Russia on the Edge??

rubleThe Russian central bank announced a shock decision to hike up its key interest rate from 10.5% to 17%, effective immediately. Incredible.  On Monday alone the ruble declined more than 9% against the dollar, and almost 50% in 2014. It looks like a massacre. Always remember an exchange rate doesn’t matter if you have no need for the other currency involved, all the doom for Russia surrounds its relationship with USD.  Do you wake up everyday worried about the dollars exchange rate with the ruble, of course not, why?  Because we DON’T buy anything from Russian and they don’t buy anything from the US on a scale measureable in the world of macroeconomics. 

If you listen to conventional financial news, they’ll all tell you that you’d have to be insane to own anything in Russia right now—stocks, bonds, currency, etc. They’ll tell you that the ruble is in freefall, and that the dollar is the place to be.

Numbers are funny things, they don’t come with much hype, can cause mass hysteria, sometimes they get ignored all together, because sometimes they tell a different story than the headlines.

  • Ruble crisis could shake Putin’s grip on power….. Reuters
  • Russian ruble crisis: Going over the Edge…………The Economist
  • Ruble collapses after Russia tries to save it, but fails………..NBC News **cough, cough**

So… just for kicks, I decided to dive into the numbers and make an objective comparison between the US dollar and the Russian ruble.

The results might surprise you.

First of all, I start off with the premise that ALL paper currencies are fundamentally flawed.

Our global monetary system is absurd—the idea of letting unelected central bankers conjure as much money as they want to out of thin air is simply insane.

But it is true that some fiat currencies have better fundamentals than others. And if you want to understand the health of a currency, it’s imperative to look at the issuer of that currency, i.e. the central bank.

As with any bank, one of the most important metrics in determining a central bank’s financial health is its level of solvency.  Specifically we look at the bank’s capital (i.e. net assets) as a percentage of its total balance sheet.

The US Federal Reserve only has a basic capital ratio of 1.26%. Talk about razor thin.  This is down from 4.5% just a few years ago.

That means if the value of the Fed’s assets declines by only 1.26%, the issuer of the world’s dominant reserve currency becomes insolvent.  So if your house is worth$100,000 dollars and that is your lone asset for which to be credit worthy, if tomorrow it is viewed to be worth $98,740.  You don’t have enough assets to cover your outstanding liabilities (debt), so you are insolvent aka bankrupt.

Now, what happens to the liabilities of an insolvent entity? They decrease in value. Just like how Greek bonds (the liabilities of the Greek government) collapsed a few years ago.

What are the Fed’s liabilities? Open your wallet. Those green pieces of paper aren’t ‘dollars’. Just look. They have “Federal Reserve Note” i.e. more debt printed on them.  So the Fed’s pitiful financial condition directly affects the value of the dollar over the long-term.

On the other hand, the Russian central bank’s ratio is 12.5%—literally almost TEN TIMES GREATER than the Fed.

Capital cushion is crucial because when the unsuspected happens, this is what can help keep you afloat.  Think about it: you might be able to keep going without savings, perhaps even accumulating debt, but only until something happens out of the blue.  Until your car breaks down, or you need to go to the hospital, for example. Then all of a sudden, your lack of capital can become a serious issue.

Another important metric is gold. As I mentioned, since all fiat currencies are fundamentally flawed, it’s important to see the amount of real assets something some would accept as payment in a crisis that a central bank holds in reserve.

To make an apples-to-apples comparison, we look at a central bank’s gold reserves as a percentage of the money supply, meaning how much gold backs the money supply.

In Russia, it’s 6.2%. And rising. Last year it was 5.5%, and the central bank is continuing to heavily stockpile more.

How much gold backs the dollar?   Precisely zero point zero percent. Zilch. Nada.

The Fed doesn’t own gold. It loudly proclaims this on its own website: “The Federal Reserve does not own gold.”

It holds ‘certificates’ which are redeemable for US dollars. But there’s not a single ounce of gold backing the US dollar.  So… with no gold and pitifully razor thin solvency levels, it really wouldn’t take much of a shock to topple the dollar.

By comparison, the ruble is much better capitalized and actually has something backing it.

Now, I’m not necessarily advocating to buy the ruble, but hard, publicly available numbers clearly demonstrate the discrepancy between “sentiment” and objective data.

If Russia is collapsing, if no one will bail them out……………………

  • where are the bank runs?
  • protests in the streets?
  • food, water, everything shortages plaguing the country?

No where, because the numbers say they shouldn’t worry.  Western investors worry sure, but Russia isn’t all that concerned, it was a necessary step in shedding her dependence on transactions in US dollars.  The Chinese still happily accept rubles in exchange for the yuan.  China has made no overtures of canceling the massive energy deals struck earlier this year with Russia which Western energy companies were completely frozen out of bidding.

What next, we will be told a 17 year old made $72 million trading penny stocks.  Numbers are funny things as are headlines, except one is always true the other well let’s say just depends.

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