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29 June 2022

Russia’s threat to the global financial order is also our chance to build a new one

Is the international economic system unravelling, or is this a moment of transformation?

By Bruno Maçães

Airports across the world are buckling under the pressure of a swift return to travel. Masks are starting to look like relics of a past age. People are returning to their offices, the illusions of continued remote working shattered. The pandemic has receded from view faster than expected. Was its impact also smaller than many predicted? Has the world actually been changed by Covid?

Evidence suggests a durable impact. Inflationary pressures are mostly due to the virus, not the war in Ukraine. Supply chains seem permanently affected. At the level of political psychology, the change was profound. As the normal rules of international politics were suspended, states learned they had to rely on their own resources. Protective equipment and vaccines were hoarded and the production of critical inputs such as semiconductors became a national prerogative. The pandemic showed global rules can always be suspended if the need arises.

[See also: Why are India and China failing to support Ukraine?]

In a speech in April 2020, Xi Jinping drew a direct line between the pandemic and a new global strategy where national power is more important than existing rules. At the start of 2020, China was already preparing for a world of disorder and cut-throat competition, but Covid-19 gave it further impetus. And it wasn’t just Xi. In a speech at the annual Valdai conference last year, Vladimir Putin mused that the pandemic had revealed how fragile the ruling order truly was, preparing the way for new shocks.

The Kremlin sees the existing order as a set of rules keeping Russia in check and denying its true self: imperial, conquering, militaristic. Ukraine is the first victim, but the larger goal involves the destruction of the existing world system. What Putin described at Valdai was a sustained attack, lasting longer than Covid and for which there is no vaccine. He thinks Russia can succeed because the system was already under pressure before he invaded Ukraine. The war would be the last straw.

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In a series of recent research notes, the Credit Suisse strategist Zoltan Pozsar has described what he sees as the new global monetary order. It is difficult not to view it as a form of disintegration. He anticipates that, instead of the money signals that normally organise the global trading system – interest rates, foreign exchange and price level – the military arm of the state will take over. In the current system, central banks ensure your money is safe. In the new one, the military would guarantee the safety of your shipments. The prices of money are managed by central banks. The pillars of commodity trading are shaped by war. The rules of the game are changing, says Pozsar.

Perhaps. To me it looks like the return to an older world, something like that internet meme in which human evolution turns back on its tracks. From Francis Drake to Wall Street by way of the City of London, and then back to corsairs and pirates.

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Even money is losing its substance. After Russia invaded Ukraine, Russian central bank reserves were frozen. Suddenly the Russian central bank could not access its own reserves held at Western central banks and financial institutions. The economist Perry Mehrling has spoken of a “hierarchy of money”. At its top are treasury securities. Backed by the full faith of the only global superpower, they were intended to be actual money rather than credit. But from the standpoint of the new geopolitics, even central bank reserves held as state treasuries are liabilities; that is, no more than credit or promises to pay. And often promises are not kept. One should interpret the growing interest in crypto as part of a desperate search for a more solid form of money, assets that, like gold, are not a liability held by someone else.

[See also: What the Terra crash means for the future of crypto]

In a report published on 26 June, the Bank for International Settlements shows that the current inflationary shock is also contractionary: since commodities, notably energy and food, are a key production input, an increase in their cost constrains output. We may even be reaching a tipping point, past which inflationary expectations spread and become entrenched. Just as economies can remain in a stable state of equilibrium during periods of low inflation, high inflation can reach its own kind of equilibrium. We are quickly transitioning from one state to the other.

Inflation is causing havoc in parts of the global financial system. Sharp rises in commodity price volatility recently set off large margin calls in derivatives markets. The search for cash to meet those calls briefly led to stress in dollar funding markets. With several rate hikes planned, some European government bond markets are under pressure. Behind the scenes, some investors whisper about a return of the eurozone crisis. Soaring food prices threaten to cause major social and political unrest in the developing world. Sri Lanka has just declared a lockdown as its fuel supplies have run out. Lockdowns are here to stay, but they will have different causes.

Are we witnessing the inevitable unravelling of the global economic order? Or is this a moment of transformation? The sooner we manage to isolate or quarantine the Russian attack, the greater the chances of a stable transition, but it would be a mistake to think this can happen without recreating the system in a new form. At any given moment, the power to make the rules matters much more than what the rules are. 

Dealing with the Russian threat may even help us create a better global economy. To have a decent chance of averting a global average temperature increase of more than 2°C above pre-industrial levels, half of the planet’s natural gas reserves need to remain untouched. Russia boasts about a quarter. There is nothing irrational about leaving them underground.

[See also: Can Ukraine win the war with Russia?]

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This article appears in the 29 Jun 2022 issue of the New Statesman, American Darkness