The writer is a research fellow at the Hoover Institution, Stanford University
Of all the sanctions the west imposed on Russia last week, sanctioning Russia’s central bank is by far the most fateful. “We will cause the collapse of the Russian economy,” said Bruno Le Maire, France’s finance minister. This is not hyperbole. And if managed smartly by the west, these sanctions can also stop the war in Ukraine and beyond.
The possibility stems from an unsung feature of any modern central bank. The Russian central bank is, like others, not only the lender of last resort to commercial banks in its domestic currency, the rouble, but also the lender of last resort in foreign exchange. FX reserves support the exchange rate and the value of the rouble, ensure the stability of the banking system and its deposits, prevent runs on banks, bail out the foreign debt of state and private corporations and manage the sovereign wealth fund.
Western sanctions strike at these foundations of the Russian economy. And this has become possible because of the digitalisation of international finance.
Unlike in times past, most components of FX reserves are not physical certificates of government bonds or piles of cash in dollars, euros, pounds and yen. In the 21st century, they are electronic book entries on the computer ledgers of the Federal Reserve Bank of New York, the European Central Bank, European national central banks, the Bank of England, the Bank of Japan and Swiss commercial banks.
This digitalisation separates ownership and control of FX reserves. Russia owns them but western issuers and computerised holders of these assets control access to them. At the end of February, they collectively closed Russia’s access to these assets, froze them and banned all private transactions with the Russian central bank so that it cannot sell securities and cannot withdraw cash from western banks. From a source of economic strength during peacetime, FX reserves turned into the source of a crash during war.
Within a fateful 24 hours, the Russian central bank and Russians lost access to 60 per cent of FX reserves, $388bn out of a total $643bn. They lost access to entire arrays of assets: securities and deposits in western central banks ($285bn) and in western commercial banks and brokerages ($103bn). The Russian central bank is left with $135bn worth of gold in its vaults, $84bn of Chinese securities denominated in renminbi, a $5bn position in the IMF and a residual $30bn in actual cash, dollars and euros. (These are my calculations from central bank data).
With 60 per cent of FX reserves out of commission, Russia has to rely on the remaining 40 per cent, but there is no freedom to operate there either. The central bank cannot sell gold for dollars and euros because all transactions with it are prohibited and foreign bankers and dealers do not want to invite western wrath. The IMF reserve position is untouchable. Some $84bn in Chinese securities could, hypothetically, have been sold back to China, with a discount, to be paid in dollars, cut to $50bn, but China’s state banks have already refused financial deals with Russia. Which leaves only $30bn in cash — too little to prevent financial and economic ruin.
The rouble is already in freefall and the run on banks in full swing. Russian corporate and individual depositors have $280bn in dollar and euro denominated account balances with Russian commercial banks. Banks cannot have that much foreign cash on hand and the central bank doesn’t have cash to save them. Now people want to withdraw rouble deposits, not because they are afraid that next time the roubles won’t be there but because they expect that next time their bank won’t be there. The Russian people saw bank failures during the default of 1998 and expect no less.
The final implosion will be over supply chains. Businesses will demand dollars for payments. The successful part of the economy, producers of natural resources and high-value goods, will operate in dollars. The rest will have to resort to barter and endure supply interruptions, work stoppages and unemployment. The government may ban foreign currency transactions and demand that businesses trade only in roubles. This is unenforceable. The economy will break and a GDP contraction follow.
These developments will weaken the Russian war effort but, alas, may not be sufficient to stop the war. But something else may. The west can offer the Russian government a deal: cash for peace. This is akin to the IMF practice of conditional loans. The west has frozen $388bn in Russian assets. We can offer to unfreeze assets in tranches, say, $50bn a piece to save their economy in exchange for withdrawing forces from Ukraine, pledging not to ever use nuclear weapons and, generally, starting a return to humanity.
Source: Economy - ft.com
