Economic Warfare Against Russia Has These Unintended Consequences

The cost of waging economic war on Russia? Well, it could be the total loss of trust in the U.S. dollar as a reliable international medium of exchange. Weaponizing the dollar has these unintended consequences…

Financially Canceling Russia Has These Unintended Consequences

From Birch Gold Group

Remember a few weeks ago when Canada invoked the Emergencies Act to freeze the bank accounts of annoying political protestors?

What if that happened to an entire country? It would look like this…

SWIFT provides secure financial messaging services for various transactions in the international community. In fact, it’s a critical piece of financial infrastructure:

SWIFT’s messaging services are trusted and used by more than 11,000 financial institutions in more than 200 countries and territories around the world. Providing reliable, secure and efficient messaging services to our community of users, SWIFT is the backbone of global financial communication.

This messaging system basically sets legal terms for both sides of a financial transaction independent of whether or not that transaction can be completed, according to Jim Rickards.

It’s also important to note: “SWIFT is not a financial institution and it’s not a payment channel,” as Rickards mentioned recently in The Daily Reckoning.

But without SWIFT, financial transactions aren’t “trusted” through mainstream channels. Which brings us to the economic showdown surrounding the military conflict between Russia and Ukraine…

This is what economic warfare looks like

In a coordinated move, the U.S. and the EU froze Russia’s access to both their own central bank reserves and the Russian sovereign wealth fund. That was a step further than expected! This SWIFT news release details how Biden and other world leaders crossed a financial Rubicon, stifling Russia’s ability to process international financial transactions:

Diplomatic decisions taken by the European Union, in consultation with the United Kingdom, Canada and the United States, bring SWIFT into efforts to end this crisis by requiring us to disconnect select Russian banks from our financial messaging services. …in compliance with the legal instruction in EU Council Regulation (EU) 2022/345 of 1 March 2022, we will disconnect seven designated Russian entities (and their designated Russia based subsidiaries) from the SWIFT network.

In short, the West have not only banned most Russian financial transactions, they’ve also prevented Russia from accessing its own money wherever possible. (Shades of Ottawa…)

Rickards summarized the initial consequences for Russia should this financial cancellation continue for any length of time:

Here’s what Biden’s team of amateurs don’t understand. Every payment, every trade, has two sides. When you blow up one side (Russia) you also blow up the other side (world banking system). Linkages are dense and immensely scaled.

Put simply, not only could Russia be financially strangled, but every institution on the other side of each Russian transaction has to deal with the fallout.

In fact, Rickards continued by providing an example of how this move could affect Europe:

For example, French Finance Minister Bruno Le Maire warns that the ban would hinder Europeans’ ability to recover payments on nearly $30 billion in debt owed them by various Russian entities. This will spill over into a global liquidity crisis within days. Count on it. It could be the worst liquidity crisis ever.

The bottom line: Removing a single link in the financial world can have catastrophic consequences.

And we don’t mean catastrophic consequences for the Russian economy and the average Russian citizen. Though that’s certainly true! The ruble is now worth less than a single penny, cheaper than Robux, the in-game currency for kid gaming site Roblox. Recent reports predict a 12% GDP contraction in the months ahead. That will absolutely feel like a catastrophe to the majority of the Russian people.

Rickards is a lot more concerned about the global consequences of this action.

Without getting bogged down in every possible outcome and their second-order consequences, here are the two biggest warning signs to look out for.

Cascading currency confusion, defaults and bank failures

Cutting Russia off from SWIFT will have a disastrous impact on Russia’s banking, without a doubt. That’s more or less the point. The problem is that some of those banks are connected in the EU, and are already failing due to liquidity issues (like Rickards pointed out above). For example:

The European Central Bank (ECB) has assessed that Sberbank Europe AG and its two subsidiaries in the banking union, Sberbank d.d. in Croatia and Sberbank banka d.d. in Slovenia, are failing or likely to fail owing to a deterioration of their liquidity situation. (NOTE: Sberbank Europe is majority owned by the Russian Federation)

It's easy to understand who’s on the other side of some of the bank’s liabilities: their depositors. What other complex business dealings were these banks involved in? We won’t know until the dominoes start to fall.

Here’s another example of the collateral damage from the financial sanctions. The Biden administration and the EU may have shot some debt holders in the foot… Reuters tells us to expect an imminent default on Russia’s hard currency debt (OFZs).

With much of Moscow's $640 billion reserves under lock and key in the West and sanctions crippling cross-border capital flows, foreign investors are effectively stuck with their Russia-issued debt holdings. The central bank of Russia temporarily halted coupon payments and the financial settlement system stopped accepting Russian assets.

