In the days since Vladimir Putin launched an unprovoked war of aggression against Ukraine, members of the European Union and the North Atlantic Treaty Organization (NATO) have responded with an array of financial sanctions without meaningful historical precedent.
These events have been unfolding at a dizzying pace: over a mere five days, the response has evolved from aggressive yet targeted sanctions against key individuals and businesses to outright financial warfare that is likely to push Russia into a currency crisis. Already on Monday, the ruble had dropped almost 30 percent relative to the US dollar.
The speed of this escalation isn’t the only remarkable thing — it also saw an unusually unified response of the EU and the United States, with the former arguably outdoing the latter in its willingness to punish Russia for Vladimir Putin’s crimes. “We are going to wage a total economic and financial war on Russia,” Emmanuel Macron’s finance minister, Bruno Le Maire, announced on French television, adding, for good measure, “We are going to cause the collapse of the Russian economy.”
This sentiment was echoed throughout Europe, across media outlets, generations, and the political spectrum. In Flanders, the young leader of the soft-left Socialist Party, Conner Rousseau, took to Instagram to declare that the Russian economy will be “strangled to death.” The latest sanctions could plausibly do this, if they are not eventually lifted.
This scenario is at odds with the initial commitment to primarily mete out the punishment to the kleptocratic big wigs of Russian industry and finance on which Putin’s power is said to rely. Such targeted measures are, in theory, designed to hit one’s adversary where it really hurts while minimizing collateral damage.
The initial raft of sanctions did just that. The UK blacklisted key banks and oligarchs and froze some of their assets, while also preventing Russian firms from raising financing in UK markets. The EU followed suit and extended the sanctions to legislators of the Russian State Duma (parliament) who had supported the recognition of the separatist republics in the Donbas.
Over the weekend, as the Russian advance continued and pressure mounted, the scope of the financial sanctions was widened, displaying the full extent of Western control over the global financial infrastructure.
First, the United States, and then, after overcoming the recalcitrance of Germany and Italy, the EU, moved to exclude key Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT). A Belgium-based cooperative, SWIFT provides banks with the messaging system needed to conduct payments globally.
In a speech in the Reichstag on Sunday, Chancellor Olaf Scholz stunned legislators by announcing a large one-off increase in Germany’s defense budget by €100 billion, in addition to committing to spending the equivalent of 2 percent of GDP on defense. While the move was hailed as a major break with Germany’s much-maligned security policy, it’s not clear whether Scholz will follow up on this pledge; Germany had first committed itself to the 2 percent in 2006.
This was quickly followed up with a far more consequential measure: the full exclusion of Russian banks from the dollar-based global clearing and settlement system that relies on correspondent relationships with New York–based banks who have a reserve account with the New York Federal Reserve.
But there remained two shortcomings. The first was that each of these measures still included exemptions for Russia’s main exports, which make up about a quarter of its economy: oil and gas. The carve-outs had come at the request of those European states heavily dependent on Russian natural gas for heating, a request that the United States honored.
The second shortcoming of these measures was that Putin had expected them. He had in fact used the years since Russia’s initial invasion of Ukraine in 2014 to accumulate massive foreign exchange reserves. What is more, Russia’s central bank has successfully de-dollarized parts of these reserves, shifting part of them into euros, pounds sterling, and gold.
A large part of these reserves, however, are not held in Russia. They are held with official institutions abroad. These include national central banks like the German Federal Bank or the Swiss National Bank, or organizations like the Bank of International Settlements. After some multilateral wrangling over the weekend, the United States, the EU, Japan, and even Switzerland eventually took actions to not only freeze the Russian central bank’s assets held abroad but to enact a wholesale ban on transactions with the bank.
This was a severe escalation with major economic and political consequences. The immediate consequence is that approximately half of the $630 billion held in reserve are now frozen. Russia’s “fortress balance sheet” is no longer an advantage, since it can’t make use of it effectively.
Run on the Ruble
To understand the economic consequences, one has to know what foreign reserves are used for. Their main purpose is to finance the central bank’s interventions in the foreign exchange market. If deprived of its reserves (or a substantial amount thereof), the bank can no longer conduct “open market operations” in which it actively purchases its own currency to maintain its value relative to other currencies.
