For months, leaders across the globe thought those were just quixotic sabre rattling by the Russian strongman Vladimir Putin. On the morning of February 24, he proved them wrong by launching a full-scale invasion on Ukraine, a European Democracy of 44 million people.
The Western World, led by USA, as a reactionary measure, took a number of steps to make sure Putin’s bellicosity pay the prices. These include removing selected Russian banks from SWIFT, agreeing to prevent Russia’s Central Bank from deploying its international reserves in ways that undermined the sanctions. It will cripple Russia’s ability to use foreign currency to support the ruble.
The measures also include committing to act against Russian oligarchs, specifically by limiting the sale of so-called golden passports to wealthy Russians and committing to freeze the foreign assets of sanctioned individuals up to and including President Putin, as well as those of their families and “enablers”.
The personal sanctions apply to the finances of Putin, his Foreign Affairs Minister Sergei Lavrov, the rest of his Security Council, and 11 other named officials. All transactions involving property owned by those people in the US and cooperating nations and all transactions they attempt in those nations (or attempt using those nations) will be blocked. They will have no way of accessing the estimated US$800 billion they are said to have stashed away in the West.
Free fall of Ruble?
Experts concerned said most devastating of all for Russia and its people will be the decision to deny the Russian central bank access to the hundreds of billions of US dollars in the form of gold and foreign currencies it has stored in foreign central banks.
Normally when a currency collapses, the capital flight out eventually slows and new capital flows in to take advantage of what now looks to be a bargain. This flow of capital acts like an automatic stabilizer of the currency.
A country’s central bank may step in to head off a collapse by using its reserves – in the form of gold and foreign currencies – to buy its own currency in foreign exchange markets. This can prevent the price from falling further.
With uncertainty and fear in financial markets about the Russian invasion, significant curbs on the flow of capital into Russia, and the freezing of the Bank of Russia’s foreign reserves, nothing stands in the way of a collapse of the ruble.
On Monday, when foreign exchange markets open, everyone in the world will be selling rubles, and nobody – including the Bank of Russia – will be buying them.
Genuine payments for goods such as oil, gas, fertilizer, and wheat will be allowed to continue for now. Cutting these off would be a “nuclear option” in that it would inflict massive damage on both sides.
This is just short of nuclear. But there’s uncertainty about how bad it will get.
Bank runs would inflict major damage on the Russian financial system. Short on crucial imports and with no ability to pay for them, domestic production would grind to a halt.
With no ability to finance ballooning deficits, the Russian government may turn to printing money, kicking off hyperinflation as happened in Germany in the Weimar Republic.
Very few countries (North Korea is one) make all of what they need at home. Since Russia opened up in the 1990s it has become increasingly integrated with the rest of the world. Russia makes most of its own weapons, but using components that come from the rest of the world. Shutting off those links will hurt.
China might help by maintaining some trade with Russia, but if the ruble is almost worthless, that may be unsustainable.
Can SWIFT be replaced by CIPS?
One of the most severe aspects of the sanction is of course cutting some Russian banks’ access to SWIFT — the messaging network at the heart of global movement of money.
Based in Brussels, but with a data center in Virginia, the cooperatively owned Society for Worldwide Interbank Financial Telecommunication, or SWIFT, is a “financial panopticon” that allows Washington to surveil cross-border fund flows. However, the actual policing often comes out of New York, where 95% of the world’s dollar payments are irrevocably settled.
However China’s Cross-Border International Payments System (CIPS) can replace SWIFT for Russian trade financing, a Chinese academic told the Shanghai-based Observer news site (guancha.cn) in a February 27 interview.
Over the weekend, the United States and its allies excluded a list of Russian banks from the SWIFT, or Society for Worldwide International Financial Telecommunications, network that clears interbank payments in US dollars and other Western currencies, although Russia has not yet been subject to a blanket exclusion.
Asia Times first reported on February 25 that China’s alternative payments system could help Russia bypass Western sanctions.
In the past, exclusion from SWIFT meant complete isolation from global markets and normal trade financing, as in the case of American sanctions against Iran. But the CIPS system, which China began to develop in 2015, is now fully operational.
China might be reluctant to help Russia circumvent SWIFT sanctions, said Professor Chen Xi of the Shanghai Advanced Institute of Finance at Jiaotong University in an “Observer” interview because the United States might retaliate by imposing sanctions on Chinese banks. That would have disastrous consequences, Chen added.
Risks to the financial system cut both ways, the German daily Die Welt wrote on February 27. “CIPS already handles US$50 billion of daily transactions. That is considerably less than the $400 billion of transactions that pass every day through SWIFT, but CIPS volume has increased rapidly,” the German newspaper reported.
“If Russia and China linked their systems and offered an alternative to other authoritarian states, this could threaten American domination of financial markets,” Die Welt concluded.
Jiaotong University’s Chen also warned that sanctions on individual banks present a risk to the Chinese payment system. “The RMB cross-border payment system still relies on banks as nodes, and these nodes can be sanctioned and pressured,” the Chinese academic said.
“For example, the payment system built by China may be independent of the SWIFT system controlled by the United States, but the intermediate nodes are all banks. The United States can sanction these banks. If no one is allowed to do business with Chinese banks, and other countries cooperate with these measures, then this system will not work.”
“Russia also built its own independent payment system,” Chen said. “It also could adopt the cross-border payment system established by China as a potential replacement for SWIFT. But the key point is that these international cross-border systems all require the participation of actual banks.
“The United States is likely to threaten all financial institutions. If anyone deals with Russia, it might sanction them. If this is the case, the big Chinese banks may not dare to deal with Russia. In this case, Russia would only be able to do business with some small banks.”
But “if the United States sanctioned Chinese banks in this way, the damage to the global economy would be too great for anyone to bear,” Chen said.
Clearing systems like SWIFT and China’s CIPS provide secure data transmission for banks that clear customer payments. They do not deal directly with goods in trade, but only with bank payments for goods in trade.
Although CIPS is under the control of the Chinese government, the Chinese banks that it serves could be subject to sanctions, at least in theory. The financial consequences of such sanctions would be enormous.
China has a net foreign asset position of $4 trillion and holds $2 trillion of US Treasury securities. It is also by far the largest exporter in the world, with 15% of global export trade compared to 8% for the United States.
“In the final analysis,” Chen explained in the Observer article, “ the game between major powers depends on strength. If the United States doesn’t need Russian resources at all, and it doesn’t need Chinese products, it certain could impose severe sanctions.
“However, given the current level of international exchange, if trade between China and Russia were cut off completely, it would take a long time for the United States to adjust to it, and the damage to supply chains would cause damage to the entire global economy.”
“A drastic measure probably would trigger a long-term financial and economic crisis, so the United States is also very hesitant to do this,” Chen concluded.
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