Two months into the Russian-Ukrainian conflict, the weaponization of finance (Weaponization of finance or Weaponization of dollor) became a buzzword. Seeing this word reminds me of history: From 1853 to 1856, Russia and Britain, France, and Turkey fought a three-year war in Crimea, known as the “Crimea War”. During this period, Britain insisted on paying its debts to the tsarist government, while Russia paid interest on the national debt to British creditors (because Britain and Russia were creditors to each other). A British minister said that as a “civilized nation” it was “of course” to pay its enemy’s debts during a war. In 1997, Soros launched a financial attack and aggressively shorted the currencies of East Asian countries, causing heavy losses to these countries. For this, we condemn Soros and hedge funds, but there is one thing we have to admit: Soros and hedge funds are just drilling holes in the rules of capitalism, but not breaking them.
Business is unethical and rules-based. Now the situation has changed. After the outbreak of the Russian-Ukrainian conflict, “civilized countries” can ignore the rules. So, we have to adjust our thinking.
Draghi and Yellen’s “Masterpiece”
In 2014, after Russia accepted Crimea, the United States and its allies began imposing sanctions on Russia. On February 24, 2022, before Russia sent troops to Ukraine, these countries imposed 6,517 sanctions on Russia; since the beginning of the conflict between Russia and Ukraine, thousands of sanctions have been imposed, including a large number of financial sanctions of course.
What is the purpose of financial sanctions? First, punish Russia; second, create financial turmoil in Russia, which will lead to economic turmoil and Putin’s resignation; third, even if regime change cannot be achieved, it must cause the greatest damage to the Russian economy and make Russia unable to stand up again. For example, there are many people in the West now who compare the current round of sanctions with the situation in Tsarist Russia on the eve of the “October Revolution”. At that time, the devaluation of the ruble, the bank runs, the shutdown of factories, and finally the people took to the streets to overthrow the tsar, and Russia was forced to withdraw from the war. This time, they want the Russian people to rise up to overthrow Putin and implement regime change.
On April 6, the British “Financial Times” published an article titled “Weaponization of Finance: How the West Can Deter Russia”, which detailed the plans of Western political and economic elites. The article said: The clear intention of the sanctions is to seriously damage the Russian economy, or as a senior US official said, the sanctions will plummet the ruble. This is a new type of war, weaponizing the dollar and other Western currencies to punish their adversaries; punish it, create a revolutionary situation, and finally weaken it.
This round of financial sanctions against Russia can be roughly divided into three categories: first, the major Russian banks are included in the SDN list (Specially Designated National, that is, “specially designated countries, companies or persons”); second, the United States and its allies announced Seven Russian banks were removed from the SWIFT (Society for Worldwide Interbank Financial Telecommunication) system; third, the United States and its allies announced a freeze on Russia’s foreign exchange reserves. But it should be noted that the United States deliberately left a huge loophole for sanctions: the United States and allies did not impose a comprehensive embargo on Russian oil and gas. The Federal Reserve Bank of Russia and Gazprombank, which service Gazprom energy trade, were not removed from SWIFT and were not included in the SDN list.
On February 24, less than 72 hours after Russia entered Ukraine, the United States and its allies threw a “financial nuclear bomb” – freezing the Russian central bank’s foreign exchange reserves. Surprisingly, the idea came from former European Central Bank President Mario Draghi and U.S. Treasury Secretary Janet Yellen. The British “Financial Times” published a special article on this, detailing how Draghi, Yellen and others discussed the matter. At the beginning, some people hesitated, but Draghi said: It has to be done, otherwise Russia will not hurt.
On February 28, 2022 local time, in Moscow, the capital of Russia, people walk in front of the screen of the foreign exchange exchange.
To be honest, reading the report made my heart palpitate. I never thought that a gentleman would come up with such an idea, but Draghi and Yellen’s intentions are very clear: to attack a country’s finance, the first thing to do is to attack its currency. The Southeast Asian financial crisis is the result of the exchange rate The attack begins; it should also be seen that the stock market is very sensitive to any political event. Before the war broke out, investors who smelled the war would run away and send their money out of Russia. Capital flight will definitely put pressure on the devaluation of the ruble. Although the pressure may not be large at the beginning, as long as the currency depreciation reaches a certain level, capital flight will intensify, and under the positive feedback effect, a vicious circle will occur – the more flight, the more devaluation, the more devaluation more escape.
After the war started on February 24, the Moscow Stock Exchange index fell by 33% and stock market trading was suspended; on February 28, the United States and its allies announced: 1. Remove important Russian banks from SWIFT, 2. Freeze the Russian central bank’s foreign reserves, The exchange rate of the ruble against the dollar fell by as much as 30%. This is obviously within the expectations of Draghi and Yellen: freezing Russia’s foreign exchange reserves, the central bank will lose its ability to intervene in the foreign exchange market, and the ruble exchange rate will inevitably fall freely.
