Last week I took part in Russian Roulette, a podcast hosted by the DC-based Center for Strategic and International Studies (you can listen to the episode here). We talked about Russian assets in the sanctioning countries — both the Central Bank of Russia-owned ones that are “frozen” (but technically not frozen), which we don’t know enough about, and the unsanctioned money Russia has made from oil and gas sales after its full-scale assault on Ukraine, which we know even less about. We also discussed how far the debate about confiscating these assets to compensate Ukraine has come and where it might, or should, be headed. It is a good time to revisit what we know about Russia’s financial assets. We now have some data for the first quarter of 2023, and there have been political developments, too, since the last time I wrote on this topic. The EU has legislated a requirement for custodians of Russia’s state assets to report to the European Commission how much they hold, and set up an expert group to look at legal mechanisms for actually seizing the foreign exchange reserves that the CBR has been denied access to.These efforts have moved things forward, a bit. It is still incomprehensible that the EU’s new reporting requirements come without any presumption that the reports should be made public. After all, these assets largely consist of western governments’ financial liabilities to the Russian state. In the current conflict, there is no good argument against disclosing how much the CBR or other branches of the Russian state holds in sovereign bonds issued by sanctioning governments (not just EU ones, of course) or on deposit with their central banks. Fortunately, a few governments have realised this: Belgium has openly said Euroclear, the Belgian securities settlement house, has €180bn in custody for the CBR.That leads me to a couple of thoughts. One is that we can now be pretty sure the CBR’s pre-February 2022 reports on its reserve management are still about right. Recall that these are the source for the “roughly $300bn” number everyone has been using for the amount of reserves sanctioned (despite the fact that western governments could just ask their own institutions instead of quoting Russian numbers). Since the Belgian number accounts for the bulk of Moscow’s eurozone government bonds (which are largely held through Euroclear even if issued by other eurozone capitals), that fits with the CBR’s information that it keeps about two-thirds of its non-gold reserves in bonds (the rest will be deposits with foreign central banks). So the “roughly $300bn” is a reliable measure of western governments’ liabilities to Russia — promises to pay that Moscow has, in all moral and political sense, forfeited. Further, the firmer public knowledge of the amounts shows how the EU can have a good nibble at Russia’s reserves even before solving the bigger legal challenges to confiscation. CBR sovereign bond holdings have, to some extent, been turned into cash over the past year as they have matured or paid interest — which sanctions mean cannot go anywhere but stay in Euroclear custody. (Belgium’s “Target2” balance with the European Central Bank has improved significantly in the year to April — which is just what you would expect if a lot of eurozone governments sent cash to Belgium as bonds and interest payments fell due and it could not go anywhere else.) Like any good custodian, Euroclear manages cash parked with it in ways that generate a return — and that return does not belong to the CBR. With rates having gone up so much, the amounts that can be earned on smart management are not negligible, although of course still a tiny fraction of the reserves themselves. The mooted plan of using this fraction for Ukraine’s benefit is nevertheless a good one — so long as it becomes a prelude and not a substitute for a legal strategy to confiscate the whole lot. What about the non-sanctioned assets from accumulated export surpluses? Matthew Klein, formerly of the FT and now the writer of the excellent financial-economic newsletter The Overshoot, has just published an update of his own very good analysis of this that is well worth a read.The overall lesson to draw from the latest Russian data is that very little has changed since the end of 2022. The surplus is now a lot smaller — $22.6bn in the first four months of 2023, says the CBR, or only one-tenth of the equivalent for all of 2022. The good news this reflects is that the west’s partial oil embargo — a ban on most direct imports and a cap on the price of any Russian oil sales western companies are allowed to service — is working. But it also reflects the bad news that sanctions on what Russia can buy with its money are not working well enough; Russian imports (now through roundabout and sometimes illegal channels) are almost back up to previous levels.The effect, however, is the same: Russia’s net wealth held abroad has almost stopped growing — and its composition is quite stable judging from the Russian public data collated by Klein. We can make the total stop growing altogether, and even start to shrink, by tightening the screws on the hydrocarbon and other extractive exports, in particular by ratcheting down the price cap and treating natural gas at least as strictly as oil. These would be good next moves from the sanctioning coalition.But even so, Russia’s net foreign earnings since the start of 