Currency war: Where's the next battlefield?

Make no mistake the world is currently engaged in a financial war and the ruble collapse is just one battle. The 2008 Great Financial Crisis ushered in a new currency war that has morphed into a financial market war, with oil as the weapon of choice.

I am not trying to be a fear monger, I am simply pointing out what is occurring in the financial markets. In the beginning, a financial war seems like a no-brainer, i.e., use financial might to damage your enemy's economy. The flaw in this logic is it assumes no impact on the economy of the attacker. In the age of open economies investors are correct to be concerned about the collateral damage.

Currency exchange rates in central Moscow, Russia.
Maxim Zmeyev | Reuters
Currency exchange rates in central Moscow, Russia.

The latest battle in this financial war is the engineered drop in oil and subsequent collapse of the Russian ruble. Now that this battle has been waged investors need to know what/where the next battlefield may be.

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In order to answer this question we need to understand what has transpired over the last few days. Many have been shocked by the lack of intervention by the Central Bank of Russia (CBR) in the days leading up to the currency collapse. Implicitly or explicitly, it appears Russian President Vladimir Putin has allowed a raid on the central bank currency reserves to benefit the oligarchs and state owned corporations. These corporations have issued debt in rubles and either immediately converted into US dollars or have used the debt as collateral at the CBR. The CBR had a choice to defend the ruble and give its foreign currency reserves to speculators or give those reserves to the state owned corporations. The lack of serious currency intervention suggests the CBR has chosen the latter.

The economic impact of this decision is likely to be felt by Russian citizens as they encounter double-digit inflation. If Putin does not handle the internal situation correctly then Russia could face social unrest which may threaten Putin's leadership. Therefore, Putin's next move will define the next battle in the global financial war. The leading battlefield candidates are the wheat market, U.S. Treasurys and Gold.

The currency collapse could accelerate Russian aggression in Ukraine. In my view, the purpose of the invasion has always been to control the port cities along the Black Sea. Since roughly 30 percent of the global wheat supply moves through these ports, control gives Putin a formidable economic weapon. Since further aggression risks more economic sanctions it is unclear if this is the most probable move.

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The most effective move would be a financial attack on the U.S. Treasury market. Russia is one of the largest holders of U.S. Treasury securities and with a push of a button it could begin to unload its position. This move would have two effects — Russia would get much needed foreign currency (U.S. dollars) and it would economically damage the United States by forcing interest rates higher. Once in possession of U.S. dollars, Russia could use it to defend the currency, pay off state owned corporate debt, or buy gold.

Defending the currency would have little impact as the CBR would continue to battle with speculators. Paying off corporate debt would benefit Russian corporations over the population. If, indeed, social unrest caused by inflation threatens Putin's leadership, Russia would be well served to be the first country to back its currency with gold. This move would immediately solve the inflation problem and placate the population.

Of course, none of us know what the next move will be, but rest assured markets will try to anticipate. This is a game of probabilities not certainties. My concern is that politicians have not considered the full spectrum of a financial war. Perhaps the computer from the hit movie "War Games" said it best: "The only winning move is not to play."

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Brian Kelly is founder and managing member of Brian Kelly Capital LLC, a global macro investment firm catering to high net worth individuals, family offices and institutions. He is also the creator of the BKCM Indexes, benchmarks for multi-asset money managers. He's also the author of the upcoming book, "The Bitcoin Big Bang: How Alternative Currencies Are About to Change the World." Kelly, a CNBC contributor, often appears on "Fast Money." Follow him on Twitter @BKBrianKelly.

Disclosures: Brian Kelly is long GDX, TLT and U.S. Treasury bonds.