New World Order in the making

As I stated in my previous article “Cyclical transformation turning into doomsday”, March 21, 2022, “The whole world is in accelerating transformation process, which seems to be cyclical and is now turning into doomsday direction.”

I also said that

Now, it is clear that Fukuyama’s end of history lasted 20 years and ended by Putin’s prophetic speech in Munich 2007, which started an era of turbulence and slow transformation process accelerating and culminating in 2022 Ukraine crisis.

Huntington’s clash of civilizations did not take place either as such but something much bigger is now emerging, a clash of “world camps”.

The humanity seems to be divided in two camps, the Western camp (the US, Canada, Europe, Australia) and the Eastern camp led by China and Russia and covering majority of Asia, Africa and South America.

The new world order is now slowly but surely emerging from complex and diverse processes worldwide. In the context of great power relations, turbulent times are going on, also on the economic scene.

Multipolar world based on BRICS-format

Russian foreign minister Sergei Lavrov just visited China and India confirming the base of new world order, the multipolar world based on BRICS-format.

Since the West has declared a hybrid war against Russia, Moscow is now searching for opportunities in other regions, Russian Deputy Foreign Minister Sergey Ryabkov said.

The BRICS countries (Brazil, Russia, India, China, and South Africa) will be at the heart of a new world order, the diplomat added. Commenting on President Putin’s decision to switch to ruble payments for gas contracts with “unfriendly” countries, Ryabkov said that Russia is not changing the terms of the contracts but is protecting its interests. The diplomat hopes that European countries will revise their decision not to pay for gas in rubles and will find a creative approach to the issue.

Foreign Minister Sergei Lavrov, after meeting several counterparts from across Eurasia in China, outlined it this way: “A new reality is being formed: the unipolar world is irrevocably becoming a thing of the past, a multipolar one is taking shape. It’s an objective process. It’s unstoppable. In this reality, more than one power will “rule” – it will be necessary to negotiate between all the key states that today have a decisive influence on the world economy and politics. At the same time, realizing their special situation, these countries ensure compliance with the basic principles of the UN Charter, including the fundamental one – the sovereign equality of states. No one on this Earth should be seen as a minor player. Everyone is equal and sovereign.”

Sanctions and their impacts on the worldwide economy

The whole sanctions regime, imposed by Western states (the US, the EU, Canada, Australia, Japan) on Russia, has large and deep impacts not only on Russia but on all key players in the world’s economic performance and its primary and secondary ramifications are felt around the world.

Russia’s attack on Ukraine was swiftly followed by a series of sanctions from the US and Europe that isolated and cast out Russia from the global financial system. After weeks of this, President Vladimir Putin declared the West was waging “economic war” and in response has begun to utilize some of Russia’s own financial weaponry.

This week (week 13) will see the first real test. Last week, Putin warned that “unfriendly” countries – by which he really meant European countries – would need to start paying for their natural gas in rubles, rather than US dollars or euros. He gave the Russian central bank until the end of March to figure out how that would happen.

Value of Russian ruble

The Russian ruble, which plummeted over 30% in the beginning of Russian invasion, has already bounced back to pre-war levels ($80-90). This means that Joe Biden’s sanction war — which sparked astronomic gas prices, an unprecedented surge in fertilizer prices, future food shortages, and an inflation crisis — was all for nothing. Now on both sides of Atlantic Ocean, sanctioning states are facing severe economic troubles, backfire process has started.

Central Bank of Russia decided on Friday (April 1) that it would loosen restrictions on the transfer of funds abroad, an indication that the currency and financial situation is stabilizing in Russia.

On Friday March 25, the Bank of Russia announced: “RUB 5000 to the ounce at an exchange rate of 100 RUB/USD implies a $1550 per ounce gold price.” The G7 countries thought the sanctions are hitting so hard that Putin will be forced to sell his gold to evade sanctions to pay for things.  The West was running around with multiple ways and means of legislation to keep the Russians from selling their gold. But now the truth came out “Russia won’t be selling any gold; they are buying it.”

