Western sanctions aim to isolate Putin by undermining the ruble

By targeting Russia’s central bank with sanctions, experts said, US and European leaders have targeted what may be one of President Vladimir V. Putin’s greatest weaknesses: the country’s currency.

In Russian cities, anxious customers began queuing outside ATMs on Sunday, hoping to withdraw cash they had deposited in banks, fearing it would run out. Panic spread on Monday. In an attempt to restore calm, the Bank of Russia posted a notice on its website: “The volume of banknotes ready to be loaded into ATMs is more than enough. All customer funds in bank accounts are fully retained and available for all transactions. »

Even before the sanctions were announced this weekend, the ruble had weakened. On Monday, it plunged again, with the value of a single ruble falling to less than 1 cent at one point. As the value of a currency drops, more and more people will want to get rid of it by exchanging it for one that doesn’t lose value – and that, in turn, drives its value even lower. value.

In Russia today, as the purchasing power of the ruble drops sharply, consumers who hold it find that they can buy less with their money. In real terms, they are getting poorer. Such economic instability could stir up popular discontent and even unrest.

“If people trust the currency, the country exists,” said Michael S. Bernstam, a fellow at Stanford University’s Hoover Institution. “If they don’t, then it goes up in smoke.”

Sanctions targeting the banking system have been announced during a tense weekend in which Mr Putin placed his nuclear forces on a higher level of alert. The United States, the European Commission, Britain and Canada have agreed to remove certain Russian banks from the international payments system known as SWIFT and to prevent the Russian central bank from using its warehouse of hundreds of billions of dollars in international reserves to undermine sanctions. .

The expulsion of the banks from SWIFT has captured the most public attention, but the actions taken against the central bank are potentially the most devastating. Ursula von der Leyen, President of the European Commission, said that it freeze transactionsand “prevent the Central Bank from liquidating its assets”.

On Monday, the US Treasury Department provided more details on how the sanctions will work, saying they would cripple Bank of Russia assets in the US and prevent Americans from engaging in transactions involving the central bank, the National Wealth Fund of Russia or the Russian Ministry. finances. As expected, there are exemptions for transactions related to energy exports, on which Europe relies.

“The central bank’s decision is absolutely shocking in its sweeping phrasing,” said Adam Tooze, director of the European Institute at Columbia University.

On Monday, the British government banned transactions with the Russian central bank, the Foreign Office and the sovereign wealth fund.

But if the allies were to impose a complete freeze on the vast amount of dollars, euros, pounds and yen that belong to Russia but are held in Western banks, it could devastate the Russian economy, causing runaway inflation. and a severe recession.

At the heart of the decision to sanction the Bank of Russia are its foreign exchange reserves. It is about the massive transport of convertible assets – currencies and gold from other countries – that Russia has accumulated, financed in large part by the money it earns by selling oil and gas to Europe and to other energy importers.

The core of why Western allies have such leverage comes down to a reality of the modern financial system: although the Russian central bank owns the assets, it does not control them.

As Mr. Bernstam explained, the Bank of Russia has around $640 billion of foreign exchange reserves on paper – or rather in the form of electronic records. But much of this money is not in Russian vaults or financial institutions. Instead, it is held by central and commercial banks in New York, London, Berlin, Paris, Tokyo and elsewhere around the world.

In countries like Russia, where the currency is not so stable, the ability to convert to a strong and reliable currency like the dollar or the euro is crucial. This is proof that the national currency – in this case the Russian ruble – has value. Russia’s vast stock of foreign currency confirms this value. It assures households and businesses that they can convert their rubles whenever they want and ensures that the nation can protect its exchange rate with other currencies. Reserves also lubricate the day-to-day transactions of Russian companies that export and import.

But once workers and managers, owners and financiers worry about not being able to exchange their rubles for dollars or euros – because the banks will not be able to access their foreign exchange reserves – they lose confidence.

This is a point that Lenin himself would have made more than a century ago, and which was repeated by the legendary economist John Maynard Keynes: “There is no more subtle and surer way to overthrow the existing basis of society than to poach money”.

The Bank of Russia can try to prop up the value of the ruble by using its reserves to buy rubles that people are selling. But it can only do so as long as it has access to foreign exchange reserves.

The question is how long he can carry out these transactions. According to Bernstam’s calculations, Russian individuals and businesses deposited $268 billion in foreign denominations in Russian banks.

Still, the central bank has about $12 billion in liquidity, a surprisingly small amount, he said. As for the rest of Russia’s foreign exchange reserves, about $400 billion is invested in assets held outside the country. Another $84 billion is invested in Chinese bonds and $139 billion in gold.

The central bank could exchange some of these bonds for renminbi, which would allow it to buy goods from China, but not from other countries. It could also sell gold, although Mr Bernstam says there will be few buyers for the massive tonnes Russia has on hand.

Other estimates put the amount of assets held outside Russia closer to $300 billion. The potentially disastrous consequences for the economy are the same.

“If the ruble crashes, it could usher in severe inflation and exacerbate a brewing recession,” said Robert Person, associate professor of international relations at the United States Military Academy, noting that his views were his own. and not those of the government. or military.

“The economic consequences of these measures could turn out to be much more serious than other measures which have received more media attention,” he added. “It touches on the basic tools of the Russian government to manage its macroeconomy.”

The United States and some of its allies have already imposed similar sanctions on Venezuela, Iran and Syria, but they all have much smaller economies than Russia.

The Bank of Russia took steps on Monday to restore confidence and more than doubled interest rates to 20% from 9.5% to offset the ruble’s rapid depreciation. The bank also released another $7 billion in reserves that had been set aside as collateral for loans and closed the Moscow stock exchange for the day. Meanwhile, the Foreign Ministry has ordered companies to sell 80% of their foreign currency, in a bid to boost demand for rubles and prevent them from hoarding dollars and euros.

Bernstam warned that the West’s attack on the Russian ruble should be handled with caution. “We don’t want to destroy them,” he said. “We don’t want the political system to collapse.”

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