foreign states could redeem their US Dollars for physical gold at a fixed price of $35 per ounce. During this time, most countries held Dollars as the global reserve currency, which at the time were claims on physical gold. The main problem of this system was that it created massive outflows of gold reserves for the US as a result of redemption by foreign governments. The idea was that other countries were to hold US Dollars as reserves that were backed by gold, thereby creating a demand for the Dollar as a real asset that could be redeemed for gold. As foreign governments began to lose faith in the system and started to redeem their Dollars for gold, the US lost large amounts of gold reserves from its vaults, and was eventually forced to stop the gold redemption. This effectively severed the link between the Dollar and gold, leaving the world to hold something completely different than what it thought it owned, paper money backed by nothing physical but the authority of the US government. The Dollar was now a money backed by the good faith of a government which just reneged on its promise to back the Dollar with gold.

This was a substantial risk nations as it left them vulnerable to holding an asset that had no long-term guarantees of value like gold. There was a need for a new system, a new global reserve currency.

The Petrodollar System

After the Gold Standard was abandoned there was a need to find another system which would support the US Dollar as the world reserve currency. And so the “Petrodollar System” was born. To better understand the history and inner workings which led to this system, I recommend reading Lyn Alden’s article, ‘The Fraying of the US Global Currency Reserve System’. It walks the reader in greater detail through the history of the worldwide monetary system, eventually the current Petrodollar system, the outcome of an agreement reached between the US and Saudi Arabia in July of 1974.

It came under the following pretenses and background.

• The world has just experienced the final severing of the Gold Standard in 1973 (Nixon put a “temporary hold” on it in 1971, blaming the problem on “currency speculators” but it was made final in March, 1973 and the Gold Standard was over).

• In October of 1973, the Yom Kippur War took place and the US backed Israel against the onslaught of a coalition of Arab States led by Egypt and Syria.

• This eventually led to the OPEC oil embargo of 1973, a catalyst for quadrupling of oil prices and a serious financial crisis.

These events led to an agreement between Saudi Arabia and the United States which had been kept a secret until recently. The Petrodollar system was born.

To make a deal both sides need to solve some of their problems.

The US had two problems.

1. The oil embargo was hurting the economy, contributing to massive inflation mainly due to skyrocketing oil prices (about 12% YOY).

2. They desperately needed to recreate demand for US Dollars which they had lost as a result from the dismantling of the Gold Standard. This would allow the US to finance economic growth and fiscal policy by printing Dollars. If they were able to create demand they could do all of that while keeping inflation low, and the value of the Dollar stable.

The Saudis had two problems.

1. They lots of oil.

2. Since the Gold Standard was over, they needed to be able to trust the currency they accepted for oil would maintain its value, and needed a place to deploy the money once they received it for oil.

So the Saudis and the Americans would work together to solve all their problems and create a new Dollar.

In July of 1974, Richard Nixon sent Treasury Secretary William Simon on a trip to Saudi Arabi to make a deal. This agreement would solve the issues for both parties.

The two sides agreed that the Saudis and consequently OPEC would only accept US Dollars for petroleum and that Saudi Arabia would secretly invest their earned Dollars back into US Treasuries (a fact held secret for over 40 years). This made sure that whenever OPEC was selling oil, some of those proceeds would be buying US Treasuries, allowing the US to pursue inflationary policy without creating largescale inflation domestically. In return, the US offered to provide Saudi Arabia with military and equipment support.

The agreement facilitated the US to fund its economic growth, essentially printing Dollars for oil, while keeping demand for the Dollars, taming the monetary devaluation otherwise caused by credit expansion. The outcome was a period of growth and prosperity in the US as it once again secured its position as global reserve currency. In addition, the Saudis were able to sell their oil for a currency they believed would maintain its value. The deal worked fabulously for close to 50 years, but there were some unsatisfied parties as a result. Not all nations benefited from the new system, and many attempted to bypass it. Those who attempted were met with sanctions or military action against them.

