The world is moving toward a system where commodities are beginning to play a system-level role in collateral

During his Valdai speech on Thursday, Russian President Vladimir Putin made the following rather dry statement:  

"It's impossible to imagine that a drop in Russian oil production will maintain normal conditions in the global energy sector and the global economy."

It certainly wasn't the highlight of the night, and I haven't seen it in the headlines of any of the recaps. The statement is, of course, true. Putin is in a sense saying: "you can't kick us out."

But let's unpack this a bit and try to get a bird's eye view of what this mundane statement implies in a much deeper sense - not in the sense of counting barrels of oil and the Brent price, but in terms of understanding the shifting tectonic plates.

Let's first imagine what a Western leader might have said in the same tone, circa January 2022.

"It's impossible to imagine that a country that loses access to dollars and Western capital markets will maintain normal economic conditions." I don't know if anybody actually said such a thing in as many words, but that's exactly what many were thinking.

Now, recall the G10 Rome meetings in late 1971, as the Bretton Woods-established gold peg of the dollar was being dismantled, when US Treasury Secretary John Connally famously told his European counterparts: "The dollar is our currency, but it's your problem." It is an oft-cited instance of American hubris.

In other words, despite its global use in trade and finance, the dollar would be managed for American economic interests.

When the collective West placed what were supposed to be crushing sanctions on Russia in 2022 in light of the Ukraine crisis, the idea was, again, "our currency (system), your problem."

The message: the dollar will be managed for American geopolitical interests.

According to the conventional thinking, being cut off from the dollar system should have spelt doom for Russia. The many forecasters predicting exactly such a dire outcome weren't necessarily simply Russophobes. They were working within a certain paradigm. Without access to its now frozen central-bank reserves, how would Russia stabilize the ruble? Without access to correspondent banking in dollars/euros, how would trade be settled? And without access to foreign capital markets, wouldn't a funding crisis ensue? This type of thinking gave rise to these types of comments:

"We will provoke the collapse of the Russian economy," in the words of French Finance Minister Bruno Le Maire about ten days into the war.

But the Russian economy didn't collapse and in fact stabilized far faster than anyone expected. The thing is Russian oil and gas was still needed. And those who thought they didn't need it (read the EU) found out the hard way that they did - even if the Europeans obscured the ramifications as much as possible through large fiscal support and subsidies. But it is no coincidence that 'deindustrialization' has become a household word in Europe. And somehow the political will to really clamp down hard on Russian energy never seems to materialize.

All of a sudden we have, from a Russian perspective: "Our commodities, your problem."

The question now is: does this mean we've suddenly awoken to a strange new world? Are we now in a system where access to real things (like commodities) now trumps access to paper promises (like dollars)? Western policymakers' futile attempts to cut Russian energy out of the world economy show that they understand only the monetary side of things. They see energy as a source of revenue for the Russian state - revenues thanks to which Russia is able to sustain its war effort. That the economy might actually fundamentally be an energy system and not a monetary system is incomprehensible to them. It is, in the strict Kuhnian sense, a different paradigm.

The BRICS countries talk a lot about a monetary reset being underway and about how new financial architecture is being created. It is fair to say that some of this rhetoric has been premature and that reports of the demise of the dollar system have been overstated. There have been a lot of checks written that BRICS and the Global South aren't ready to cash.

Nevertheless, change is afoot, and what is taking shape has roughly the following contours: commodities are beginning, at the margins, to act as system-level collateral. By contrast, up to now, the system relied on trust in the issuer of paper claims (dollars, US Treasuries, euro-denominated assets). Gold accumulation by central banks has been massive - it is a quiet de-dollarization of reserves. Oil-for-yuan deals are modest but growing. And what can the commodity seller do with the yuan it receives? Convert it to gold on the Shanghai Gold Exchange. This may not yet be widespread, but the plumbing is there.

The anchor is shifting from debt claims to real assets - and this is bad news for countries whose economies are perched precariously atop a mountain of debt claims. Think of this as part hedge against Western sanctions and weaponization of the system, and part recognition that commodities have intrinsic durability that paper claims can't always guarantee.  

Ultimately, of course, paper promises can be inflated. It's not lost on anybody in the Global South that the dollar is down some 111% against gold in just two years and that US debt seems to be spiraling to infinity.

If the current system is one where money, credit, and financial assets are king, this means the constraints in this system are money-related. The crises tend to start with something like a spread blowing out, liquidity drying up, or collateral chains breaking. This is basically a money problem, not a real-economy problem. Remember the 1998 Asia currency meltdown; or the Global Financial Crisis of 2008; or Covid; or the UK gilt crisis of 2022; or the various US repo spikes. Such dislocations are dealt with by throwing balance sheet at them - swap lines, quantitative easing, backstops, emergency loans.

In 2022, we suddenly found out that Russian energy is not just another financial dislocation that can be covered with a swap line or emergency loan. From this, it follows that we need to think in terms of two economies: the real economy of energy, resources, goods and services, and a parallel financial economy of money and debt. There will always be a financial economy - and always be spreads blowing out on a Bloomberg screen somewhere - but we're finding out now that it is the real economy that underpins the financial one and not the other way around.

But here's the catch. When energy is abundant and cheap - and when money holds its value against energy - this energy foundation to the economy can be disregarded. The peak of renewables-based energy transition euphoria in Europe coincided with the peak of Russian supply of cheap hydrocarbons to Europe. A coincidence?

The legendary strategist Zoltan Pozsar once wrote: "Russia and China have been the main 'guarantors of macro peace', providing all the cheap stuff that was the source of deflation fears in the West, which, in turn, gave central banks the license for years of money printing (QE)."

I would add that this also gave the West license to dwell comfortably in the illusion that the economy is primarily a monetary system and not an energy-and-real-stuff system. Ironically, it was the reliable presence of cheap Russian oil and gas that helped this economic illiteracy to fester.  

Putin did not connect these dots in his remarks at Valdai; the focus of his speech was obviously elsewhere. But the dots are there to be connected. And there are a lot of people in Moscow and Beijing to whom these dots are very apparent.