The West has yet to use its full arsenal of measures against the Russian economy. What is the most effective thing it could do now?
The elephant in the room in the discussions about Ukraine is just how hard the US and Europe really want to hurt Russia.
The United States could bring Russia to its knees economically within days, via full exclusion of all Russian banks from the SWIFT system and by blocking all clearing in US dollars. It has chosen not to do so.
The SWIFT system sits at the very top of Western property right transfers.
Russia and much of eastern Europe were not a part of the Roman Empire that laid the basis of the Western legal system.
Compiled by Emperor Justinian (the Corpus Juris Civilis) and further developed in the Napoleonic code, civil rights, contract law, and land and property registries were well established. The Charlemagne and Hapsburg empires brought Germany, the Czechs and Poland into the fold.
Russia has never had anything like this legal structure. Communism (with no belief in private property) followed the tsars, leaving the country nothing to fall back on when the Soviet Union collapsed. The KGB fraternity was best placed and organised to steal the state companies in the vacuum created, and to adopt the tried-and-true law of “do as I say, or else”.
Ukraine is courageously trying to move away from Russia’s idea of property rights, towards the Western model.
Russia and China both ignore the rule of law and international agreements as they see fit, the latest example being Russian atrocities that ignore the Geneva Conventions (that Moscow signed and ratified). For hundreds of years the tsars did what we observe in Ukraine today.
China too eyes Taiwan and other territories with no basis in law.
None of this is new, yet Europe, and Germany in particular, appear to have been willingly oblivious: living in a sort of “pacifist bubble”, enjoying consumerism and growth dependent on the whims of Russia with respect to energy.
Having miscalculated on the military front, Russia has now asked China for help to overcome its property rights problems with the West.
The Russian military miscalculation is that the lessons of history have not been understood by Vladimir Putin. He should have read more Tolstoy: “Nobody spoke a word of hatred for the Russians. The emotion felt by every Chechen was stronger than hatred. It was … a feeling of such disgust, revulsion and bewilderment at the senseless cruelty of these creatures that the urge to destroy them was as natural as that of self-preservation.”
This is what Putin’s army of 150,000 soldiers is up against today, in a country of 45 million people that is 1260 kilometres across and does not want to be subjugated.
Russia must also be surprised at how co-ordinated the response of the West has been, and could still be again.
In responding to Russia’s plight, China now faces major dilemmas. It could help Russia to evade sanctions by buying less oil and gas from the Middle East and more from Russia. China can also supply Russian consumers. This could help Russia avoid capitulation.
However, overt help for Russia may draw China into the property rights firing line.
The table sets out Russia’s foreign exchange reserves situation to February this year. Russian Finance Minister Anton Siluanov told state television that about $US300 billion ($405 billion) of the $US630 billion reserves is “usable”. This would provide about one year of import cover. Gold is very usable (and easy to deliver to China if needed), and likewise for assets located in China. Together they are worth $US224 billion, which implies about $US76 billion is coming from elsewhere ($US80 billion if the currencies column on the right-hand side of the table is used).
This is interesting because this “extra” could only be assets in countries that are supposedly covered by the sanctions – I am thinking of the leeway being given to European transactions for Russian energy, and of course deposits in Switzerland (estimates suggest $US200 billion of Russian money is there, enjoying property rights not available at home).
For debt servicing the situation is somewhat better, as it applies only to Russia’s foreign debt of $US480 billion or so (internal debt is of no consequence for the issues considered here). The debt service ratio is around 12.1 per cent. Russia would need to come up with only $US58 billion a year (so usable reserves would cover about five years of servicing).
Talk of defaults is therefore somewhat puzzling. It’s either because (a) the US won’t let Russia pay funds due to Western entities, such as money owed to a US bank (possible, but unlikely); or (b) with its usual respect for contract law, Russia is singling out US dollar holders. Frivolous offers to pay in roubles underline its lack of form in contract law.
China would not like to see the US test its full arsenal of measures on Russia, which could one day be used against Beijing. It is therefore likely to opt for face-saving compromises rather than escalate the situation.
The US, by focusing SWIFT restrictions on only some of Russia’s banks, is also looking to avoid escalation. But this is a very weak restriction. By allowing some banks to continue to operate, all Russian banks can get by. This is the very nature of regulatory arbitrage that we saw in the run-up to the financial crisis.
Unless all Russian banks are treated the same way all over the world, they will get by for any obligations they care to meet. Europe will continue to pay for its gas, while Russia will use this to pay for imports, any debt service it chooses to honour, and possibly weapons. Indeed, with rising energy prices and European payments for its supply, Russian reserves could just as easily go up rather than down. They would not be a constraint at all.
The US appears to give weight to concerns about stumbling unintentionally into a nuclear conflict with Russia – like the stumbles that led to the outbreak of World War I in 1914.
One issue here is whether Putin is really crazy, or whether he likes to pretend he is so that his threats carry more weight. I am sceptical on the former, because the Russians do love their children too, and the oligarchs love their global wealth.
For the US, the main issue therefore is the European alliance. European nations may be willing to pay more for their energy, but they don’t want their supply to be cut off. Understandable. So, this takes me back to the benefits of the Roman Empire and the Napoleonic code.
A middle course that cuts off money to Russia temporarily and keeps energy supply moving would be for the gas payments to be fully sequestered (before going into the SWIFT transfer system) until the crisis is resolved. The reserves constraint would become more binding without having to collapse the financial system.
While Russia does not follow the rigours of Roman contract law, it should be happy with that compromise arrangement, because we do follow those rules.
Adrian Blundell-Wignall writes on the world economy and is a former director of the OECD.
