Economic uncertainty hangs in the air. Inflation is rising, supply chains are disrupted, and global conflict only compounds those problems. I’m not going to talk about the ongoing crisis in Ukraine as that is beyond the scope of this post. But the fallout of Putin’s actions, and the U.S. response, may set an interesting chain of events into play that could reshape the world.

Vladimir Putin has been sanctioned by the U.S. for his military actions in Ukraine. Several corporations have pulled their operations out of Russia, big tech has denied Russia access to their platforms, and Russian oil has been banned from the United States. How do these sanctions affect Russia? Unlike economically weaker countries that we have imposed sanctions on in the past, Russia’s economy is largely self-sufficient. As the largest land mass in the world, Russia can produce their own oil and grow their own food.

If I’m grading economic report cards (a feature I’m considering adding to this site), Russia could do much worse. Debt has been falling rapidly under Putin. Based on the most recent reports, Russian debt is about 15% of their GDP. Before Putin took office in 1999, debt was over 100%. For comparison, United States debt is around 75-80%. 20 years ago, we were around 55-60%. Putin has massively reduced debt while ours has skyrocketed. This is important because debt factors into how much leverage you have at the negotiation table.

I prefer to use the debt-to-GDP ratio as a measurement. Dollars and USD conversion rates are not as accurate due to fluctuating inflation and conversion rates. But GDP is also not a be-all, end-all statistic. How much of that GDP is based on actual production?

Russia’s GDP breaks down as follows: 4.7% agriculture. 32.4% industry. 62.3% service.

The US GDP breaks down as follows: 0.9% agriculture. 19.1% industry. 80% service.

The United States’s GDP is much more dependent on service. Service includes government spending, finance, academia, communications and anything that does not produce a material good. Russia’s economy is far more efficient at producing actual goods and services. This is why sanctions may not be the slam-dunk that the U.S. thinks they are. Russia can produce internally. The U.S. could potentially produce internally, but the infrastructure is not there at the moment. I believe that sacrificing our self-reliance in the 1970’s was a mistake.

This is where China enters the conversation. Let’s look at China’s GDP: 7.9% agriculture, 40.5% industry, 51.6% service. From clothing to computers, China produces the vast majority of the world’s physical goods. By all means, China should be the leader of the world’s economy. This is not discounting their debt, which hovers around 50% of their GDP. But the Chinese yuan is not the world’s reserve currency. The US dollar (USD) is. But the USD is not based on production. It is not backed by gold. It carries massive debt. How is it still the world’s reserve currency? What is the USD based on?

It is based on trust.

The US, for all of its faults, is the most stable power on the global stage. We have been operating under the same constitution since 1789. I talk about abuses to this document frequently in my writings. But for all the flaws of modern government, the US is still stable compared to the rest of the world. Stability encourages investor and consumer confidence. We put our flag on the moon. We built Wall Street. We built Silicon Valley. The United States has grown more intellectual capital than any civilization in human history. We have always been a “safe bet.”

Unstable countries do not inspire consumer confidence because there is no succession mechanism in place. Uncertainty is always right around the corner. But this is also not an ironclad rule. Vladimir Putin has presided as Russia’s dictator for two decades. In many ways, this is also stability. But what happens if he dies, is forced to resign, or his regime falls? Hard to say. But it proves that there are different scales of authoritarianism. There is stable authoritarianism like that of Putin’s Russia, or even Kim Jong-un’s North Korea. There is also unstable authoritarianism like Liberia, where civil war is always a heartbeat away.

Which is why there is so much trust in the USD. Our economy is still riding on the goodwill that was established post-World War II, where the rest of the world was in shambles, and America by default became the global leader. In 1950, I don’t think you could dispute this. But it’s not 1950 anymore. Much of our foreign policy still operates on the assumption that Great Britain and her colonies (and by association, Europe) have a hegemony on global commerce. This is false, and faith in the USD is still riding on the outdated post-World War 2 order. So, what happens when faith and trust in the USD disappears?

I believe we’re seeing cracks in the foundation of that trust. I consider Canada to be a branch of the Western/US financial system. Canada has been economically targeting protestors by shutting down their access to banking. This may seem like it’s just a Canada problem, but I disagree. Domestic policy is always a beta test for foreign policy, and vice versa. The United States and the Western financial systems just did the exact same thing to Russia. I am not here to argue the merits of either decision, that is irrelevant to the point of this post. The point is that through these actions, trust in the US/Western financial system, and by default, the USD, has been shattered. If you say or do the wrong thing, you can be shut off from the economy. And what the right thing is depends on who is in power. That does not inspire domestic or foreign confidence. That also signals instability. When the only thing backing your currency is trust, where does that leave the USD?

By shutting Russia out of the USD and its institutions, we throw them into the arms of other global leaders like China. I’m not as doom and gloom on China as some. China has debt. China has massive demographic problems. Their economy has serious problems. But China’s economy is based on tangible assets. In many ways, this also inspires consumer confidence.

China also doesn’t give caveats with their foreign investments. The United States may offer infrastructure investment to Angola. But in return, Angola has to clean up their corruption. China will build your infrastructure regardless. On the surface, China is a more attractive partner to a country like Angola. But, in ten years, China may be targeting Angola’s citizens if they’re saying bad things about the Chinese Communist Party. So, China can renege on these deals with weaker powers. What about a stronger power like Russia? Russia brings more leverage to the table than a developing country.

Putin’s Russia may never regain trust in the West and the USD. But Russia can grow their own food and get their own oil. Based on similar interests, Russia could strengthen their relationship with China, who is the biggest manufacturing power in the world. What happens if these two countries say, “screw the West” and create their own currency? A currency based on actual goods, services and economic production? The United States would have very little to leverage against such a deal. What if an observer state like India, who produces an enormous amount of the world’s pharmaceuticals, joins Russia and China? This could completely flip the currency/banking system that’s been in effect for 100 years.

It’s something to think about. In addition to killing the only backer of our promissory notes, trust, we have massive additional problems on the horizon. Inflation is rising and we continue to print an endless supply of currency. Our interest rates have been held too low for far too long. Rates will have to be raised to tackle inflation. It’s not a matter of if, but when. Raising rates will create short-term pain for the American consumer. Federal Reserve Chairman Paul Volcker understood this in the late 70’s under Jimmy Carter. His economic understanding was a big factor in why Ronald Reagan, about as far away from Carter economically as you could get, retained his services. All of these problems have further eroded global trust in the USD.

The short-term pain of raising rates could give powers like Russia and China an opening to kill the credibility of the USD once and for all. There is also enough evidence based on the economic ignorance of the current administration to show that short-term pain will be anything but short-term. The petrodollar is built into the “trust” of the USD. If we are no longer exporting oil into the world by sabotaging our own production, how does that inspire trust and consumer confidence in the USD? What is the USD even based on anymore?

The hegemony the USD holds on global commerce is about to undergo a severe test. Keep mind of your tangible assets and your debts, because a currency based solely on trust cannot last when that trust is shattered.

Stats pulled from The CIA’s World Factbook.