SCENES from Moscow and other Russian cities over the last 24 hours suggest the initial stages of a bank run, whilst the rouble fell almost 40 per cent in early trading as East Asian markets have opened. This was the intended result of the economic sanctions announced by European powers, Canada and the US, subsequently joined by Japan, over the weekend.

The sanctions are measures of an unusually severe degree, threatening potential economic devastation, but the major mechanism they use have been road-tested over the last decade of economic crisis and disorder.

The economic blow from central bank sanctions on Russia will remain exceptionally severe. Bank of Russia will likely find that capital controls and dramatic interest rate hikes are what it relies on to try and defend the rouble and thus its banking system.

Oligarchs and messaging systems

First, talk of financial sanctions has previously tended to focus on the flows of Putin-regime connected and often criminal financing that make their way through Western banking systems — notably including London.

Restrictions on the ability of this or that oligarch to transact as they wish, whilst important, are closer to a severe nuisance rather than applying critical pressure. Likewise the ban on “golden passports” for oligarchs: long overdue, but hardly a knockout blow.

Second, the critical part of the package is not the removal of three major Russian banks from the Swift interbank messaging system. But Swift is not essential to foreign trade: banks in different countries can request money off each other in different ways if they are denied access to it, even if that has to be via fax.

Since 2014, after the US first threatened to pull the plug on Russian access to Swift, the country has been busily setting up its own interbank communications system, SPFS, operational since 2017.

China also has the Cross-Border Interbank Payments System, operational since 2015 and providing renminbi-denominated payment services for 80 participating banks, HSBC and Standard Chartered amongst them. India is currently moving towards establishing a rupee-denominated payments system to “soften the blow of sanctions.” A similar system had been established by New Delhi to swerve round sanctions imposed on Iran. Trade without Swift access is very much harder, but not impossible.

Nor has the oil and gas trade been directly targeted. With prices for both already shooting up and with Russia supplying about 40 per cent of Europe’s natural gas, the costs to those trying to apply the sanctions start to look greater than the benefits of applying them. Gas stocks in Europe are at a record low: were Russian gas flows to halt entirely, the continent has about six weeks’ of supply at hand.

Weaponising central banks

There is, however, an economic weapon that can be utilised at low economic cost to those wielding it. A bank run in Moscow costs Berlin, London or Washington nothing. And so the primary weapon of the sanctions package are the restrictions on Russia’s central bank.

The Bank of Russia’s reserves are valued at around $640bn. In recent days, it has been selling these at pace, buying up roubles in an effort to preserve the currency’s international value. The sanctions block Russia from selling most (perhaps all) of those reserves, meaning it cannot easily prop up the value of the rouble.

That, in turn, threatens a bank run, as depositors look to remove their increasingly worthless roubles from bank accounts and turn them into more valuable and stable currencies — like the dollar or the euro.

Not all of Russia’s central bank reserves have been rendered useless. Around $145bn of them are held as gold (which is physically held in Russia) and if it cannot be sold directly — literally transferring physical bars of the yellow metal — it can in theory be converted into promises to pay them later.

A further $90bn (or around 14 per cent) of these reserves are held as renminbi and China has consistently indicated it will not join measures against Russia. The Bank of Russia has spent the eight years or so since 2014 busily both building up its reserves and divesting itself of dollars and dollar-denominated assets. Its $6bn holdings of US Treasuries today are far below the record high of $176bn in October 2010.

This was completely political — a deliberate attempt to minimise the potential impact of future sanctions, of the kind being applied now. Its huge current account surplus, the $19bn difference between what Russia exports and what it imports that has been built up over a decade of oil and gas sales, also provides some protection against aggressive economic sanctions. The share of dollars in Russia’s export trade has fallen from 69 per cent in 2016 to 56 per cent in early 2021.

But if most of the reserves can’t be touched, Bank of Russia will most likely be forced to push up interest rates to dramatic levels and to impose capital controls — barring the movement of money and financial assets out of the country. The economic consequences of both will be dire and may not be enough to staunch a run on its banks.

How the ECB deployed the central bank weapon

Central banks are the nerve centre of any currency’s finance and banking system. Their primary function is to act as a “lender of last resort” for a currency’s banks, stepping in to guarantee that banks in financial difficulties do not fail.

As an extension of this primary function, they may well have powers to (for instance) defend the value of a country’s currency — which can be seen as a subset of defending the credibility of its banks.

But this huge domestic power can be flipped, judo-style, into an overwhelming weakness where a country no longer has full control over its central bank and cannot, as a result, guarantee the stability of its banking system.

There is a precedent for the weaponisation of central banking that we are now seeing play out. Documents leaked in November 2014 showed that the European Central Bank (ECB) threatened the Irish government with the collapse of its banking system if it did not accept the ECB/EU/IMF bailout four years earlier.  

Even more dramatically, the ECB repeatedly threatened to end emergency support for Greece’s insolvent banks if the newly elected Syriza government did not accept the bailout conditions it was offered from February 2015 onwards.

These conditions included extended austerity, to which Syriza was vehemently opposed. Syriza attempted to get out of the bind with a referendum on accepting the bailout in July that year, but its gambit failed. Europe’s first radical-left government in decades was brought to heel.

Both Ireland and Greece were eurozone members and politically aligned with the European institutions — ultimately, it was Greece’s unwillingness to break more fundamentally with those institutions, by leaving the euro, that allowed the ECB to threaten its banks’ collapse and scuppered Syriza’s anti-austerity programme.

Outright central bank sanctions, too, were used during the financial crisis. Britain’s freezing of Icelandic financial assets in October 2008, using the powers available under the Anti-Terrorism, Crime and Security Act 2001, saw its central bank briefly (if incidentally) targeted.

The same ECB technique — attack the central bank to undermine the banking system — has now moved from threat to application against a hostile country, presently at war with a close ally of those applying sanctions.

The warhead of the weapon is the same, but the context is radically different and radically more dangerous as a result: Putin’s lurch from dark hints to the mobilisation of Russia’s nuclear forces shows both how effective the weapon is, but also the grave consequences of actually using it.

Russia cannot respond in kind to the central bank attack — Russia’s financial system is small, relative to the dollar-finance system and weakly integrated into it — and so its government has instead responded where it has the capacity to do so. It is troublingly unclear how far this prospect of an immediate Russian military escalation was built into the Western powers’ planning.

The people that suffer most immediately from the joint powers’ central bank sanctions will, of course, be the Russian public, now contemplating the loss of an elementary utility in modern life, the banking system — alongside the serious prospect of hyperinflation. The rest of us, meanwhile, are being dragged terrifyingly closer to the precipice of nuclear war.

Published originally at Pandemic Capitalism, a weekly newsletter on the global economy — visit https://jamesmeadway.substack.com to subscribe.