March 27, 2022

Ukraine and the Global Economic War: Barbarism or Civilisation?

Prabir Purkayastha

DOES the Ukraine war and the action of the US, EU, and the UK spell the end of the dollar as the world's reserve currency? Even if the peace talks between Russia and Ukraine reach a 15-point peace plan, as Financial Times has reported, the fallout for the dollar still remains. For the first time, a major nuclear power and major economy were treated as a vassal state. Its $300 billion foreign exchange reserves lying with the US, EU and the UK were seized.

The threat to the dollar hegemony is only one part of the fallout. The other is the complex supply chains, built upon the promise of a stable trading regime based on the WTO principles, is also threatening to unravel. The US is discovering that Russia is not simply a petro-state as they thought but supplies many of the critical materials that the US industry and the military need. This is apart from Russia being one of the critical suppliers of wheat and fertilisers globally.

Seizing Russia's funds means that the faith the US is the world's banker and the dollar is the global reserve currency, is in question. Why should countries maintain any trade surplus and bank it abroad if that surplus can be seized at will? The promise of a dollar as the world's reserve currency was that all surpluses in dollars were safe. With the seizing of the Afghan central bank's 9.5 billion dollars recently, the US had shown that it considers that dollars held by another country with the US central banks as a fair game. It may be an economic asset in the books for a country. But it is effectively a political liability, as the US government can seize this asset at its will. This was also shown earlier in Iraq, Libya, Venezuela. Seizing Russia's foreign exchange reserves by a handful of western countries – ex-colonial and settler-colonial states – means that the so-called rules-based order is now based on weaponising the dollar and the west's control over the global financial system.

Economists – Prabhat Patnaik, Michael Hudson – and financial experts such as Zoltan Potsar of Credit Suisse are now predicting a new regime in which the Chinese Yuan or a variant of it will emerge as the world's new reserve currency.

Why these predictions? After the Second World War, the Bretton Woods agreement led to the dollar becoming the world's reserve currency. It replaced the British pound and was pegged to gold, with $35 to an ounce of gold. In 1971, President Nixon removed the US dollar from the gold standard, which meant that the dollar was now backed only by the US government (or US Treasury) guarantees. In the post-war years, the dollar as reserve currency had three things going for it. It was backed by the US, which was the world's largest industrial producer; the US was the pre-eminent military power even if challenged by the Soviet Union; and it was backed by West Asian oil, the largest traded commodity, being priced in dollars.

The denomination of West Asian oil, particularly of Saudi Arabia, was critical to the US and was determined by its military power. The coup in Iran against Mosaddegh, the 1963 coup in Iraq, and many other political events there can be understood more easily, if we understand why oil was so important to the US. This was the basis of the Carter doctrine, extending the Monroe doctrine equivalent to the Persian Gulf Region. Or what the cartoonists drew: "Our oil is under their sand". The US control over West Asian oil and its industrial and military power ensured that the dollar remained as the world's reserve currency.

The fall of the US as the world's industrial power has gone hand in hand with the rise of China. A measure of China's industrial rise can be seen from a simple statistic given by Lowy Institute using IMF data on global trade. In 2001, over 80 per cent of countries had the US as their major trading partner. By 2018, that figure had dropped to a little over 30 per cent – 128 out of 190 – and had China as their major trading partner. Not the United States. This dramatic change has happened in less than 20 years! The reason for this change is industrial production: China overtook the US in 2010 to become the largest industrial producer in the world ( India is the fifth largest industrial producer but produces only 3.1 per cent against 28.7 per cent by China and 16.8 per cent by the US. It is not surprising that trade follows industrial production.

Two recent events are important in this context. China and the Eurasian Economic Union consisting of Russia, Kazakhstan, Kyrgyzstan, Belarus and Armenia seem to be moving towards a new international and monetary system. India and Russia also seem to be working out a rupee-rouble exchange based on India's need to import Russian arms, fertiliser, and oil. India had already created a similar system earlier for buying Iranian oil. This might also give a fillip to increasing India's exports to Russia. Saudi Arabia has recently indicated that it might also designate its oil sales to China in Yuan and not dollar. After 1974, this is the first time Saudi Arabia would sell any oil in a currency other than the dollar. This means an immediate fillip to the yuan, as 25 per cent of all Saudi Arabia's oil is sold to China.

The US dominates the services, intellectual property and information technology markets. But all of them are based on a complex of supplies and, therefore, complex global supply chains. If the western economic war means taking out Russia's supplies from the global market, many supply chains are in danger of unravelling. I have already written about the energy war and how European Union depends on gas piped from Russia to Europe. But there are many other commodities that are critical for not only those sanctioning Russia but also those who may find it difficult to trade with Russia as a consequence of the west's sanctions.

Strangely enough, one of the key elements in the supply chain for manufacturing chips depends on Russia. This is sapphire substrates (using artificial sapphires) that go into chips, of which Russia seems to have a near-monopoly. The other threat is neon gas supplies to chip makers. The major neon gas suppliers are in southern Ukraine, one in Mariupol and the other in Odessa. They together produce about 50 per cent of global neon supply and 75 per cent of the supply to the world's chipmakers.

I have already highlighted earlier the danger to EU's climate change plans and its shift to gas as a bridge fuel. Using batteries as the key storage element in the renewable energy route also has a substantial Russian weakness. Nickel is critical for electric batteries, and the largest supplier of nickel in the world is Russia. With the US and EU imposing sanctions, this may lead to China, already emerging as the world's largest battery supplier, creating an even more dominant position.

The other supply chain issues are palladium, platinum, titanium, and rare earths. All of these are required by advanced industries, creating supply chain bottlenecks worldwide. They are also on the list of 50-strategic materials that the US needs. If we remember how the supply chains seized up during Covid-19, the coming crisis could be a lot worse. Sanctions are easy to impose, much harder to lift. And even after the lifting of sanctions, the supply chain will not come together seamlessly as it did before. Remember, these supply chains have been incrementally configured over decades. Undoing them using the wrecking ball of sanctions is easy; redoing them is a lot harder.

The food supplies to the world will be hit even harder. Russia, Ukraine and Belarus produce a significant amount of fertilisers needed by farmers everywhere. Russia and Ukraine are among the biggest exporters of wheat. If Russian wheat is sanctioned and Ukraine's harvest is hit due to war, the world will not find it easy to thwart a severe food shortage.

There is no question that the world is on a cusp. It will either lead to the complete destruction of the Russian economy, even if Russia achieves a quick peace in Ukraine and there is no NATO-Russia War. Or it will reconfigure a new economic order which has been in the offing: a world order with cooperative solutions instead of military and economic wars.