The financial measures just announced against Russia are unprecedented for a country of its size.
This of course means it’s impossible to predict exactly how their impacts will reverberate around the Russian – and global – economy. And we still need to see the exact details of the plan.
But on their face they threaten the collapse of the Russian ruble, a run on Russian banks, hyperinflation, a sharp recession and high levels of unemployment in Russia, as well as turmoil in international financial markets.
Over the weekend the European Commission, France, Germany, Italy, Britain, Canada, and the US imposed four measures they had been holding off on:
- they removed selected Russian banks from SWIFT, the global financial messaging system that enables money to travel around the world
- they agreed to prevent Russia’s Central Bank from deploying its international reserves in ways that undermined the sanctions, crippling its ability to use foreign currency to support the ruble
- they committed to act against Russian oligarchs, specifically by limiting the sale of so-called golden passports to wealthy Russians
- they committed to freeze the foreign assets of sanctioned individuals up to and including President Putin, as well as those of their families and “enablers”.
The personal sanctions apply to the finances of Putin, his Foreign Affairs Minister Sergei Lavrov, the rest of his Security Council, and 11 other named officials.
The US says it is “exceedingly rare” to designate a head of state. Putin joins a small group that included North Korea’s Kim Jong Un, Belarusian President Alyaksandr Lukashenka, and Syrian President Bashar al-Assad.
The ruble will collapse
All transactions involving property owned by those people in the US and cooperating nations and all transactions they attempt in those nations (or attempt using those nations) will be blocked. They will have no way of accessing the estimated US$800 billion they are said to have stashed away in the West.
Denying access to the SWIFT financial messaging system by sanctioned Russian financial institutions will block a large volume of transactions between Russia and the rest of the world. Just how disruptive this will be, and whether Russia can find a workaround, are still to be determined.
But most devastating of all for Russia and its people will be the decision to deny the Russian central bank access to the hundreds of billions of US dollars in the form of gold and foreign currencies it has stored in foreign central banks.
Normally when a currency collapses, the capital flight out eventually slows and new capital flows in to take advantage of what now looks to be a bargain. This flow of capital acts like an automatic stabiliser of the currency.
A country’s central bank may step in to head off a collapse by using its reserves – in the form of gold and foreign currencies – to buy its own currency in foreign exchange markets. This can prevent the price from falling further.
With uncertainty and fear in financial markets about the Russian invasion, significant curbs on the flow of capital into Russia, and the freezing of the Bank of Russia’s foreign reserves, nothing stands in the way of a collapse of the ruble.
Just short of ‘nuclear’
On Monday, when foreign exchange markets open, everyone in the world will be selling rubles, and nobody – including the Bank of Russia – will be buying them.
Genuine payments for goods such as oil, gas, fertiliser, and wheat will be allowed to continue for now. Cutting these off would be a “nuclear option” in that it would inflict massive damage on both sides.
This is just short of nuclear. But there’s uncertainty about how bad it will get.
Bank runs would inflict major damage on the Russian financial system. Short on crucial imports and with no ability to pay for them, domestic production would grind to a halt.
With no ability to finance ballooning deficits, the Russian government may turn to printing money, kicking off hyperinflation as happened in Germany in the Weimar Republic.
Very few countries (North Korea is one) make all of what they need at home. Since Russia opened up in the 1990s it has become increasingly integrated with the rest of the world. Russia makes most of its own weapons, but using components that come from the rest of the world. Shutting off those links will hurt.
Putin’s response is anyone’s guess
China might help by maintaining some trade with Russia, but if the ruble is almost worthless, that may be unsustainable.
All measures combined may bring Russia’s economy to the brink of collapse.
It has been done before, but never on such a scale. Iran, Afghanistan and Venezuela were brought to their knees by similar actions. Russia is among the world’s top 12 economies, bigger than Brazil and Australia.
Game theory can’t tell us for sure how Putin will respond. His options are limited, and can we be sure he is rational? He appears not to have anticipated the fierce response of the Ukrainian military; did he also not anticipate the fierce response of the global financial hegemony?
Aside from military responses, his only remaining sticks would inflict at least as much damage on Russia as they would the rest of the world. He could halt gas exports to Europe – the Europeans would freeze, but he’d be cutting off one of Russia’s last financial lifelines.
How far will he – and those around him – be willing to go?
The effect on financial markets is more obvious. Markets hate uncertainty. They will bid up the value of safe-haven assets such as gold and the US dollar, and bid down the value of risky assets like stocks. Energy and other commodity prices will continue to rise at a time when inflation was already a big problem.
Just days ago when the financial sanctions looked like being weaker, it was looking as if they would make little difference. It certainly doesn’t look that way now.
Steven Hamilton, Visiting Fellow, Tax and Transfer Policy Institute, Crawford School of Public Policy, Australian National University