Western sanctions show Russia’s vulnerability in the global economy
The United States, Europe and their allies are not launching missiles or sending troops to repel the Russian invasion of Ukraine, so they have armed the most powerful non-military tool at their disposal: the global financial system.
Over the past few days, they have frozen hundreds of billions of dollars of Russian assets held by their own financial institutions, withdrawn Russian banks from SWIFT, the messaging system that enables international payments, and made many kinds of foreign investment in the country. exceedingly difficult, if not impossible.
The impact of this kind of supercharged economic warfare was immediate. On Thursday, the value of the Russian ruble hit a record high, despite efforts by the Bank of Russia to support its value. Trading on the Moscow stock exchange was suspended for a fourth day and financial behemoths stumbled. Sberbank, Russia’s biggest lender, was forced to close its European subsidiaries after running out of cash. At one point, its shares on the London Stock Exchange fell to a single penny.
There is more to come. Inflation, which is already high in Russia, is expected to pick up alongside shortages, especially of imported goods like cars, cellphones, laptops and packaged medicines. Companies around the world are withdrawing their investments and operations from Russia.
The sanctions “are severe enough to dismantle Russia’s economy and financial system, something we have never seen in history,” Carl B. Weinberg, chief economist at High Frequency Economics, wrote this week. .
Russia had sought to “sanction” itself in recent years by further reducing its financial ties with the West, including reducing its reliance on the US dollar and other common reserve currencies. It has built up a large reservoir of foreign exchange reserves as a bulwark against hard times, trying to protect the value of its currency. He also shifted his holdings heavily from French, US and German assets to Chinese and Japanese assets, as well as gold. Its banks have also attempted to “reduce risk exposure from a loss of access to the US dollar,” the Institute of International Finance said in a February report.
But the catastrophe currently spreading through the country’s banks, markets and streets is proof that self-reliance is a myth in a modern globalized world.
There are approximately 180 currencies recognized by the United Nations. But “the reality is that most global payments still flow through a Western currency-dominated financial system,” said Eswar Prasad, a professor of international trade policy at Cornell University.
Most of the world’s trade is done in dollars and euros, which makes it difficult for Russia to avoid the currencies. And up to half of the $643 billion in foreign exchange reserves held by Russia’s central bank are actually under the digital control of the central and commercial banks of the United States, Europe and their allies.
“They control the wealth of the world,” even the parts they don’t own, said Michael S. Bernstam, a fellow at Stanford University’s Hoover Institution.
Although there has been speculation that Russia could mitigate the fallout from the sanctions by using its gold reserves, turning to the Chinese yuan, or doing cryptocurrency transactions, it so far seems unlikely that these alternatives will be sufficient to prevent financial hardship.
“When the largest economies in the world and the deepest and most liquid financial markets come together and impose this level of restrictions on the largest Russian banks, including the Russian central bank, it is very difficult to find a way to significantly offset a lot of that,” Treasury Secretary Janet L. Yellen told reporters on Wednesday. “I believe these will continue to bite.”
Sanctions can have a longer term cost. The overwhelming control of the West could, in the long run, encourage other nations to create alternative financial systems, perhaps by creating their own banking networks or even moving away from dependence on the dollar to carry out international transactions. .
“I would compare them to very strong antibiotics,” said Benn Steil, senior researcher at the Council on Foreign Relations. “If they are over-prescribed, the bacteria eventually become resistant.”
Other countries, such as Iran, North Korea and Venezuela, have already suffered this kind of financial sanctions, losing their access to SWIFT or to some of their foreign exchange reserves. But the range of restrictions has never been imposed on a country as large as Russia.
During congressional testimony this week, Jerome H. Powell, the chairman of the Federal Reserve, was asked how easily he thought China and Russia could create an alternative service that could undermine the effectiveness of SWIFT sanctions in the future.
The Russian-Ukrainian War and the World Economy
“In the short term, it’s not something you could create overnight,” Powell said. “It’s really a longer-term question.”
This long-term trend away from SWIFT can happen either way, some economists said. China already has an alternative system in place, which Powell noted. In the future, the current network may be overtaken by new messaging systems and new financial technologies.
The crushing domination of the dollar on the financial markets is of another order. Over the years, economic leaders have warned that such a concentration of power sets up an unstable world order. And the more investment capital flowing around the world, the greater the financial leverage of the US currency.
There are other world reserve currencies, including the euro and the yen. But a ready alternative to dollar dominance has been hard to come by, especially among countries Russia works closely with.
“China is far from ready to achieve this,” said Adam Posen, president of the Peterson Institute for International Economics.
In some ways, Russia’s efforts to break free from the dollar show how difficult it is to break away from the world’s dominant currency.
Nearly half of the country’s external debt is still in dollars, and households and businesses continue to hold dollars, the Institute of International Finance pointed out. And while Russia and Europe have sought to settle their trade in euros, the country’s main export is oil – which tends to be settled in dollars.
“I think in the longer term, American rivals such as China and Russia will certainly try to find workarounds,” said Mr. Prasad, a professor at Cornell University. But “that can’t change in no time.”
Russia’s vulnerability to financial sanctions may be a sign that its policy of economic isolation – notably its limitation of trade ties – has backfired, said Mr. Posen of the Peterson Institute. If Russia had been more integrated into the larger trading system, causing a financial crisis by applying sanctions would have cost its Western trading partners more, making this form of punishment a less attractive diplomatic tool.
“It illustrates the opposite of what the Russians thought,” Posen said. “You’re less likely to be cut aggressively if you’re more integrated.”
Ana Swanson contributed report.