Feb 24 • 7M

Russia, Ukraine, China, Oil, and Bitcoin

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If you are not a subscriber of The Pomp Letter, join 215,000 other investors who read my personal opinion on finance, technology, and bitcoin each morning.

To investors,

Russia invaded Ukraine last night. This conflict carries complexity across geopolitics, national security, and financial markets. It would be impossible for any one person to unpack the nuanced situation, and the subsequent ramifications, in great detail with only a few thousand words.

Rather than regurgitate the sequence of events that have unfolded over the last 24 hours, I want to turn our attention to a few topics that I am thinking about this morning.

First, war is an ugly thing. Violent conflict leads to loss of human life and incredible economic hardship for millions of people. Those who are affected most tend to be the average citizen who has no appetite for war, nor was a participant in any events leading up to the conflict. It should go without saying, but I hope that every single Russian and Ukrainian citizen is safe. My family and I are incredibly fortunate to live in the United States and have a daily life that doesn’t require us to worry about other nation states firing missiles at us or invading our city.

Second, it feels like there is a significant shift in geopolitical order that is playing out before our eyes. Russia’s invasion of Ukraine is essentially an attempt by Vladimir Putin to call the United States and NATO’s bluff. He doesn’t believe they have the political will to impose painful enough sanctions, while also understanding that there is very little appetite for war among the citizens of member nations. Simultaneously, China is ratcheting up their provocations of Taiwan, including 9 Chinese Air Force planes entering Taiwan’s airspace this morning and a warship violating Taiwan’s defense zone.

Both Russia and China understand that the long-standing American protectionism has weakened in the various regions and they are making a play to gain more global power, influence, and resources. I am not an expert on geopolitics, but it is hard to ignore the importance of these events, specifically through the lens of the confidence game on a global stage.

Third, Russia is the third largest oil producer globally. They are responsible for approximately 12% of the global production. Brent oil prices in the United States, and globally, have been quite high in recent months, so the current US administration has been asking for more oil to be supplied to the market in an attempt to curtail price increases. Both Russia and Saudi Arabia have said they will not increase production, so that leaves the US in an awkward position. To further complicate the situation, brent oil prices spiked significantly on the news of Russian invasion and now is trading well over $100 per barrel.

In some weird way, the increased price of oil combined with the continued purchasing of Russian oil by the international community, means that Russia is actually profiting handsomely from the invasion. Unfortunately, the United States and our allies can’t stop purchasing the oil for any material amount of time because we have made prior decisions that make us dependent on non-US oil producers. I won’t play Monday morning quarterback on those prior decisions, but the importance of energy independence is fairly obvious right now.

Fourth, Russia’s actions will likely lead to a flurry of financial sanctions from the United States and our allies. The most significant action would be the removal of Russia from the SWIFT system. There could also be sanctions against Vladimir Putin personally, along with a cadre of other high-ranking Russian leaders. Regardless of the exact sanctions, it would be naive of the international community to think that Russia hasn’t war-gamed this situation in preparation.

Many people don’t know this but Russia has one of the largest foreign currency and gold reserves in the world. They were the fourth largest behind China, Japan, and Switzerland at the end of 2020. This $600+ billion in foreign currencies and gold will be a tool in their toolbox once sanctions are implemented. Now I don’t know exactly what Russia has planned, but it is very clear that they are willing to take the risk of catastrophic sanctions. They either don’t believe the US and NATO will levy crippling sanctions or they have a plan on how to get around them.

This brings me to my final point. The United States has been the producer and distributor of the global reserve currency for decades. One of the benefits of that position is that we can impose financial sanctions on those that we disagree with or those that are violating our view of good and evil. The nuance to financial sanctions though is that they only work if the intended target is using the currency that you produce and distribute. Given that Russia has an incredible amount of foreign currencies and gold, these sanctions may not be as effective as they would have previously been.

This brings me to the most important point — the United States has to start considering what to do in a world where a large portion of the world doesn’t use the US dollar as their reserve currency.

The hypothetical situation would see Russia and China, who have long publicly stated their intention to get off the US dollar system, decide that the costs to using the current global reserve currency has become too high. They are unlikely to use rubles or renminbis as the new reserve currency. There isn’t enough global buy-in, along with a general challenge of convincing the world that these new nation states won’t repeat the mistakes of the past nation states.

This game theory leads us to bitcoin. The next best option to being the producer and distributor of the global reserve currency is to be the most advanced user and holder of a global reserve currency that no single country controls. That incentive leads these superpowers to realize that bitcoin will be essential for decades to come. The countries that have a large ownership stake, along with conducting mining and other pro-bitcoin activities within their country, will have a significant advantage.

The United States shouldn’t give up on the US dollar. In fact, we should continue to optimize for the production and distribution of the global reserve currency. There is safety and stability when you occupy that position. But we must also begin to hedge ourselves. It is time for insurance. Even if our leadership believes there is an incredibly small percentage chance that the US dollar may not be the global reserve currency in 50 years, we should position ourselves to be a leader in that small possibility.

The United States should put bitcoin in the central bank reserves. We should immediately incentivize as many bitcoin miners globally to move to the US. We should remove the capital gains tax on bitcoin spending and treat it like a traditional currency. And the United States should begin educating its population on the decentralized, digital currency. These steps will take years to successfully complete, but it is important that we begin now.

There are many politicians in both Congress and the Senate who are working on these initiatives. We need many more. The current geopolitical situation will be written about in history books. It is imperative that we remain compassionate to those who are adversely affected by war, we remain steadfast in our disagreement with the aggressors, and we plan for various future scenarios, regardless of how unlikely we believe they are.

Hope everyone has a great day in light of the circumstances. Give your loved ones an extra hug when you see them. Most of us reading this are so fortunate. I’ll talk to everyone tomorrow.

-Pomp

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