There is a very complicated intellectual, monetary and financial reasoning behind this procedure but it seems to be a real game-changer on “the Grand Chessboard” of great power competition. The outcomes of reality test will be emerging in sight within next 3-4 months.

Payments in Russian rubles

On March 28, Putin instructed the Russian government, the Central Bank and Gazprom to implement a set of measures to change the currency of payment for natural gas supplies to unfriendly countries by March 31. The head of state clarified that Russia would supply gas in accordance with volumes and pricing principles concluded in the contracts. It is only the currency of payment that would change, he added.

Putin’s justification was: “in a situation where the financial system of Western countries is used as a weapon, when companies from these states refuse to fulfill contracts with Russian banks, enterprises, individuals, when assets in dollars and euros are frozen, it makes no sense to use the currencies of these countries. We supplied European consumers with our resources, in this case gas, and they received it, paid us in euros, which they then froze themselves. In this regard, there is every reason to believe that we have supplied part of the gas supplied to Europe virtually free of charge. This, of course, cannot continue. “

This Putin’s decree only concerns Gazprom’s pipeline exports and does not mean that some of the clients may end up without gas in the beginning of April. European client companies will receive first payments for some contracts in rubles in the second half of April and in May. The decree would allow for uninterrupted transit without breach of sanctions or existing contracts, as it requires Gazprom’s clients to switch to making payments through Gazprombank, which would take their euros, exchange them to rubles at the Moscow Exchange and deposit money at rubles accounts.

Payments should be made in Russian rubles and existing contracts will be frozen unless payments are made in rubles. If gas buyers from unfriendly states refuse to pay for gas in rubles, Russia will view it as breach of contract, President Vladimir Putin said. “If such ruble payments are not made, we will consider this to be the buyers’ failure to perform commitments with all ensuing implications,” Putin said.

Moscow could apparently be pursuing two goals: first, forcing Russia’s energy customers to bypass the sanctions; second, ruble payments support the value of the ruble and frustrate the sanctioning countries’ hope of causing its value to collapse.

“Given that the prestige of the dollar as the world’s main reserve currency has been plummeting in recent years, while trust in other internationally recognized currencies is also not at its highest now, broadening the use of national currencies is the only and inevitable alternative to these processes,” Kremlin Spokesman Dmitry Peskov told reporters on Wednesday, March 30.

The Kremlin official noted that the Cabinet is already working on widening the use of national currencies in settlements with other countries. “Widening the practice of using national currencies is an area that our government is also pursuing and we need to move further on all fronts. This is in our interests and in the interests of our partners,” Peskov insisted. Vyacheslav Volodin, speaker of the State Duma, proposed to expand the list of goods exported for rubles, including fertilizers, grain, oil, petroleum, coal, metals and lumber-related goods.

Bretton Woods I, II, III

On March 7th Zoltan Pozsar, who formerly worked at the NY Fed, was an advisor at the US Treasury and currently is now a strategist at Credit Suisse, published a research report titled “Bretton Woods III.”

Anyone familiar with the Bretton Woods agreement understands the reference. Under Bretton Woods I (1946-71) the US Treasury kept the dollar’s exchange rate stable by selling gold via the London Gold Pool at $35 an ounce. In August 1971, President Nixon stopped the drain by closing the Gold Pool and halting gold convertibility of the dollar (so called Nixon shock) and declared the dollar to be a floating currency. The suspension of dollar convertibility marked the end of the Bretton Woods I and formulated “Bretton Woods II”. Other major currencies became under pressure and finally in early 1973 all major currencies became floating.

Pozsar makes the case that Bretton Woods III is a reversion back to a monetary system, in which currency is backed by commodities as opposed to being backed by a sovereign issuer’s “full faith and credit.”

Fiat currency is a “promise” to repay a debt obligation and nothing more. A hard asset-backed currency is a guarantee that repayment will occur. Now, when Russia announced the Russian ruble will be a general means of payment in international trade and is backed by commodities (oil, gas etc.), the real game-changer is emerging.

