Russian Exchange Stabilization Fund – From Rubles to foreign currencies to gold?

As part of the moves to protect surplus $ nations from the U.S.$ and its malaise, Russia has joined the ranks of nations actively making moves to ward off the threats from the U.S. currency. 

The two main threats are:  1. Imported inflation. 2. Appreciating currency values.

Both of these are caused by the depreciating U.S. $ internationally, springing from the huge and constant U.S. Trade deficits. With the U.S. making absolutely no effective moves to rectify this deficit, eventually the weight of nations following the Chinese & Russian roads, will lead to major U.S.$ crises and the probable disruption of global trade as we know it now.

In moves designed to avoid precipitating the downfall of the $, China and now Russia are preventing such $ surpluses from entering their nations to bring on inflation or causing their currencies to appreciate, by sending them back to alternative foreign currencies as well as retaining them in a portion of U.S.$ then investing them abroad.

The fund, which receives oil export revenues above a certain point, was created as an inflation-fighting tool to absorb the petrodollars pouring into Russia's economy as oil prices break new records and to help pay down foreign debt. These funds will now be invested in Western government bonds and eventually also in blue-chip shares, once legislation is passed permitting this. Last year Russia used some of its “windfall” oil profits from its Exchange Stabilization Fund to repay around $20 billion of foreign debt.

This Russian Exchange Stabilization fund has grown considerably over the last year, fed by ‘windfall’ profits from its sales of oil. Russia's ‘oil fund’ currently stands at 1.8 trillion rubles (US$66.7 billion, euro 52 billion), is forecast to grow to about 2 trillion rubles (US$74 billion) by the end of 2006.

This year Russia’s Finance Minister Kudrin said that the deposits would be moved out of the Ruble and switched into 45% in dollars, 45% in Euros and 10% in Pounds Sterling. The move will not result in any net purchase of foreign currencies because the Rubles held in the fund will be exchanged into Dollars, Euros and Sterling from the central bank's own reserves. In the past these would have almost certainly have been placed in the U.S.$ to around 80% if not all of them.

This should not be seen in the context of making the Ruble convertible [June 8th this begins]. The protection the investments provide the Ruble, will make it a more reliable, convertible currency in terms of foreign exchange rates, but the investment is not connected to its convertibility otherwise. Once it is established as a convertible currency, the objective is to have it used in the global system as part of other countries reserves.

As part of the process of elevating the status of the Ruble, Russian lawmakers gave initial approval to legislation that would ban businesses listing prices in Euros and $s and bar Cabinet ministers from referring in their speeches to currencies other than the Ruble. The Ruble has recovered from the days of chronic weakness during the economic turmoil of the post-Soviet era.

China, through its revaluation in terms of a ‘basket of currencies’ [of the currencies of the countries China trades with] has followed the same route as Russia is doing at present [as above].

What conclusions can we draw from these moves on the Stabilization Fund concerning gold and the $?

• Both the move to make the Ruble convertible and the diversification of the Rubles in the Stabilization Fund are not directed against the $, but are an attempt to ward off the dangers that might affect Russia from the decline of the $. After all there are too many U.S.$ in reserves to attack it. This is indirectly, gold positive as it undermines the future stability of the global monetary system, through its turning from the main global reserve currency.

• It is part of a pattern of moves, which includes the oil Bourse where oil will be priced in Rubles, which will lead to the international acceptance of the Ruble as a reserve currency. [These moves are similar to those the U.S. followed in the seventies]. Any move that prices oil in other currencies is damaging to the global monetary system and therefore is gold positive.

• The U.S. will now have to reduce the number of $' offshore, which will become surplus to requirements. Ideally, this should translate into spending the U.S. $ on capital goods to develop their infrastructure, as is the case in China, but it may well mean these $s are sold for other currencies. This will lead to a decline in the exchange rate of the U.S.$

Some observers have thought this a prelude to buying gold, but we think not, at least not with funds from the Stabilization Fund. Yes, President Putin has indicated he want to see Russian Gold reserves raised to 10% of Russia’s reserves but the Central Bank of Russia has not reported taking any action on this front yet. One of the biggest difficulties that any Central Bank faces is the actual task of buying the gold. The main routes to more gold a Central Bank can take, are these:

• Buying in the open market. The moment the news gets out that the Russian Central Bank was in the market and that words had turned into actions the gold price would rocket. In this tight market now, the gold price is demonstrating just how capable it is of rising far more.

• The second line of purchase is to buy direct from the Banks selling the gold. We asked the head of one of the fixing bank's gold department why this was not done and he said they don't trust each other.

• The third and most likely way for both China and Russia is to buy the gold direct from their own local gold miners and hold it in reserves, without letting it reach the open gold market. We suspect China may have done that over a period. This is the most efficient and price insensitive method of buying gold.

We certainly think Russia & China, at least, are toying with the idea and indeed many other Central Banks are contemplating buying gold for their reserves. This year should see some movement forward by Central Banks being buyers rather than sellers and holders. 

What we are waiting to see is a mindset change to recognizing that gold is needed as a support for currencies in general, to restore confidence in them. 

But to recognize, as in time they will have to do, that the overissueance of paper currency and their over reliance on confidence in that piece of paper, has led to the system needing the support of gold, is a huge metamorphosis.

Germany is there in mind at least, as is Italy. [France's bankers are there but their politicians are too powerful at present]. Russia is getting there and China thinks they may be too late. But when the oil/$ reserve currency crisis arrives in the market place [which could be in the next few months], the spur to make them think differently will be there, as will the support of the system to do so. Need will force them to do so, to preserve what they have left of confidence in their paper money.

© 2006 Julian D. W. Phillips
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