Weapons of Financial Destruction and the New World Disorder
Biden didn't have to take a blowtorch to the financial system in response to the Russian invasion of Ukraine. But he has done so.
The comprehensive sanctions the United States and the West have imposed on Russia take us into an entirely new world. The sanctions are multidimensional, but most important is the “freezing” of Russian foreign exchange reserves, what President Biden called Putin’s $630 billion war fund in his State of the Union. This action means that all previous economic contracts between Russia and the West are invalid. Biden’s figure was probablyoverstated by half, but the precise figure doesn’t matter. It’s the principle that counts.
The effective nullification of contracts is the Big Enchilada, an H-Bomb rather than an A-Bomb, a 50-megaton Weapon of Financial Destruction (WFD). Without bothering to announce it, the United States and its allies have thrown a wrench into the gears of important sectors of the world economy. They are badly underestimating the fallout. Remarkably, they did this against the backdrop of a worldwide crisis in supply chains. That is about to get a lot worse.
Among the cascading dominos: 30 percent of the world’s wheat exports are now cut off. Russia’s exports of fertilizers—18 percent of the potash market, 20 percent of ammonia exports—are off market. Energy prices have exploded. A suddenly bipartisan United States has imposed a (mostly symbolic) ban on Russian oil imports. The Biden administration has insisted that it doesn’t want to diminish world oil and gas supplies but, grosso modo, the effect of its sanctions point strongly in that direction.
No one knows what Russia’s reaction to the sanctions will be, though there are straws in the wind. If the Russian trust fund can be expropriated at will, what does it even mean for Russian companies to sell goods for cash? In the emerging standoff, there is much debate about what the West is willing to buy, little attention to the terms on which Russians are willing to sell, if they are willing to sell at all. They are in a position to impose staggering costs on the West in retaliation. Odds are they will do some of that, maybe a lot of that. However, much of the dysfunction, like chaos in commodity markets stemming from defaults, is just embedded in the situation created by the West’s use of WFD.
When 5 percent of OPEC’s production was withdrawn from world markets in 1973 and 1974, it led to a quadrupling of oil prices. Removing 30 percent of tradable grain and 20 percent of fertilizer would have similar effects. We do not know how many hundreds of millions of people will be priced out of the market for grains in the aftermath of the recent WFD use. Perhaps one of the sanctions-crazed liberal humanitarians can tell us.
In a fit of righteous anger, Western governments chose these steps. They will come to regret having done so. They did it with little to no attention to the likely consequences. Officials are now salivating about the terrific damage they have inflicted on the Russian economy, but these WFD will almost certainly prove to be the mother of all self-inflicted wounds. Almost certainly, too, they will not dislodge Putin from Ukraine or from power.
Other peoples will suffer the most, but basically we did this to ourselves. The Biden Administration did not have to take a blowtorch to the financial system in response to the Russian invasion of Ukraine. But it has done so. And now it has no diplomatic path back from the precipice.
We need a clear-eyed assessment of strengths and weaknesses in the looming struggle. That conflict pits not only Russia against the West, but also Russia and China against the West. Putin, it seems certain, told Xi what he intended to do. In the long statement the two leaders issued before the war, they pledged to have each other’s back. The implied deal is that China will help Russia through its present financial disaster, compensated by pricing arrangements advantageous to China on energy, metals, and foodstuffs over the long term. China may bend before the threat of U.S. sanctions, but it will not abandon Russia. Note well, too, that China is not harmed by the re-deployment of U.S. forces and expenditures toward Europe.
Russia and China are now permanent allies. The simplest way of understanding why they are permanent allies is that the United States made each singly, and both together, permanent enemies. Both powers reached the conclusion that the United States was “agreement-incapable.” The U.S. formula, by using all its power to ensure that they couldn’t have any other friends, forced them into the deepest partnership.
The rights and wrongs of that Western policy, birthed in all essential aspects by neoconservative thought in the 1980s and 1990s, we may leave for another time. The struggle the hawks and the neocons prophesied—and in my view are directly responsible for precipitating—is upon us. How fares “liberal hegemony,” the “rule-based order,” in this approaching bipolarization of the world’s financial and economic system?
Any assessment must take place against the backdrop of two vital trends. One is the complete abandonment of fiscal responsibility by the U.S. government, too dreary to describe in detail. The second is the magical floatation of U.S. financial markets in the years preceding 2022, abetted by a Federal Reserve prepared to do anything to backstop them. Its bond purchases, under the name of quantitative easing, went way beyond anything central banks had done previously. And boy did the markets respond. Unheard-of valuations, based on fabulous earnings twenty-years-hence, became the norm in many frothy sectors, beyond anything seen in 1929 or 1999. Based on the historic ratios assessing valuation over time, the market was in the top one percent of every measure known to dry-eyed prognosticators. Recent declines, about 10 percent as of March 4, come from a very high perch, the all-time highs registered in early January 2022.