Pozsar said that “We are witnessing the birth of Bretton Woods III – a new world (monetary) order centred around commodity-based currencies in the East that will likely weaken the Eurodollar system and also contribute to inflationary forces in the West.”

Pozsar adds, “A crisis is unfolding.  A crisis of commodities. Commodities are collateral, and collateral is money, and this crisis is about the rising allure of outside money over inside money. Bretton Woods II was built on inside money, and its foundations crumbled a week ago when the G7 seized Russia’s FX reserves.”

Pozsar distinguishes “inside money” from “outside money.” Inside money is created by the Central Bank/inter-bank lending mechanism that can magically turn one dollar of reserve capital into nine dollars of “credit” capital and the one dollar of reserve capital is backed by nothing tangible – just the “full faith and credit” of the issuing entity. In contrast, Pozsar’s Bretton Woods III means that “outside money” is “commodities collateral,” meaning tangible assets for which definitive value can be determined, as opposed to the sovereign promise of “full faith and credit.” 

In periods of banking crises, banks are reluctant to participate in the “inside money game” (e.g. 2008 finance crisis), because they don’t trust the fiat currency collateral and thus are reluctant to lend money to their banking peers. Every time this occurs, the Central Banks have to print more money to “lubricate” the system enough so that it functions.

If currency issued by governments and printed by central banks is backed by hard assets, this problem is avoided. In this system, the counterparty to trade or financing transactions would have the option of demanding payment in the hard asset or assets backing the currency – most likely gold or possibly a pre-agreed upon commodity asset. Remember, fiat currency is nothing more than an unsecured debt instrument of the issuing entity.

Freezing Russian currency reserves, held at western Central Banks, by the US/EU authorities brought to light the inherent fragile point of the modern Central Bank fiat currency reserve system. Any country that keeps currency reserves for trade settlement purposes at foreign Central Banks, specifically the Federal Reserve and the ECB, is at risk of having those reserves confiscated, thereby rendering them worthless.

In response, Russia is now demanding payment for energy in either rubles or gold from “unfriendly” countries. In this trade settlement arrangement, a country purchasing oil or gas from Russia in exchange for gold would need to 1) demonstrate that the gold being used for trade payment actually exists and 2) transfer the ownership rights to Russia. Russia ultimately would likely demand repatriation of the gold.

The response by the west – led by the US and its control of the global reserve currency – in all likelihood has triggered a reset of the global monetary system. It appears for now that Russia – likely with China’s tacit support – has set in motion a global monetary system reset.

In the new system, countries which supply the world with goods that have price inelasticity of demand – oil, natural gas and food commodities, for instance – will have the power to enforce trade settlement in hard currencies – e.g. gold or other hard assets – rather than fiat currency central bank accounting ledger adjustments. This is the nature of the monetary system reset that has been triggered.

Reactions from Europe

The UK has refused to pay for Russian goods, such as natural gas, in Russian rubles, a representative of Prime Minister Boris Johnson said. The British government remains in touch with UK-based companies that could be affected by Putin’s decision to switch into Russian rubles in payments for natural gas supplies to Europe.

French President Emmanuel Macron, Italian Mario Draghi andGermany’s Olaf Scholz also said that it would be impossible to pay for Russian gas contracts in rubles. They noted that the requirement to pay for Russian gas in rubles did not comply with the terms of the earlier concluded contracts. Bulgaria also refused to pay for Russian natural gas supplies in rubles, Lena Borislavova, a representative of the Bulgarian government said.

Putin’s ultimatum split Europe, with the EU’s G7 members publicly vowing not to pay, while privately, some, including Germany, have inquired about how such the payment system would operate. Officials in Austria and Hungary say there’s no alternative to Russian natural gas, with Budapest stressing that more costly American-sourced LNG is not a realistic substitute.

