Putin’s biggest mistake of the Ukraine war? Trusting the Western financial system

Peter Martin, The Conversation, 09/03/2022

THE West is arraying financial weapons never deployed before against a country of Russia’s size, forsaking some of the principles that have defined it.

Part of what has defined the West – and most of what has been the world’s engine of prosperity for the past century and a half – has been the free flow of goods across borders, a working banking system, and property rights.

There’s been an implicit understanding that no sizeable nation (Russia’s economy is about the size of Australia’s) would be denied access to these things. Otherwise the financial system wouldn’t be the financial system.

That seems to have been the understanding of Russian President Vladimir Putin. But ten days ago, the West did the unthinkable, and the global financial system may never be the same again.

Russia’s vast war chest

Over the seven years since Putin last invaded Ukraine (and annexed Crimea) in 2014, Russia’s central bank has almost doubled its holdings of foreign currency and foreign bonds and gold, building up a reserve of US$630 billion at a considerable cost to the living standards of ordinary Russians.

It was a war chest that would enable Russia to continue to buy things that could only be bought in foreign currency, even if customers overseas refused to trade with it and supply it with that currency. It was Russia’s insurance policy.

And although it could have been stored in Russia, much of it was kept in banks in the UK, Western Europe and the US, for easy access when it was needed to buy things on those markets.

Whatever his other suspicions of the West, Putin seemed to think its financial system wouldn’t be turned off – not to a nation of Russia’s size.

China will learn from Russia’s mistake

On February 27 the West froze the assets and travel of named oligarchs and Russian officials, as was expected.

Also, and less expected, it stopped named Russian banks from accessing the messaging system used to transfer money across borders, ensuring they were “disconnected from the international financial system”.

And, much less expected, it froze the reserves of Russia’s central bank stored in France, Germany, Italy, the United Kingdom, Canada, and the US – the hundreds of billions of savings legitimately placed in foreign banks for safekeeping.

That action broke the bond of trust that makes a bank a bank. And while effective – Russia can’t get access to hundreds of billions of foreign dollars it has painstakingly built up to buy supplies and support the ruble on currency markets – it can only be done at this scale once.

China will have taken note and won’t be entrusting any more foreign assets to banks in France, Germany, Italy, the UK and the US than it can afford to lose.

Freezing foreign reserves has been done before – but only to the less powerful nations like Iran, Afghanistan and Venezuela. This is the first time it’s ever been done to a member of the G20 or the UN Security Council.

The battle of the fridge vs the TV

The ruble has collapsed 40%. Denied access to the foreign currency it would need to support the ruble in the market, Russia’s central bank has attempted to stem the tide by more than doubling its key interest rate, lifting it from 9.5pc to 20pc.

There’s a fraction of a rouble per US cent. (Supplied: Trading Economics)

Russia has blocked Russians from sending money abroad, stopped paying foreigners interest payments on government debt and required every Russian firm earning dollars to hand over 80% of them in exchange for rubles.

For ordinary Russians, there’s a “battle of the fridge versus the television”: the stark contrast between the reality of daily life against the claims of state media.

Until recently, Russian TV wasn’t even using the word “war” (although it has started). The television has been telling Russians things are normal.

But Russians’ fridgesATMs, and their blocked Visa, Mastercard and ApplePay accounts are all telling them something else.

From buying a washing machine to getting a mortgage, an awful lot is suddenly expensive or unavailable. But official polls (for what they are worth) show public support for the “special military operation”. Television has been using the realities of shortages and price increases to attack the West for becoming anti-Russian.

Hitting Russia’s elite and military where it hurts

Whatever ordinary Russians actually think about the war, the impact of the West’s unprecedented sanctions on the Russian elite is likely to matter more. No longer able to travel aboard, access their offshore savings or pay the school fees of their children abroad, the oligarchs have at least the potential to exert influence.

The final way in which the financial embargo might succeed is by starving Russia of foreign exchange to the point where it can’t buy spare parts for its military or the computer chips and other materials needed to make those parts.

There’s every chance none of these will work quickly, every chance they will further impoverish Russians, and every chance that, if Russia subjugates Ukraine, the West will find the sanctions impossible withdraw without losing face.

The global financial system changed when the West did the barely thinkable on February 27. It’s hard to see a way back.


Peter Martin is visiting fellow at the Crawford School of Public Policy, Australian National University. This article originally appeared on The Conversation.  





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  1. Peter Small, 09/03/2022

    This is an excellent article by Peter Martin and I would encourage all Australian citizens engaged in trade to read and understand the article. I am not sure though that Biden’s unprecedented action was not anticipated by both Putin and China; possibly others too.
    Denying Russia access to its own foreign currency reserves held in other countries central banks has two principal outcomes. Firstly it denies the Russian Central Bank access to its own money to support its currency. The second as Peter Martin points out, is to deny Russia the foreign currency to buy goods and services it needs from other countries.
    Let us look at these two issues in more detail, but first it is important to understand “the main game in town”.
    During the half-century since the United States went off the gold standard in 1971, the world’s central banks have operated on the Dollar Standard, – holding their international reserves in the form of US Treasury securities. The resulting US Treasury-bill standard has enabled America to finance its foreign spending including its military expeditions, and investment takeovers of other countries simply by creating more dollar debt or IOU’s. US balance-of-payment deficits end up in the central banks of payment-surplus countries as their reserves.
    As nearly all world trade is transacted in US Dollars, this gives the US enormous monetary privilege enabling the US to impose neoliberal policies on the rest of the world, and claim exceptionalism for itself when the “world based order” doesn’t suit its immediate objectives.
    So the long term objective of emerging powers like Russia, China, and I would include India is to break this half century privilege of America having the US dollar as the Worlds trading currency. Biden’s action as described by Peter Martin, is hastening the demise of the power of the US dollar. Countries are now looking at other ways of carrying out trade because America is no longer trusted to protect the system it helped create.
    So let us return to my initial points. Russia is self-sufficient in energy and in food. Which means it does not need foreign currency to buy either energy or food. (It is a big energy and grain exporting nation. 35% of the world’s grain comes out of the Black Sea ports, and 40% of Europe’s energy comes from Russia. Interruption of these exports from Russia are going to cause serious disruption of the whole global economy). But Russia, however Biden sanctions Russia’s foreign reserves will never be short of food or energy!
    Secondly what Russia does need to import, it can buy from friendly countries such as China, India, or Iran and Syria? And these countries already have other payment systems to transact trade.
    Then if the Russian Central Bank cannot get asses to its overseas foreign reserves then it cannot support its currency. As we are seeing now the Russian currency, the ruble is and will depreciate.
    As Australian farmers know a depreciating currency is good for exporters, not good for imports, nor for holidays abroad, but it is difficult for Russians to travel abroad and as Russia is self-sufficient in most things the depreciating rubles principle impact will be inflation. Wars are also inflationary but there are fiscal and monetary mechanisms to control inflation.
    In my view Biden has shot himself in the foot and brought forward by possibly a generation, the demise of the USD as the worlds trading currency.
    And all over a war that should never have happened.

    • Geoff swindells, 10/03/2022

      Yes, that is the whole point, this war should never have happened, but how else can Putim be stopped? If these sanctions didnt happen now, they would have happened the next time he invaded a soveriegn state

      • Peter Small, 11/03/2022

        A good starting point to understand some of the background to the current crises is the google “Minsk Agreement”. This agreement was signed by Russia, Ukraine, France and Germany and certified by a special resolution of the United Nations Security Council.

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