What is Money? Russia Edition
“We invented money and we use it, yet we cannot . . . understand its laws or control its actions. It has a life of its own.”
“What is money?” This question began a widely discussed Wall Street Journal column by Jon Sindreu on March 3, titled “If Russian Currency Reserves Aren’t Really Money, the World is in for a Shock.” The purpose of the article was to analyze the effects on international finance, geopolitics, and the role of the dollar in both, of the unprecedented sanctions imposed on Russia after its invasion of Ukraine. These sanctions, in the space of three weeks, froze hundreds of billions of foreign assets of the Central Bank of Russia and cut major Russian banks off from the global financial system, among other effects, putting Russia almost on par with North Korea in the international community, notwithstanding its membership in the so-called G-20.
Oddly, although beginning with this question, the column did not attempt to rigorously answer it. The reason, perhaps, is that defining what money “is” – is a fraught endeavor not easily undertaken. For their part, economists typically define money in three ways: (1) as a “medium of exchange” – meaning it is the token given to others in exchange for things the giver wants; (2) as a “store of value” – meaning this token is viewed as an item that will remain valuable far into the future; and (3) as a “unit of account” – meaning that the token is based on a relatively simple numbers system which can be used to denominate the price of goods and services.
Each of these definitions, notably, defines money in terms of its function, but does the function of a thing define what it “is”? The answer is no, the function of a bicycle may be to get us from place to place, or for exercise on a path, but that function is not what a bicycle “is.”
The best answer which those who ponder these questions deeply come up with is that money is nothing other than faith. Former Wall Street Journal journalist and co-host of NPR’s Planet Money, Jacob Goldstein, the author of Money, The True Story of a Made Up Thing, writes that “money is money because we believe it’s money.” In his book The History of Money, anthropologist Jack Weatherford writes that the dollar rests on “the faith of the people who use it – faith that it will be able to buy something tomorrow, faith that the U.S. government will continue to exist . . . and faith that other people will continue to believe in it.” And, in his book The Future of Money, Cornell Professor of Economics Eswar Prasad writes that “trust is crucial to the functioning of a modern financial system.” In short, money is almost like language, it is a construct and convention of humans that is necessary for human interaction and development, and it is essential to a society unless and until something in the society goes fundamentally wrong.*
It may seem a strange thing to say, but it follows from this that the Russians, by maintaining a large reserve of dollars in banks outside of its territory, trusted that that money would remain available to it after its attack on Ukraine. President Putin, in his own convoluted way, acknowledged that he had made this mistaken assumption, by claiming in a speech on March 16 that “now everyone knows that financial reserves can simply be stolen.”
In his column, Sindreu did not use the word “stolen,” but he did write that if “currency balances were to become worthless computer entries and didn’t guarantee buying essential stuff, Moscow would be rational to stop accumulating them and stockpile physical wealth in oil barrels . . . At the very least, more of Russia’s money will likely shift into gold and Chinese assets.” Sindreu then asked the question which seems to have launched a thousand follow-up articles, which is that if Russia stops using the dollar to the greatest extent it can, will other nations “that aren’t sanctioned” want “to diversify their geopolitical risk.”
In other words, does the imposition of these sanctions on Russia pose a threat to the dollar as the world’s reserve currency and, thereby, the many advantages the United States gains through this circumstance? To ask this question, of course, is not to criticize the imposition of the sanctions, but to attempt to analyze what the implications of the sanctions might be.
In answering this question there are, not surprisingly, differences of opinion. However, what is not in dispute is that many nations would dearly love to have another currency challenge the dollar as the reserve currency. Of course, resentment of the dollar as the world’s reserve currency is nothing new — French finance minister (and later President) Valéry Giscard d’Estaing famously said in 1960 that the dollar gives the United States an “exorbitant privilege” – but anger at the sanctions imposed on Russia is shared by other large nations, including China (officials of whom have called the sanctions “outrageous” and which in February announced a “friendship without limits” with Russia), India, South Africa and Brazil, all of whom refused to join the sanction regime.†
The difference of opinion amongst analyst, instead, is whether it is practical for a reserve currency to emerge from any global competitor – the most obvious choice would be China. Those arguing against the Chinese renminbi emerging as a rival to the dollar point out that China is an autocratic society without a strong judicial system imposing law neutrally, that international actors would have much greater reason to fear arbitrary action by it than by the United States, and that China has imposed strict “capital controls” which restrict the free movement of its currency outside of its boarders. In other words, does the world want to put its faith there?
Those commentators who claim that the sanctions will speed the displacement of the dollar as the world’s reserve currency acknowledge these arguments but point to steps already being taken by China to weaken the dollar. China, for example, is currently negotiating with Saudi Arabia to accept Chinese currency instead of the dollar for oil sales to China, which would represent a shift given that Saudi Arabia has since 1974 traded oil exclusively in dollars. China and Russia have also agreed to trade with each other in their respective currencies and not in dollars. These commentators also argue that the Chinese are “playing a long game” that will result in Russia becoming in essence a minor partner or even a vassal of China, similar to North Korea.
At least so far, the markets have not forecast a weakening dollar, as of early March the dollar reached its highest level since the coronavirus-induced volatility of two years ago.
In his Wall Street Journal article Sindreu concluded with a prediction not as to the dollars’ future role, but as to the effects of the Ukraine invasion and the sanctions response on geopolitical relations, stating that they seem “set to further the deglobalization trend and entrench two separate spheres of technological, monetary and military powers.” This prediction appears widely accepted by experts, that the West and China/Russia will “decouple” and that the movement of the last thirty-years towards a more integrated unipolar world has ended.
As we say at PMA always, we do not have a crystal ball, but we do have great faith in the United States of America. Although the challenges of the last two years have shaken assumptions and been difficult, we do not intend to change our fundamental position in favor of the United States as a result of the very upsetting new war in the heart of Europe.
* When a monetary system breaks down, such as in the case of hyperinflation, not only is wealth destroyed, but so is the faith that members of that society held in each other and in their government. Thomas Mann, the Nobel Laureate in literature, who self-exiled from Germany in 1933, wrote that the hyperinflation in post WWI Germany made Germans “cynical, hardhearted and indifferent” and that a “straight line” runs “from the madness of the German Inflation to the madness of the Third Reich.”
Moreover, the contention made by some that if paper money were “backed by” a precious metal that its value would be “intrinsic” and not ultimately based on faith, is open to question, because gold and silver are not items that cure illnesses or provide food, they are also tokens whose value ultimately depends on a societal convention that the metals are indeed valuable. What can be said is that such a convention as to gold has lasted much longer in history, that the convention likely originated from the relative scarcity of the metal, its unique properties as a metal, and the ability to use gold almost like a commodity, i.e., to fashion it into useful things such as swords or jewelry. But surely gold does not retain value today because it can be transformed into a weapon. And while its relative scarcity makes it a hedge against inflation, even precious metals when used as coinage currency have been debased by leaders since the days of ancient Rome.