Austria’s Finance Minister Magnus Brunner said that the country had an action plan to follow should Russia cut its natural gas supplies. This is an emergency, multi-level plan, the official said. According to him, the Austrian parliament has coordinated measures for the strategic replenishment of gas reserves. Earlier, representatives for Austrian gas company OMV said that they did not receive a request from Gazprom regarding the need to switch into Russian rubles in payments for natural gas.

Prior to this, Robert Habeck, Germany’s Vice-Chancellor, Minister for Economic Affairs and Climate Protection, stated that Germany would not pay for natural gas supplies in Russian rubles. Habeck also announced an emergency plan that Germany would resort to should Russia cut off its energy supplies to Europe. Germany’s gas storage facilities are currently 25% full. According to Habeck, this ensures the security of Germany’s energy supplies.

CEO of Germany’s multinational BASF SE, the world’s largest chemical producer, has warned that curbing or cutting off energy imports from Russia would bring into doubt the continued existence of small and medium-sized energy companies, and further would likely spiral Germany into its most “catastrophic” economic crisis going back to the end of World War 2. 

Inflation in the US and EU

Inflation rate is increasing rapidly in the EU, the latest statistics tell that the average inflation rate is 7,5%. Germany is facing 7,6% inflation in March and will be facing double-digit rates quite soon, which is egregious in the post-WWII Germany, although they have some practical experience of hyperinflation in the Weimar Republic back in 1920s. If/when the ECB will hike interest rates in the near future, it may lead into an economic debacle and sparking historic sovereign debt crises in the process. The existential crisis of the whole EU is looming now around the corner.

The National Farmers’ Union has warned the UK is sleepwalking into a food security crisis. Soaring energy and fertilizer costs have led to an unprecedented situation where growers’ margins have collapsed, forcing many to halt growing operations. 

The price of gas in Europe rose above $1,400 per 1,000 cubic meters during Wednesday trading for the first time since March 24. The price of gas futures for April delivery at the TTF hub in the Netherlands went up to $1,412 per 1,000 cubic meters, or 123 euro per MWh. The total increase in the gas price since the trading started has reached 13.5%.

As the Bank of England scrambles to try and tame inflation with aggressive rate hikes, Bank of England Gov. Andrew Bailey warned during a speech this week that the British economy is sliding into stagflationary hell as the energy price crunch spurs inflation that’s hotter than at any point during the 1970s. According to Bailey, surging energy costs have forced the BoE’s Monetary Policy Committee to confront the biggest challenge in its short history: how can a central bank tackle inflation without driving the economy into recession?

In the US, inflation rate according to CPI (Consumer Price Index) is also well over 7% but the algorithm has been re-calibrated in such a way that it is no more indicating a real inflation rate, which seems to amount up to nearly 15%. The Fed’s favorite inflation indicator – Core PCE Deflator (Personal Consumption Expenditures) – which was expected to rise from +5.2% YoY to +5.5% YoY in February, surged to +6.4% YoY, the highest since 1982. Key contributors to the spike in PCE include “Motor Vehicles & Parts”, “Housing” and “Gasoline & Other Energy Goods”.

IMF warns Russia sanctions threaten to chip away at dollar dominance

Financial sanctions imposed on Russia threaten to gradually dilute the dominance of the US dollar and could result in a more fragmented international monetary system, Gita Gopinath, IMF’s First Deputy Managing Director, told The Financial Times.

“The dollar would remain the major global currency even in that landscape but fragmentation at a smaller level is certainly quite possible,” Gopinath told adding that some countries are already renegotiating the currency in which they get paid for trade. The war will also spur the adoption of digital finance and central bank digital currencies. Gopinath told the FT that the greater use of other currencies in global trade would lead to further diversification of the reserve assets held by national central banks.

China – Russia partnership confirmed again

Chinese Foreign Minister Wang Yi met with Russian Foreign Minister Sergey Lavrov on Wednesday, highlighting the continuing efforts to strengthen strategic partnership, amid the Ukraine crisis and other ongoing crises such as Afghanistan.