Here's what’s really surprising about this situation:

Moscow reneged on OFZs during its 1998 financial crisis, but even then it kept up payments. Before the latest devastating Western sanctions which froze central bank assets, such a Russian default was on no one's radar.

You might call this an “involuntary default.” No matter what you call it, though, it represents a significant escalation in the economic war the West is waging.

Let’s be clear, though – none of the consequences we’ve discussed so far approach the truly catastrophic. At this time there are no non-Russian banks in serious trouble that we know of. So far the world’s tightly integrated financial system has more or less shrugged and moved on.

The world’s central banks, though? They’re busy dusting off their Plan B documents. Here’s why…

Shocked world banks rethinking their reserves

The Wall Street Journal is less concerned about Russian bank failures than a permanent shift in global finance. Reporter Jon Sindreu says these economic sanctions have the world’s central bankers once again asking, “What is money?”

Why? Well, if Russian currency reserves can be frozen at the flick of a switch by politicians, couldn’t any other nation’s?

Yes, it would seem:

Sanctions have shown that currency reserves accumulated by central banks can be taken away. With China taking note, this may reshape geopolitics, economic management and even the international role of the U.S. dollar.

A Reuters column put a spotlight on how the geo-economic ripple effects could be even worse, starting with the potential for reserve managers asking where to put their currency reserves in the first place, including U.S. dollars:

While a huge blow for Russia's economy, the move quickly prompted questions about whether targeting reserve holdings as an act of 'economic warfare' may prompt a rethink by reserve managers across the globe - not least in countries that may be at loggerheads or face a potential conflict with U.S. or EU governments - over where to bank their national stash.

It's a potentially huge issue for world markets given that central bank foreign currency reserves totaled a record $12.83 trillion late last year - a rise of $11 trillion over the past 20 years. This money is held mostly in U.S. and European government debt - with the U.S. dollar still accounting for almost 60% of that and the euro about 20%...

It seems like the world's central banks are having their own lightbulb moment.

For citizens, it goes like this:

If my government can freeze my bank account for any reason, is it really MY money?
If it’s not really my money, what should I do to regain my financial independence and freedom?

For central banks, the discussion goes something like this:

If governments can freeze our currency assets for any reason, why do we have them?
Sell currencies, buy alternative stores of value.

In other words, central banks are suddenly looking at their paper assets as liabilities rather than assets.

You probably know what a central bank’s “alternative store of value” is…

Central banks worldwide hold this “geopolitical hedge of last resort”

Smart central banks were swapping their paper assets for gold before the Russia-Ukraine conflict:

...the central bank of Hungary tripled its gold reserves to more than 90 tons last spring because the metal is free from credit and counterparty risks. Large purchases of gold were limited in the past to the central banks of Russia and some other countries trying to free themselves from reliance on the dollar because of political confrontations with the U.S.

(Note: Hungary shares a border with Ukraine, and was a one-party socialist state under the thumb of the USSR from 1949-1989.)

The Nikkei article continues, “Although the Federal Reserve is starting to tighten its grip on credit, other central banks continue their shift to gold, reflecting global concerns about the dollar-based monetary regime.”

So there are several concerns international central bankers have:

  1. "The value of the dollar against gold has dropped sharply over the last decade.”
  2. Extreme U.S. inflation rates, thanks to the Fed’s astonishingly incompetent monetary management, which no one can pretend are “transitory” anymore
  3. Debt doesn’t pay very much interest these days
  4. Annoy the wrong person and you could get frozen out of your own bank account

Perhaps it’s no surprise that world central bank gold holdings are currently at a 31-year high.

Adam Glapinski, president of the National Bank of Poland, explained:

“Gold is not directly linked to any nation's economy and can withstand global unrest in financial markets.”

Fortunately, central bankers have much larger worries than everyday folks like us. They have to look out for an entire nation’s economy. We only have to look out for ourselves and our families.

Even so, it seems like a good time to consider whether to follow their lead. Take a look at your retirement savings and ask whether you’re comfortable with your risk profile. If you aren’t, swapping some paper assets for physical gold and silver might be the right move for you. Worried about inflation? We’ve done an extensive survey of inflation-resistant investments that can help shelter your savings.

When all is said and done, central banks mostly choose physical gold as their alternate store of value. As Ray Dalio said,

“Gold is the only financial asset that isn’t someone else’s liability.”

That’s probably why central banks trust gold. After all, someone else can always choose (or be forced) to default on that liability. That’s one thing gold can’t do.

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