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March 1, 2022

When President Putin announced that he was sending peacekeeping troops into Ukraine, Western governments immediately responded by pledging sanctions. The big question is, will these sanctions have any effect on Russia, or will they merely expose the impotence and ineptitude of Western governments?

The United States still operates as though it is the world’s hegemon, and as though the dollar is the world’s reserve currency that other countries can’t do without. But successive rounds of sanctions on Venezuela, Iran, Cuba, and other countries around the world have incentivized other countries to reduce their reliance on the dollar and reduce their exposure to the US banking system.

Punitive taxation under the United States’ worldwide system of taxation has also incentivized banks and financial institutions around the world to cut off access to US customers and reduce their exposure to the US financial system. So depending on how exactly the ultimate sanctions on Russia are formulated, the effect on Russia could be minimal. But what the sanctions could expose is the weakness of the US dollar.

While the US imagines that the US dollar and access to the US banking system can be weaponized and used against its opponents, this current situation may expose the dollar-based financial system as being nothing more than a paper tiger whose importance is no longer as important as it once was.

Russia Already Sanctioned

One problem with further sanctions is that Russia has already been under stringent sanctions since its 2014 takeover of Crimea. And even before that there were sanctions and financial restrictions on certain Russian entities. So the current sanctions will merely add more sanctions on top of existing sanctions.

In all likelihood, Russian financial institutions have already minimized their exposure to the US banking system, so the effect of sanctions will likely be limited in Russia. US financial institutions too have largely minimized their exposure to Russia, and thus the effect of sanctions on US institutions will likely be minimal.

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In essence, any sanctions will likely be nothing more than a slap on the wrist, a ban on business activity that is already not taking place. While it looks good for public consumption, it won’t actually do anything substantive.

Will Europe Follow?

The real question is whether or not Europe will follow the United States’ lead. Many European banks have much more significant exposure to Russia, and thus sanctions could significantly impact their operations.

European countries also have much stronger trade relationships with Russia, particularly when it comes to energy imports. With nearly half of its solid fuels, 40% of its natural gas, and a quarter of its oil coming from Russia, strict sanctions on Russia could harm Europe’s economy.

While Russia has vowed not to limit its energy exports to Europe in response to sanctions, that may not be possible, depending on how sanctions are ultimately worded. If the US decides to impose sanctions in such a way that it makes it impossible for European countries to pay for their imports of Russian oil and gas without facing penalties from the US or losing their access to the US banking system, that could force their hand.

Then it becomes a question of what European countries value more: access to energy or pleasing the US. With US-European relations having been damaged under President Trump’s tenure, and with President Biden not doing anything to repair those relations, European countries might very well decide that they would rather stay warm and fuel their economies by maintaining trade relationships with Russia than do the United States’ bidding. And if that happens, it might expose the fact that the dollar is no longer as important to the rest of the world as the US government thinks it is.

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Russia’s Diversification

In addition to decreasing its reliance on the US banking system, Russia has also diversified away from the dollar as an international payment. It has increasingly turned towards the euro, the yuan, and even to gold. As a percentage of international reserves, gold plays a much more important role to Russia than it does to the US or other Western countries. And by stocking up on gold, Russia doesn’t have to fear being cut off from the dollar.

While the US continues believing that the rest of the world values the dollar as much as it does, other countries have been quietly divesting themselves of dollar-denominated assets, reducing their reliance on the dollar in international trade, and stocking up on gold. As a result, US sanctions may not have the same bite and effectiveness that they have had in the past. And at some point, countries will have reduced their exposure to the dollar and to the US banking system to such an extent that sanctions will be completely meaningless and ineffective.

The Effect on Consumers and Investors

This isn’t to say that consumers and investors will remain unaffected, however. While most of us probably don’t buy anything that comes from Russia, the effects of sanctions on world energy markets may very well be reflected in higher energy prices, pushing up the cost to heat our homes and run our cars. And unease in stock markets may result in losses to stock markets that could cost you significant value from your retirement savings. But there are ways to defend yourself against that too.

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Here again is where the importance of gold comes into play. On the one hand, the decreased reliance on the dollar on the part of Russia and other countries could mean that dollar-denominated assets such as stocks and bonds are no longer as surefire as they used to be.

As the rest of the world slowly moves away from the dollar and protects itself against potential future US sanctions, US investments could slowly lose value. Investing in gold, which is a highly liquid asset in demand worldwide, could help defend against that trend.

On the other hand, buying gold is an important part of a diversification strategy, which is one reason Russia and other countries have been buying so much gold in recent years. Just as central banks are increasing their gold holdings to diversify their asset holdings and ensure that they have a ready source of wealth in case of a financial crisis, many investors today are turning to gold to ensure that they have ready wealth when they need it.

Between rising inflation and rising geopolitical tensions, we’re entering a new world, one which will be strange and unfamiliar to investors used to low inflation and world peace. The next 5-10 years could completely upend everything we thought we knew about investing, and could result in a world completely different from the one we thought we’d be living in. And unless we adjust our strategies to survive in that new world, we could end up seeing our dreams disappear into thin air.

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Nathan Rosevear

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