In the case of Russia, there was a run on the ruble brought about by the crisis and the resulting sanctions, already producing a sharp fall relative to the dollar. This not only means that the state’s debt servicing costs increases, but that it also faces a much higher import bill. The decline in the ruble’s purchasing power mainly hits Russia’s citizens, who can buy fewer domestic and imported goods with their rubles. And in order to stave off any further depreciation, the central bank must drastically raise interest rates.
The consequences of higher interest rates for real wages can be quite severe, even with individual hikes of 0.5 percent, staggered over years. On Monday, the Russian central bank raised its main interest rate from 9.5 percent to 20 percent overnight. These burdens come after a decade of stagnating living standards and relative austerity, the result of Putin’s ambition to accumulate his war chest.
The political consequences could prove equally dire. After the initial sanctions against its central bank, the Russian government responded by raising the alert level of its nuclear arsenal. According those familiar with the matter, this doesn’t yet mean that nuclear missiles are now aimed at foreign targets. But it is nonetheless a dangerous “acceleration of the logic of escalation” between nuclear armed camps. There is a reason sanctions of this severity have never been levied against a major world power in the nuclear age: they are profoundly dangerous.
These are the stakes of all-out financial warfare with a major nuclear power. Perhaps such stakes can be justified in pursuit of short-term goals. And yet it is no longer clear what the aim of these sanctions is. There is no way in which they could be considered targeted specifically at Putin’s “selectorate,” given that that most of the oligarchs’ assets are not denominated in the ruble and that most of them are held abroad. How about freezing those assets?
While there have been the first signs of public dissent in Russia, with thousands of arrests, a scenario in which the class of billionaires and state company directors withdraws its support for Putin seems unlikely. And it might not matter if they did. It seems increasingly possible that Russia has become a “personalist dictatorship” in which the oligarchs rely more on the dictator’s support than he on theirs. In such a state, the dictator cares little about the consequences of his actions and thus cannot be induced to change his behavior in response to the immiserating consequences of a financial war.
There is, in other words, a distinct possibility that “the oligarchs” are powerless to respond to intolerable economic consequences by dislodging Putin. Neither is there an equivalent of the Roman Praetorian Guard. All this makes financial sanctions of this severity even harder to justify.
The only way in which these sanctions, aimed squarely at the Russian populace, could be justified is if they were temporary and simply intended as a means of strengthening Ukraine’s bargaining position in the ongoing negotiations with Russia at the Belarusian border. Yet there is no clear timeline, nor are there any criteria, for their removal.
This turn of events is especially jarring because it comes right after the international outcry over the confiscation by the United States of the central bank assets of Afghanistan, announcing that half (roughly $3.5 billion) would be redistributed to 9/11 families while the latter country was in the midst of a potentially devastating famine. It also comes at a time when the discourse around sanctions seems to be changing.
Any lessons learned in recent years seem to have been obliterated in the course of a weekend. But experience tells us that sanctions are never an alternative to war but rather a means of war; that they are not about behavioral change but long-term attrition and exhaustion of the enemy and its people; and that they do not affect military events in the short term.
Indeed, these sanctions will likely do little or nothing to arrest the Russian advance on Kiev. Due to the energy carve-outs in the initial sanctions, the Russian economy remains a foreign-exchange-generating structure. These carve-outs, in conjunction with the fact that the government has ordered its main export companies to part with 80 percent of their foreign exchange income (dollars and euros still used to pay for Russian gas and oil) in exchange for rubles, effectively guarantee that Russia’s war-making capacity will not be affected anytime soon. But the lives of its citizens will.
There are alternative proposals that are less destructive. Apart from ending exemptions for energy carve-outs, Western allies can do what they arguably should have done after the invasion of 2014: strengthen Ukraine financially and logistically. As John Maynard Keynes urged in 1924 in a letter to the League of Nations, we should “provide positive assistance to the injured party as compared with reprisals against the aggressor.”
The main tension in all of this is hard to overlook: the long-professed concerns with Putin’s human rights abuses against the Russian people are at odds with the sudden nonchalance with which potentially enormous costs are now being imposed on those same people. This war is of Putin’s making, not theirs.