Delayed Reactions to Announcements

Russia's decision to link the Ruble to the gold price has been so under-reported that I've been unsure if it really happened. Not even Zerohedge had much mention of the event until this article was published today.

Another puzzling aspect of the event is that nothing much of note has happened in the currency and gold markets since it happened. The Ruble has strengthened, and is back to roughly where it was at the start of the war. But the gold price has been flat, and other currencies have remained steady.

This is astonishing, because the link between the Ruble and gold has the potential to redefine the world's financial order. So why aren't we seeing more talk and more action in the markets?

The reasons for this are multiple. We can mention the relatively small importance of the Ruble in the current financial system. Those who are used to thinking of the Dollar as king, and the Euro, Pound and Yen as it's vassals, don't put much importance to the Ruble. There's also the complexity of global supply chains. It's impossible to judge with certainty what the impact will be of a change in a peripheral currency. It's also impossible to know exactly what everyone else is thinking, and markets operate to a great degree on the assumption that tomorrow will be similar to yesterday.

This is why we often see a delay between an announcement and its impact on markets.

A mathematical riddle known as the green-eyed logic puzzle sheds light on how this works. It turns out that even with everybody acting with perfect logic, certain things require time to be figured out. However, once the puzzle is solved, there's a dramatic change in everybody's behavior. In the case of the green-eyed prisoners, they end up escaping their imprisonment on the exact same day.

The situation we currently have in the financial markets are similar to the starting conditions of the green-eyed logic puzzle. There's been an announcement. Yet, no-one knows how to act because no-one knows the circumstances of everybody else.

The fact that the announcement is coming from a peripheral actor adds to the confusion. There's also the imperfection of human rationality. We're not faced with a clean cut logic problem, but a real world problem. However, this can play to our advantage. There's opportunity in that some will be quicker to figure out the new situation than others. We won't see the sudden switch from one state to another as happens in the purely mathematical case. Instead, we'll see a cascade of events.

My guess is that we will see a series of cracks appear in various markets, and a series of measures taken to adapt, which in turn will lead to stress in more peripheral markets. We may see cracks appear in the European gas markets as early as this week. This will impact the Euro. Gold markets will be affected. Deficit countries will struggle to get imports. Currencies will have to be revaluated. Debt will be inflated away.

The Ruble may be a peripheral currency, but Russia runs a trade surplus. It can therefore greatly upset trade simply by insisting that deficits are made up for in gold, as was the norm back in Cantillon's time. Other surplus countries may follow suit. If so, we'll be on a gold standard no matter how much deficit nations protest.

As always in uncertain times, gold will provide safety, especially in countries where deficit currencies are in use, because those currencies are increasingly likely to hyper-inflate.

Sovereign

By Heritage Auctions for image, Mary Gillick for coin - Newman Numismatic Portal, Public Domain, Link