The US has been able to maintain the Dollar as the world reserve currency, something that was justifiable when the agreement was struck. Meanwhile the economic justification has changed with the US no longer being such a large economy in comparison to the rest of the world. The US is no longer the biggest importer nor the largest GDP economy world wide. This leaves other countries, like China, which are outgrowing the US, dependent upon US monetary policy.

China has long identified their exposure to US Treasuries as a national risk. Other countries, through the Petrodollar system, are forced to trade in US Dollars even when not dealing with the US. The United States has been able to fight this off using military threats and sanctions for years, forcing countries to use US Dollars to trade.

Here’s a quote from Lyn Alden’s above article on the Petrodollar,

“Back in 2000, Saddam Hussein began selling oil priced in the newly-created euro. A couple years later, the United States invaded Iraq and removed Hussein from power based on allegations of Iraq possessing weapons of mass destruction. These allegations turned out to be untrue, and Iraq quickly went back to selling oil in dollars.”

A similar story is behind the US/NATO invasion of Libya. Quaddafi organized an effort to create an African Dollar, which would be backed by Libyan gold and would be the only currency accepted by African countries in exchange for oil. This would bypass the need for Dollars in Africa and essentially create a gold backed currency, uniting Africa economically while hurting demand for the US Dollar. Libya was invaded by NATO, pipelines and irrigation systems were destroyed causing massive destruction and stopping the chance of an African gold backed currency that was supposed to be live by 2023.

The US has also threatened Germany and Russia with sanctions over the building of the Nordstream2 pipeline, which would establish Russian trade with Europe in Euros, long before the current conflict. As we can clearly see, the US has been sanctioning and at times attacking any threats to the Petrodollar, a system that made sense at its inception in the 70’s when US GDP was around 40% of global GDP. Today, that is no longer the case.

Today it is increasingly difficult to justify a system where the US controls the world reserve currency and oil can only be traded in Dollars worldwide. They have enforced the system through military force, coercion and sanctions, but countries are starting to look for ways around the US Dollar. A factor that has worked for the benefit of the Dollar was its stability of value. This was maintained by the hegemonic worldwide position of power which the US has held. Foreign countries preferred to hold the reserve currency in the form of the most stable currency, something that would change in 2008.

The 2008 Global Financial Crisis

The GFC in 2008 was critical milestone to the development of this story since it sent a message to the global community that the US was pursuing an inflationary monetary policy at the expense of the value of the US Dollar, the global reserve asset. A sharp contrast from the 70’s era monetary policy of Fed Chair Paul Volker. As the crash of 2008 happened, countries around the world were watching to see if the US would choose to let things play out on their own, allowing banks and insurance companies to fail, or would they resort to credit expansion as an effort to save the economy. They chose the latter and bailed out the domestic economy with Quantitative Easing (QE), sending a message that they are willing to devalue the Dollar to save their own economy. The effect was that the US economy had a quick turnaround, but the global reserves countries hold in US Treasuries were devalued along with the Dollar. As the US has began to engage in aggressive QE, and continues to do so, it has sent a clear message to the world, “we are willing devalue your reserves to save our economy”. As 60% of the world’s reserves are in US Dollars, this poses a substantial risk to central banks worldwide, a risk they are keen on mitigating.

Back to Russia

Russia faces the same risks, but is a much smaller economy than China’s, and therefore may be looking to protect itself form what it sees as a hostile US. Since 2013, Russia has been meticulously dialing down the amount of trade it carries out in USD and the amount of USD reserves its central bank holds. They have been working hard to stabilize their economy, and to diversify away from the Dollar.

As Russia has enormous natural resource reserves, and have been opening trade routes with China, India, the EU, and Saudi Arabia to bypass the Dollar, they have become a large threat to the Petrodollar. We may be witnessing the last battle over the Petrodollar, developing before our own eyes. A possibility that the world is shifting out of Dollars. Russia has been shifting its reserves since 2013 to hold less Euros and Dollars, and more Chinese Renminbi and gold. Moreover, Russia’s gold stock is held in Moscow rather than in NY or in London as most countries hold their gold. This has not made Russia too popular with the US, gently said.