2022 have now reached about $250bn. A little less than half of this is an increase in Russian claims on assets abroad. (The remaining just-over-half is a reduction in Russian liabilities to the rest of the world, which Klein suggests we should interpret as capital flight. I agree.) In previous Free Lunches (and in the podcast above) I have argued that this hundred billion or so deserves more attention. Why do I think the accumulated surplus matters? The answer is not entirely obvious, so it is worth going through the arguments.Klein points out that large surpluses can be a sign of weakness rather than strength, insofar as they indicate the inability of a country to spend its earnings on things it needs. And if new net foreign wealth accumulates in private hands (another indicator of capital flight) rather than state hands, it may not seem like an advantage for the Kremlin. But think about how Moscow funds its payments to soldiers, weapons factories and other military spending (as well as how it pays for social spending that keeps a lid on discontent). Its budget depends hugely on taxes paid by oil and gas exporters. Now, these taxes are paid in roubles and the exporters are themselves arms of the state. So if the state is basically paying itself in roubles, why does it matter how much it makes abroad? For it literally doesn’t bring the euros and dollars home to spend. The reason is that when Gazprom, say, receives euros from a European natural gas consumer, the hard currency can back a domestic claim in Russia. Gazprom can, for example, exchange the euros for roubles with a Russian counterpart — this would most likely be done through the Moscow Exchange’s National Clearing Centre, as I have described before and which has, for unexplained reasons, not been sanctioned by the west. Or it could borrow roubles against hard currency collateral. Whatever the exact process and while the euros still “live” in the eurozone (perhaps now in the NCC’s correspondent account in Frankfurt), the hard currency now ultimately backs a chain of new domestic claims. It will figure as someone’s new savings or wealth.What could the government do if this did not happen? It could always create such claims without backing. Gazprom could borrow unsecured money to pay its rouble taxes. Or if it owed no taxes because sanctions squeezed its income, the government could run down its savings, tax more, borrow more or print money. There are signs of all three happening. Any of these lets the government shift more domestic resources into warfare and military production and away from other uses. But none does so in return for (ultimately) a claim on something outside Russia. In the previous case of external surpluses, whatever deprivations in consumption or peaceful investment Russia’s war is inflicting on its population would, at least, be matched by a real saving in their balance sheets. Without external surpluses, they would be mere deprivations. The political difference could be enormous.All this means that immobilising Russian assets abroad — and ultimately confiscating them — makes a tangible and significant difference to Moscow’s capacity to wage war. That includes not just official reserves but the unsanctioned surpluses we should think of as “shadow” reserves. So what should be done now? Here are five proposals for leaders who want to make a difference:Disclose all information about official reserves immediately: pass regulations requiring central banks and private financial institutions to post on their website and keep updated the holdings of the CBR.Identify and publish transaction details for the bank accounts of western subsidiaries of Russia’s extractive exporters, where the hard currency payments are received, and trace as far as possible where the money goes from there.Sanction the NCC.For the Russian hydrocarbon sales that remain legal, require payments above estimated production costs (perhaps $20-$30) to be paid into escrow accounts.Toughen the squeeze on hydrocarbon revenues by lowering the price cap, and introduce similar restrictions on EU imports of Russian gas (which has few other places to go, except for some liquefied gas).The point of all of this is, of course, to better corral the Russian state’s wealth — the ultimate goal being to make it pay for its crimes.Other readablesA reconstructed Ukraine can serve Europe’s self-interest by helping the continent deliver its green transition.How will AI affect productivity? Delphine Strauss investigates. And in an interview with the FT Gita Gopinath, the IMF’s second-in-command, says AI could boost productivity but comes with risks of inequality and monopolisation.Noah Barkin’s latest newsletter gives an excellent overview of Europe’s dilemmas over China.It’s 50 years since Ireland joined the EU, and John FitzGerald and Patrick Honohan have written a blissfully succinct and clear book about how the country’s economy has been transformed by membership. It’s free until the end of the day, so download your copy now.Numbers newsThe factories are coming! First Noah Smith, then Paul Krugman, have circulated versions of the chart below, showing how US manufacturers have gone on an enormous construction spree after the Inflation Reduction Act was passed. The OECD has published its latest growth forecasts. Chris Giles interviewed its chief economist.
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