After a currency devaluation, if there are not enough foreign exchange reserves, the central bank generally has two policy options: raising interest rates or allowing the currency to depreciate. If interest rates are raised, it is likely to lead to an economic recession; if left alone, it is difficult to judge how far and when the ruble will depreciate, which will bring inflationary pressures, bankrupt Russian companies that have borrowed a lot of foreign debt, and also lead to import-dependent companies. Unsustainable, culminated in a series of financial chaos. Either of these two outcomes is what the United States hopes to achieve. According to the “Financial Times” report, Draghi and Yellen were still afraid of leaking information and could not have the effect of a surprise attack.
It’s ridiculous: they see themselves as hedge fund managers ready to short foreign currencies. But in fact, nuclear weapons should be a strategic deterrent, its role is to contain, not to sneak it out. This may indicate that economists are really not useful in the field of geopolitics. The question is: are their goals achieved? It depends on how Russia responds.
First, after the United States announced on February 28 that it would freeze the Russian central bank’s foreign reserves, the Russian central bank raised the benchmark interest rate from 9.5% to 20%, allegedly to compensate bank depositors. Second, the implementation of capital controls is mainly in three aspects: (1) 80% of foreign exchange held by exporters is sold to the central bank; (2) foreign holders of Russian stocks and bonds are prohibited from selling stocks and bonds. Third, in 2022, Russians will be restricted from exchanging foreign currency, with a limit of $10,000. Fourth, the purchase of oil and gas by “unfriendly countries” must be settled in rubles.
From the actual results, the ruble exchange rate has basically returned to the pre-war level; after the stock market resumed, it has also been relatively stable under the premise of strictly restricting short-selling and short-selling; on April 8, the Russian central bank announced that the benchmark interest rate will be reduced from 20% to 17% %. All this shows that Russia’s financial stability has stabilized, and has even basically returned to pre-war levels; it shows that the United States and its allies have not achieved their expected goals. Many people believe that the fourth measure above is Russia’s “smart trick” and has played an important role in stabilizing the ruble. I think that the reason why Russia has withstood the huge pressure is not in Article 4.
Russia’s Three Winning Factors
Russia’s response is correct. For example, in the face of the freezing of the central bank’s foreign reserves, the Russian central bank raised interest rates on the one hand, and strengthened capital controls on the other hand to curb currency depreciation and stabilize the exchange rate. And quickly make a decision, I believe they have a plan before.
The U.S. Treasury Department announced that it would freeze the assets of the Russian Central Bank in the United States.
Why mention this in particular? I have a personal experience: 10 years ago, I participated in a panel discussion at the annual meeting of the world economy in Petersburg, with a total of 4 people, including the newly appointed but not yet appointed governor of the Bank of Russia, Elivira Nabiulin Na, as well as the then Minister of Economy of Russia and the head of Sberbank. What are the 4 of us discussing? The Russian economy was difficult at the time, but interest rates were high. The head of Sberbank attacked the central bank of Russia for “why still raise interest rates? It makes us unable to live”. The discussion was a mess, and the Minister of Economy was sweating profusely. I asked: Are you worried about the devaluation of the ruble if you have to raise interest rates in a recession? They replied: yes. Therefore, I proposed: The devaluation of the ruble must be caused by capital flight. Under this circumstance, raising interest rates will crowd out companies. What should we do? capital controls. Unexpectedly, as soon as I finished speaking, the audience applauded enthusiastically. However, Russia was reluctant to capital controls at the time. Why? The oligarchs are too powerful and they want money to flow freely.
The Russian central bank is smarter this time. Not entirely on capital controls, nor entirely on interest rate hikes, but a combination of the two. Looking at it now, their series of specific countermeasures are generally fine.
Other countries must pay rubles to import Russian oil and gas, which is beneficial to the stability of the ruble currency to a certain extent, but it should not be exaggerated. Whether a country’s currency is stable or not depends critically on the balance of payments status. If your balance of payments is in deficit, then no matter what tricks you play, you will not be able to withstand the pressure of currency devaluation. On the contrary, if you have a very good balance of payments, the local currency will definitely not depreciate under the conditions of capital controls. Fortunately, Russia’s balance of payments situation is very good.
In fact, Russia attaches great importance to exports, especially oil and natural gas. Based on the rise in oil prices, since 2014, its trade has maintained a large surplus. The current account has a surplus of several hundred billion US dollars every year, and its overseas net assets have reached 440 billion US dollars. A considerable part of Russia’s current account surplus has been converted into foreign exchange reserves, accumulating $630 billion. Relative to most countries, Russia’s balance of payments is very good. With such a balance of payments situation, how can the ruble depreciate?
