by Bill O’Grady | PDF

In mid-March, we wrote a report detailing the effects of financial sanctions on Russia.  And now, about six weeks later, we are seeing the response from Russia.  As we noted in our earlier report, Western sanctions on Russia were extensive.  Although something similar was deployed against Iran, never before had such sanctions been used against a major country.

The initial response from the financial markets was swift; the ruble (RUB) plunged.  However, over the past couple of weeks, the RUB/USD has recovered all of the initial losses.  It should be noted that some of the recovery is due to capital controls as Moscow has made it very difficult to move money out of Russia.  Exporters who acquire hard currency are required to turn 80% over to the Russian Central Bank.  The bank also lifted interest rates to 20%, yet recently reduced its policy rate to 17%.  But perhaps the most radical action the government has taken is to demand payment for energy in RUB.

In this report, we will begin with examining the concept of money and the complications that international trade creates, including a discussion of the reserve currency concept.  Using this construct, we will apply it to the specific case of Russia.  Our contention is that the dollar/Treasury reserve system is, at best, being tested, and at worst, unraveling.  We will also include comments about emerging reserve currency blocs and conclude with potential market ramifications.

Read the full report

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