Martin Seale

The members of NATO have imposed sanctions on Russia following its Special Military Operation in Ukraine which began on 24^th February.  NATO would clearly like these sanctions to severely damage Russia.  It is unlikely that they will for two main reasons.  Firstly, Russia is a currency creating state and does not therefore have financial constraints.  Secondly, Russia is a country which is very rich in natural resources.  Over the last few decades, Russia has been exporting large quantities of raw materials, everything from oil and gas to agricultural fertilizers.  It uses some of the foreign currency that it earns from these exports to buy imports.  If Russia is no longer able to buy these imports, it will develop import substitution industries and will make most of these previously imported products in Russia.   Since it is so rich in natural resources it can do that.  It will clearly take a certain amount of time to organize but, in principle, it can be done.  In the interim, Russian workers will not go cold or hungry, unlike those in the UK on universal credit and low wages.

When people think about exports and imports, exports are usually seen as good and imports are seen as bad.  But this is the opposite of how it should be viewed.  Exporting involves doing work and then transferring the product of that work to a foreign country – for money.  The product being sold will be priced in the currency in which the seller wishes to be paid, euros in the case of Russian gas sales.  What does the exporter get in return for the products of his labour?  He gets pieces of paper, euros which are just a form of IOU.  Of course, in today’s world no pieces of paper actually change hand.  Instead, an account owned by the exporter in a bank in the importing country will have its balance increased.  In return for transferring the products of his labour, the exporter gets an IOU which is more grandly called a financial asset.

It is, of course, intended to use these financial assets at some point in the future to acquire real things like food or medicines or cars.  There is a risk involved in holding a financial asset:  its value may go down.  It is not normally a risk that you will be unable to use your financial asset.  The imposition of sanctions by the US and Europe against Russia restricts the use it can make of the financial assets it has accumulated over decades by exporting more than it imports.  The financial assets have not been seized, at least not yet.  Britain and the US quite literally seized the financial assets of Venezuela in an attempt to effect regime change there.  They did the same with Afghanistan.  In Russia’s case, the US, Europe and Britain have so far restricted what the financial assets can be used to buy.  The general rule is that Russia’s foreign reserves cannot be used to purchase products that could be used to help in Russia’s war in Ukraine. 

Additionally, Russia has in the past issued a small amount of bonds denominated in dollars.  Capital and interest payments were due on these bonds in April.  The US government ruled that Russia cannot use its accumulated dollar reserves to meet these payments.  So there will likely be a technical default by Russia at the beginning of May.  It’s a technical default because everyone knows that Russia has the funds to make the payments but is being blocked from using them for political reasons.  Expect to see a storm in a teacup on this matter in early May.  

Of more interest will be the payment by Europe for the gas it imports from Russia each year.  Gazprom sells gas to Europe for Euros – currently some .8 billion euros each day.  In the past, Gazprom will have had an account in euros at some European bank.  The balance in that bank will have been increased by .8 billion each day.  But Gazprom pays its workers in rubles so it will typically sell a large amount of these Euros in exchange for rubles to acquire the funds it needs to pay its Russian workers.  The Russian Central Bank will have a certain idea of what it thinks should be the correct exchange rate between euros and rubles.  Since the Russian state is a currency creating state, it will create whatever amount of rubles it needs to buy Gazprom’s euros at the desired exchange rate.  The Russian central bank ends up with a lot of Euros.  Euro assets of the Russian central bank will increase, and the ruble liabilities of the Russian central bank will increase by an amount which reflects the exchange rate that ruled when the transaction occurred.

Putin decreed on 24 March that Gazprom should now be paid in Rubles rather than euros.  It is somewhat unclear what the ultimate purpose of this decree is.  Since gas contracts are denominated in euros and since Russia is keen to be seen as a country that always honours its legal contracts, it would not attempt to force countries to start paying in rubles.  Instead, the account into which payments are paid has changed.  Rather than paying into a euro account in a European bank, gas purchasers will pay into a euro account in the private unsanctioned Russian bank called Gazprombank which will then auction the euros for rubles.  These rubles will then be paid into a ruble account owned by Gazprom.  And so Putin’s decree is satisfied.  The gas supplier, Gazprom, has been paid in rubles.

(Note, the recent decision by Poland not to pay for its gas using the new system is entirely political.  It believes it has enough gas to get it through to the end of the year when its gas contract with Gazprom ended and any new contract would have required payment in rubles.)

In this auction of euros by Gazprombank, who will want to exchange rubles for euros?  If Russians were to buy the euros they would find that they were severely limited in how they could spend them in Europe, if at all.  Gazprombank may buy some of the euros (speculatively).  Since the Gazprom pension fund is the main shareholder in Gazprombank that may limit any such speculative purchases.  Probably the main buyer will be the Russian central bank.  It has the monopoly ability to create rubles so it will simply create rubles to buy euros at the exchange rate that it wants to exist between euros and rubles.

There are three definite outcomes of Putin’s decree.  1) Russia will continue to transfer a large quantity of its natural resources to hostile countries in return for euros, 2) Gazprom’s euro assets will cease to increase, its ruble assets will increase and this may encourage it to invest in Russia, 3) the Russian central bank’s holdings of euros will increase.  Since these euros will be in a Russian bank, Gazprombank, they will be outside of European control.  

It seems that Russia will have created something like the Eurodollar that came into being in the 1950s.  A Eurodollar was a dollar that would not be spent in the US.  By forcing gas buyers to deposit euros in a Russian bank, Russia is effectively creating a ‘RuskiEuro’ that can circulate within the Russian Federation and be used for trade settlement with countries that are not sanctioning Russia, like India and China.  See Neil Wilson for a more detailed account: https://new-wayland.com/blog/how-russian-gas-is-paid-for/

Perhaps, though, the most important outcome is the warning shot Russia has sent to Europe:  new contracts for the sale of gas may be priced in rubles.  In which case, a buyer of Russian gas will have to figure out how to acquire rubles.  That may be difficult if Europe is not actively trading with Russia.

The purpose of Putin’s decree may be simply to force Europe to trade with Russia in the medium to long term when new gas sales contracts are signed.  How else will Europe acquire the rubles it needs to pay for the gas?