The United States, Europe and their allies are not launching missiles or sending troops to push back the Russian invasion of Ukraine, so they have armed the most powerful non-military instrument they have available: the global financial system.
In recent days, they have frozen hundreds of billions of dollars in Russian assets owned by their own financial institutions, removed Russian banks from SWIFT, the messaging system that facilitates international payments, and made many types of foreign investments in the country. . extremely difficult, if not impossible.
The impact of this kind of staged economic warfare was immediate. On Thursday, the value of the Russian ruble hit a record low, despite efforts by the Bank of Russia to maintain its value. Trading on the Moscow stock exchange was suspended for a fourth day and financial giants stumbled. Sberbank, Russia’s largest lender, was forced to close its European subsidiaries because it ran out of money. At one point, shares on the London Stock Exchange dropped to a single cent.
There’s more to come. Inflation, already high in Russia, is likely to accelerate, along with shortages, especially of imported goods such as cars, mobile phones, laptops and packaged medicines. Companies around the world are attracting investment and activity from Russia.
The sanctions “are severe enough to dismantle Russia’s economy and financial system, something we’ve never seen in history,” Carl B. Weinberg, chief economist at High Frequency Economics, wrote this week.
Russia had worked in recent years to make itself “sanction-proof” by further reducing its financial ties to the West, including reducing its reliance on the US dollar and other common reserve currencies. It built up a fat reservoir of foreign exchange reserves as a bulwark against hard times, trying to protect the value of its currency. It also heavily shifted its holdings from French, US and German assets to Chinese and Japanese assets, as well as gold. Its banks also sought to “reduce exposure to risks associated with the loss of access to the US dollar,” the Institute of International Finance said in a February report.
But the disaster now rippling through the country’s banks, markets and streets is proof that autonomy is a myth in a modern globalized world.
There are about 180 currencies recognized by the United Nations. But “the reality is that most global payments are still made through a western currency-dominated financial system,” said Eswar Prasad, a professor of international trade policy at Cornell University.
Most of the global trade is conducted in dollars and euros, making it difficult for Russia to avoid the currencies. And as much as half of the $643 billion in foreign exchange reserves owned by the Russian central bank is actually under the digital thumb of central and commercial banks in 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 researcher at the Hoover Institution at Stanford University.
While there has been speculation that Russia could mitigate the impact of the sanctions by using its gold reserves, turning to Chinese yuan or transacting in cryptocurrency, so far it seems unlikely that those alternatives will be enough to stave off financial pain. .
“When the world’s largest economies and deepest and most liquid financial markets come together and impose this level of restrictions on the largest Russian banks, including the Bank of Russia, it is very difficult to find a way to significantly reduce large parts of them. compensate,” Janet L. Yellen, the Secretary of the Treasury, told reporters on Wednesday. “I believe these will continue to bite.”
The sanctions may incur costs in the longer term. The overwhelming control of the West could, in the long run, encourage other countries to create alternative financial systems, perhaps setting up their own banking networks or even withdrawing from reliance on the dollar to conduct international transactions.
“I’d like to compare them to very potent antibiotics,” said Benn Steil, a senior fellow at the Council on Foreign Relations. “If they are overprescribed, the bacteria eventually become resistant.”
Other countries, such as Iran, North Korea, and Venezuela, have faced these kinds of financial sanctions before, losing access to SWIFT or some of their foreign exchange reserves. But the series of restrictions has never been imposed on a country as large as Russia.
In a congressional statement this week, Federal Reserve chairman Jerome H. Powell was asked how easily he thought China and Russia could create an alternative service that could undermine the effectiveness of SWIFT sanctions going forward.
The war between Russia and Ukraine and the world economy
“In the short term, you can’t create that overnight,” said Mr. powell. “It really is a longer-term question.”
That long-term trend away from SWIFT may occur anyway, some economists said. China has already set up an alternative system, which Mr Powell noted. In the future, the current network may be overtaken by new messaging systems and financial technology.
The dollar’s towering dominance in the financial markets is of a different order. Over the years, economic officials have warned that such concentrated power creates an unstable world order. And the more investment capital flying around the world, the more financial leverage the United States currency has.
There are other global reserve currencies, including the euro and the yen. But a ready-made alternative to dollar dominance has been hard to come by, especially among countries with which Russia works closely.
“China is far from ready to fulfill that,” said Adam Posen, president of the Peterson Institute for International Economics
In some ways, Russia’s attempt to break away from the dollar shows 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 still hold dollars, according to the Institute of International Finance. And while Russia and Europe have tried to regulate trade between them in euros, the country’s main export is oil – which is usually settled in dollars.
“I think in the longer term certainly US rivals like China and Russia will try to find solutions,” said Mr Prasad, a professor at Cornell University. But “this can’t change on the dime.”
Russia’s vulnerability to financial sanctions could be a sign that its policies of economic isolation — particularly restricting trade ties — have backfired, said Mr Posen of the Peterson Institute. If Russia had been more integrated into the wider trading system, triggering a financial crisis by applying sanctions would have been more expensive for its Western trading partners, making this form of punishment a less attractive diplomatic tool.
“This illustrates the opposite of what the Russians have thought,” said Mr Posen. “You’re less vulnerable to being cut off in an aggressive way if you’re more integrated.”
Ana Swanson reporting contributed.