The Fed’s magic dust was based on interest rate suppression, made for the previous world economic order. It’s not going to work in the new one, in which every country faces a real bad case of stagflation—runaway inflation, followed by big job losses—that looks worse to me (though not as yet to the markets) than what went down in the 1970s.
The world economy changed in profound ways under the auspices of the “Washington System” of the last 30 years. What had been a Western Unit within the global economy—the trilateral ties among the United States, Western Europe, and Japan—became a Global Unit that incorporated the entire world. During this time, both Europe and the United States lost a lot of the manufacturing capacity that had previously put them at the top of the rankings. That was “off-shored.” China became the center of world manufacturing. As Americans discovered in 2020, there were tons of indispensable things that China made. In many sectors, like pharmaceuticals, it achieved market dominance, producing 60 to 80 percent of the goods.
Russia is a sort of China writ small in terms of its productive capacity. Everybody repeats, mindlessly, that it’s a nothing in world GDP rankings, but that does not alter the fact that it produces things that are desperately needed and whose absence from world markets would have seismic consequences. That makes today’s sanctions totally different from those of the Cold War, when the Soviet Union existed as an autarchic island, entire of itself. As Larry Summers observed to Fareed Zakaria, this interdependence makes Russia far more vulnerable than it once was to Western sanctions. Right, Larry: It also makes us much more vulnerable to the blowback.
Dollar hegemony came about in the first instance because of American economic strength, but then stuck around for a host of reasons. The use of the dollar within the Cold War trilateral bloc made easy its extension to the rest of the world. But then a strange thing happened. The policies on which it had been created in the first place were repudiated. In the old days, the United States was the safest place to park your assets. Now, transacting anything in dollars makes your assets subject to expropriation according to the decree of the U.S government.
The aggressive geopolitical exploitation of dollar hegemony really got underway in the 21st century, with the second decade much more ambitious than the first. Each year brought a new escalation. Biden’s February 2022 seizure of the $7 billion in assets held by Afghanistan’s central bank—shocking to anyone versed in international law—proved to be an important harbinger of how far the authorities were prepared to go.
How does this emerging contest look from the vantage point of the Global South? The West’s lineup of allies is impressive and includes states with large economies, in Europe, Japan and some smaller states in Asia. From the vantage point of Latin America, Africa, the Greater Middle East, India, ASEAN, how does it look? If you were sitting in those places, which bloc would you choose, if you had to choose? What can each side do for you, how can they get after you and punish you? In other words, what are their carrots and sticks?
It is in that vast hinterland that the fate of the Western-led “international liberal order” will be decided. It is being challenged by a China bloc, of which Russia is a part. In this contest, a disturbing reversal of the Cold War pattern, China wields a lot of carrots, whereas the United States has a lot of sticks. Like the Communists of old, the U.S.A. hopes to win converts by coercion.
In the economic architecture of the last decades, other countries needed U.S. dollars, in which their debts were often denominated, but they needed precious few U.S. goods. The gap between what Americans owned and what they owed widened precipitously, especially in the past ten years. The American economy intensified its standing as an empire of consumption, floating on the high tide of electronic wealth. Less and less was its financial prowess production-based, anchored in the ability to make things. (The exception of course, is state-subsidized armaments. America can make a lot of those.)
At the same time as the United States was allowing its industrial and manufacturing base to rust away, it exploited dollar hegemony for geopolitical ends. For every sin in the world there was a sanction. These were to be employed, in theory, just to hurt the bad guys, not ordinary people. Of course, it didn’t work out that way. It never works out that way.
China, by contrast, developed an extraordinary capacity to build the things that poorer states need. It can supply the goods they have to have. This disparity didn’t seem to matter to the markets in the past, but it is going to matter a lot.
The unsettling conclusion is that everything we learned about the workings of the international economy must be reassessed, given that so many of its basic underpinnings have been overturned. Don’t think of trade in the dreamy way that economists talk about it, with everyone exchanging goods and services in Benthamite bliss at the joys of utility maximization. No, it won’t be like that.
Instead, batten down the hatches for neo-mercantilism on steroids. At some of its most salient junctures, exchange between the blocs will be like two rival gangs of mafiosi making a guns-for-drugs swap—disagreeable, but necessary—and coming to the transaction in a remote warehouse with lots of armed backup just in case. “Let me see the merchandise. Don’t try to pull a fast one.”
The WFD have been released and will likely prove radioactive for years. In Washington, there is no thought of going back, however. Everybody wants to go forward. Good luck to the rest of us.
David C. Hendrickson is president of the John Quincy Adams Society and professor emeritus of political science at Colorado College. His website is davidhendrickson.org. Twitter: @dhendrickson50.