But Russia hasn’t done this meticulous and purposeful restructuring for no reason. Looking from the outside, one may come to a conclusion that they have been planning and preparing for a move such as the one we are witnessing right now. We have seen that the West’s sanctions included freezing of Russia’s reserve assets by the US and UK, a move which appears the Russians have been preparing for since 2013. The recent confiscation of bank reserves sends the world a message that the reserves held by central banks are possibly worthless, and may leave countries looking for alternatives. A move that Russia has been making for a decade.

We are seeing the possible dissemination of the Petrodollar and a “Great Restructuring” possibly in the making. Saudi Arabia is considering to trade oil for Yuan, while India is ramping up Russian oil imports. All these events and many more are creating a precedent for a major global economic shift. Meanwhile the US has possibly already started looking elsewhere for their oil supply, with Iran and Venezuela.

What the Future Holds

The world appears to be in an interesting inflection point where there is a push towards more economic independence for individual nations. Systems that rely heavily on one country’s currency are not everlasting and as change occurs, it becomes difficult to justify them. Currently the US is still the world’s biggest economy, but that is in decline. China is making and executing a longer term plan which they are more flexible to do as a result of lower bureaucracy and regulations, something that the West has troubles with. ESG policies of the West make it very difficult to make changes, to extract and use natural resources, and to act based on calculation rather than on emotion, placing immeasurable obstacles in the path to solving measurable problems. China, and other developing countries do not face these obstacles, and as nations can move in the direction they choose and see fit for their future with greater relative ease. An example is in the most important resource for mankind, and a person point of interest for me, energy.

China has proclaimed intentions to build 150 nuclear reactors in the upcoming 3 decades ( current there are 437 worldwide), something that would not be possible in the West due to heavy regulation. China is securing energy for the future, without dealing with taboos, but rather by looking at the stern fact: nuclear energy is the safest, cleanest, most cost effective for of energy. This is just one of the examples where Chinese ability to grow may leave the west behind due to complicated regulation structure. As China and other nations grow in regards to the US it becomes exceedingly difficult to justify the US Dollar as the world reserve currency. The Russo-Ukraine war, may actually be the apex of a worldwide restructuring, were we shift from a globalized system to a bipolar global economy. This outcome would be far more catastrophic for the West, than for the East. This is due to the West’s overweight reliance on Russian natural resources, and Chinese manufacturing.

We may also see an economic decoupling where nations will run towards a “neutral reserve asset” to hold outside the US Dollar. There have been several proposals and such as John Mayard Keynes’ suggestion of the Bancor in the 40’s and the IMF’s SDR. The SDR is a basket of currencies of leading world economies.

I don’t see SDRs or basket currencies as the solution to finding the next neutral world reserve currency for two main reasons. First, they still consist of a basket of the same currencies available today, and therefore the reserve currencies are still technically US Dollars or other fiat currencies. The basket would just create a political struggle between the countries for who would have the largest weighting in the basket. This would not be too revolutionary nor would it be neutral. Second, the countries in the basket would be more likely to pursue inflationary monetary policy together in such a scenario.

Currently, I do not see a more feasible solution available for a “neutral” global reserve currency than gold. It is a physical asset which has real constraints on government’s ability to inflate the money supply. It is truly neutral and private. There would certainly be challenges and competition around gold, but in my opinion it is the best solution presently available, better than cryptocurrencies.

We may have to go through a whole evolution of history in order to return back to the global commodity currency most fit to be a money and has been for most of humanity, gold. We wait and watch. This is a time I see as full of uncertainty. If we do see a “Great Restructuring” where there is West vs. East scramble for resources and readjustment of the economy, there will be massive disruptions in many sectors. I recommend a defensive approach, especially for investors and individuals with high risk aversion.

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Disclaimer:

None of the contents of this, or any of my articles are intended to be taken as financial advice. Please do your own research, and come to your own conclusions before making any investments based on the information provided here.

Regards,

Robert Rothbart

1. Along with the articles cited here, Lyn Alden and Luke Gromen have been major resources for developing this perspective.

2. For a better understanding of the local history of The Ukraine conflict, I highly recommend watching this lecture and analysis by Dr. John Mearsheimer at the University of Chicago.