China and Russia will continue to practice genuine multilateralism and promote a multi-polar world and democracy in international relations. Both countries would continue to strengthen their strategic partnership and further bolster foreign policy coordination, enhance cooperation on the bilateral track as well as in various multilateral formats.

Wang pointed out that China-Russian relations have withstood new tests by changes in the international situation, maintained the right direction and demonstrated a solid development trend. Lavrov said Russia is ready to work with China to continuously strengthen high-level strategic coordination and deepen mutually beneficial cooperation in all areas and oppose hegemonism.

The United Nations General Assembly voted on March 2 to condemn Russia for its military operation, with China abstaining. While sowing discord between China and Russia, some Western media smeared China’s efforts for peace due to the abstention vote.

Despite speculation in the West that China faces the risk of secondary sanctions due to its ties with Russia, experts said China and Russia will not reduce their existing cooperation because of the risk of sanctions, which will not help the US achieve its strategic goals, because sanctions are bound to create divisions in the Western world and will also backfire on themselves. China and Russia are building up their relations because cooperation and business between neighbors brings substantial benefits to both sides, which is the essence and basis of the ties.

The de-dollarization process, led and supported by China and Russia has been studied here and here on this website.

India-Russia trade relations

India expected to ignore Western warnings by creating a rupee-ruble trade mechanism that could commence as early as early April 2022. India is considering a rupee-ruble trade agreement with Russia, a proposal from Moscow that will put New Delhi on a confrontation course with the West but one that could help to buffer the Indian economy against gathering global headwinds including spiking oil prices. 

One possibility could be “swapping of the rupee by Russian bank for renminbi from a Chinese bank branch in India.” Renminbi, unlike rupees, can be used by Russians. Meanwhile, Chinese banks can use the rupees to buy dollars, as it does not face any sanctions. Other reports have suggested the plan could involve rupee-ruble-denominated payments through Russia’s SPFS messaging system, an alternative to the more widely used SWIFT system that seven Russian banks are now punitively barred from using.

A third way to proceed may be such in which a Russian bank will only need to open an account in an Indian bank and an Indian bank will have to set up an account in Russia through which Indian exporters will get paid in the local currency rather than dollars or euros for their exports to Russia. In this case, it shall be agreed on the exchange value and also have a notional value of equivalence, most likely in dollars or euros, to which the value of the Indian and Russian currencies will be pegged.  

India is considering a proposal from Russia to use a messaging system developed by the Russian central bank for bilateral payments as New Delhi is not following the US-led economic campaign against Moscow.  The plan involves using Russia’s messaging system, known as SPFS, for rupee-ruble-denominated payments. The proposal is expected to be discussed as Russian Foreign Minister Sergey Lavrov arrives in India for his two-day visit on Thursday.

As the West is looking to limit its purchases of Russian energy, India is looking to buy more Russian oil at a discount price despite pressure from Washington to join the campaign against Moscow. India is also a major purchaser of Russian weapons and the Biden administration is openly considering sanctions on New Delhi over its stockpile of Russian arms. India has abstained from condemning Russia’s attack on Ukraine at the UN.

Saudi Arabia, Oil trade – from petrodollar to petroyuan

One of the core staples of the US dollar’s reserve status has been a global financial system based on the petrodollar, where oil producers would sell their product to the US (and the rest of the world) for dollars, which they would then recycle in dollar-denominated assets and investing in dollar-denominated markets.

Now, Saudi Arabia is in active talks with Beijing to price its oil sales to China in yuan, a move that could cripple not only the petrodollar’s dominance of the global petroleum market but also a move aimed at the heart of the US financial system. The Saudis have traded oil exclusively in dollars since 1974, in a deal with the Nixon administration that included security guarantees for the kingdom.

Saudi Arabia and Russia have kept close contacts on continuous base regarding oil trade, pricing of energy and arms sales. This cooperation seems to go further without any suspension.

Closing words

We are living in the middle of historical changes, which slowly but surely are forming the world around us, for better or worse, remains to be seen. The only certain looser will be Europe, so frivolously it has played all the cards in hand so far.