However, Russia also has two “unexpected”. The first “unexpected” is: the United States will freeze foreign exchange reserves. Although it does not completely rule out this possibility, it is always considered unlikely. The second “unexpected” is that the United States freezes its foreign reserves, and other countries will follow suit, which makes the foreign reserve currency and investment diversification strategy fail to improve the security of foreign reserves. These two “unexpected” indeed caused considerable difficulties for Russia.
Third, the “loopholes” left by the financial sanctions of the United States and its allies are too large. I don’t think Draghi and Yellen are brilliant. They have forgotten one of the most basic principles of economics: exchange rates are determined by the balance of payments. If there is no free movement under the capital account, the exchange rate depends on the current account. Freezing the assets of the Russian central bank can weaken the ability of the Russian central bank to intervene in the market, but why does Russia have to use its foreign exchange reserves to intervene in the foreign exchange market?
Of course, the most fundamental loophole is that the United States has not completely embargoed Russian oil and natural gas. In this way, a huge loophole has to be left for financial sanctions. It is precisely because of this loophole that Russia can still earn a lot of foreign exchange, and can still conduct financial transactions through Russian banks that are not included in the SDN list and have not been excluded from SWIFT.
In the future, will Russia’s balance of payments situation deteriorate or improve? The key depends on the export of oil and natural gas. At present, Russia’s oil exports account for 12% of the world’s oil exports and natural gas accounts for 15%, while Germany relies on Russia for 40% of its natural gas, and countries such as Hungary rely on Russian gas to a higher degree. Therefore, as long as Europe still relies heavily on Russian oil and gas, it cannot impose a comprehensive embargo on Russian oil and gas, and Russia will not be defeated. Now, the most important and hardest thing the United States has to do is to significantly increase its own oil and gas production, release reserves, or pressure OPEC countries to increase production. European countries are also adjusting their energy structure and reducing oil and gas demand. And the purpose of all this is to close the loophole as soon as possible without comprehensive sanctions on Russian oil and natural gas.
However, the irony is: Western sanctions against Russia have further pushed up global oil and natural gas prices, and Russia has had a better life exporting oil and natural gas. Bloomberg predicts that Russia’s oil revenue will be better than previous years in 2022 due to rising oil and gas prices, and the trade surplus will increase further. In short, weaning off Russia’s oil and gas dependence will not happen overnight.
Implications from sanctions against Russia
How long will the Russia-Ukraine conflict last? He patted his head and said: Maybe three or five months, maybe a little longer. In my opinion, if the Russian-Ukrainian conflict ends before Europe is free from Russian oil and gas dependence, the US financial sanctions will fail.
If the conflict between Russia and Ukraine is over before this winter, will the United States continue to work hard to replace Russia’s oil and gas sources? the answer should be confirmed. However, the enthusiasm of European countries may decline in the future, so the replacement of oil and gas sources may be delayed for a long time. But in any case, it should be a high probability event that the United States will finally implement comprehensive sanctions on Russian oil and gas.
The U.S. and its allies’ sanctions against Russia bring at least two thoughts:
First, what direction will the future international financial system and international monetary system develop? From post-war to 1971, it was Bretton Woods System I (gold-exchange standard), and from 1971 to the present it was Bretton Woods System II (dollar standard). The international monetary system consists of a series of rules, conventions, infrastructure and corresponding international organizations. For example, as an international settlement system, SWIFT is an integral part of Bretton Woods System II. If due to geopolitical reasons, even a nuclear power can be excluded from this international settlement system, countries that are worried that they will also be excluded from SWIFT will not Start a new stove? Ragrame Rajan, the former governor of the Reserve Bank of India, believes that once such a situation occurs, it means the fragmentation of the international monetary system.
Again, credit is the foundation of any financial system, let alone the international monetary system. Once the participants in the monetary system, especially the international reserve currency providers, stop being trustworthy, the basic principle of “play by rules” will be completely destroyed. The financial sanctions tactics proposed by Draghi and Yellen have been successful for about two or three weeks, but their damage to the international monetary system is permanent, and the prospect of the existing international monetary system with the dollar as the “anchor” is worrying .
Second, how to ensure the safety of a country’s overseas assets? In the past, we have been worried that the United States has maintained a large amount of foreign and domestic debt for a long time, and issued a large amount of money through QE. Sooner or later, the dollar will depreciate sharply. The depreciation of the dollar will cause China, which holds a large amount of dollar foreign exchange reserves, to suffer heavy losses. In order to avoid losses from the depreciation of the US dollar, in the past we mainly considered how to diversify the risk of foreign exchange reserves, but now the nature of the problem has changed. The United States and its allies froze the foreign exchange reserves and other overseas assets of the Russian Central Bank, giving us a wake-up call: It turns out that the overseas assets accumulated by a country through decades of hard work can be destroyed in an instant.