The failure to crush Russia for its invasion of Ukraine by applying trade sanctions, confiscating some of the central bank’s reserves and excluding the country from the international financial system (SWIFT), has sent a signal to non-Western countries. Russia is calling the American and European bluff on two fronts: geopolitical and financial. It is now clear that we are no longer in the so-called ‘unipolar moment’ where the United States and the collective West militarily dominates the globe. One former American diplomat is even arguing that this represents the end of 500 years of Euro-Atlantic ascendancy.
Just as importantly, it has shown that countries can survive Western financial and economic attacks. The sanctions against Russia served dual purposes: the first was to slow the war effort and express solidarity with Ukraine. The second was to bring the country to its knees and force it to retreat and eventually break up. While the former was largely achieved, as to the latter, the opposite has happened. Russia’s economy, exports and currency have all performed strongly. Other non-Western countries, looking at this, are apprehensive that the attacks that happened to Russia can easily happen to them. It is a justified fear. Over the decades many countries that dared to defy the Washington line have been targeted. Venezuela, for example, had its gold reserves stolen by the British. Most of Southeast Asia has suffered from crises due to having their debt denominated in US dollars. These countries are starting to believe, having watched Russia’s financial survival, that it may be possible to find a way to get out from under American hegemony by creating an alternative system.
The outline of such an alternative may start to emerge this month at the St Petersburg International Economic Forum. It is being attended by the BRICS countries: Brazil, Russia, India, China and South Africa. But more than 80 other countries, including giants like Saudi Arabia, are also going. Together, they represent over four fifths of the world’s population. On the agenda is finding ways to develop a gold-backed system that will presumably run parallel with the existing one. If they can succeed, and it will not happen quickly, it will represent a weakening of US and Europe’s control over the world’s financial architecture.
This seems like good news, and not just because it might eventually make weaker countries less vulnerable to Western influence. It may create what the current system desperately needs: redundant capacity that can act as a buffer if something goes wrong. It is not widely understood that the foreign exchange markets are essentially a high-tech casino making money out of money. Trade in goods and services represents only about 1 per cent of turnover. Most of what happens is derivatives, transactions derived from other assets such as government bonds. As a survey by the Bank for International Settlements records, over the counter foreign exchange markets reached $US7.5 trillion per day in April 2022, with the US dollar on one side of 88 per cent of the trades.
It is all driven by high tech algorithms and intensely interconnected. If something goes wrong, as it did in the 2007-2008 global financial crisis, complete collapse can occur extremely quickly. Ironically, in that crisis it was the somewhat antiquated Chinese financial system that provided the redundancy. To use an analogy it was as if the supercomputers of America, Europe and Japan all quickly succumbed to a virus but then it hit the Chinese system, which was more like a 1980 Atari computer that did not recognise the malware. It slowed the crisis down long enough to give governments time to provide rescue funds.
'If a possible new system does open up it will pose some difficult questions. Will countries that in the current system float their currencies, let the market decide the value, fix their currency in the emerging system? Will that mean they have to continually adjust their currency in the new system to maintain consistency?'
If an alternative financial system, led by Russia, does emerge it might represent a type of redundancy, a place to go should the high-tech casino collapse. It would not be without its flaws, and would mark a progression in their capacity to operate without reference to norms which at least ostensibly seek to have underlying democratic liberal values. The intention seems to be to link national currencies to the gold price (not gold itself), suggesting that countries in the new system will fix the value of their currency, rather than let the markets determine the price in relation to other currencies.
This makes some sense, if for no other reason than that in the current system the constant fluctuations of currencies in relation to other currencies – determined by ‘market forces’, traders in New York and London – makes no sense. The Australian dollar, for example, has fluctuated between 50 cents to the US dollar and one dollar, or parity, against the US dollar when the relative performances of the two economies was not notably different. No-one understands why currencies oscillate the way they do, least of all the traders. It is the reason that China has fixed its currency to the US dollar, to ensure some certainty with its foreign transactions.
If a possible new system does open up it will pose some difficult questions. Will countries that in the current system float their currencies, let the market decide the value, fix their currency in the emerging system? Will that mean they have to continually adjust their currency in the new system to maintain consistency? How will arbitrage between the two systems work, or will it be possible to keep them separate? You can bet those casino players will try to find a way to exploit opportunities. Will countries use the new system for their trade and the existing system for their finance? Will some countries exit the current system completely, in the way that Russia has been forced to?
It is too early to even guess at answers to these questions. But there seems little doubt that a massive shift in world finance is underway.
David James is the managing editor of personalsuperinvestor.com.au. He has a PhD in English literature and is author of the musical comedy The Bard Bites Back, which is about Shakespeare's ghost.
Main image: Armored tank on the background of stock charts. (Getty images)