Western Sanctions Aim to Isolate Putin by Undermining the Ruble

By targeting Russia’s central bank with sanctions, experts said, American and European leaders have taken aim at what could be one of President Vladimir V. Putin’s greatest weaknesses: the country’s currency.

In Russian cities, anxious customers started lining up on Sunday in front of A.T.M.’s, hoping to withdraw the money they had deposited in banks, fearful it would run out. The panic spread on Monday. To try to restore calm, the Bank of Russia posted a notice on its website: “The volume of bank notes ready for loading into A.T.M.s is more than sufficient. All customer funds on bank accounts are fully preserved and available for any transactions.”

Even before the sanctions were announced over the weekend, the ruble had weakened. On Monday it plunged further, with the value of a single ruble dropping to under 9 cents at one point. As the value of any currency drops, more people will want to get rid of it by exchanging it for one that is more valuable — and that, in turn, causes its value to drop further.

In Russia today, as the purchasing power of the ruble drops sharply, consumers who hold it are finding that they can buy less with their money. In real terms, they become poorer. Such economic instability could stoke popular unhappiness and even unrest.

“If people trust the currency, the country exists,” Michael S. Bernstam, a research fellow at the Hoover Institution at Stanford University, said. “If they don’t, then it goes up in smoke.”

The sanctions aimed at the banking system were announced during a tense weekend in which Mr. Putin put his nuclear forces on a higher level of alert. The United States, the European Commission, Britain and Canada agreed to remove some Russian banks from the international system of payments known as SWIFT and to restrict Russia’s central bank from using its storehouse of hundreds of billions of dollars’ worth international reserves to undermine the sanctions.

Kicking banks out of SWIFT has gotten the most public attention, but the measures taken against the central bank are potentially the most devastating. Ursula von der Leyen, the president of the European Commission, said it would freeze its transactions” and “make it impossible for the Central Bank to liquidate its assets.”

Just how comprehensive that freeze will be is still unclear. Biden administration officials said the details are still be finalized. There are likely to be exemptions, and possibly significant ones that apply to oil and gas payments.

On Monday the British government banned transactions with the Russian central bank, the foreign ministry and the sovereign wealth fund.

But if the allies were to impose a full-fledged freeze of the vast amount of dollars, euros, pounds and yen that are owned by Russia but held in Western banks, it could devastate the Russian economy, causing spiraling inflation and a severe recession.

At the heart of the move to sanction the Bank of Russia are its foreign exchange reserves. These are the massive haul of convertible assets — other nations’ currencies and gold — that Russia has built up, financed in large part through the money it earns selling oil and gas to Europe and other energy importers.

The crux of why the Western allies have such leverage comes down to a reality of the modern financial system: Although Russia’s central bank owns the assets, it doesn’t control them.

As Mr. Bernstam explained, the Bank of Russia has roughly $640 billion in foreign exchange reserves on paper — or rather as electronic entries. But a big chunk of that money is not located in Russian vaults or financial institutions. Rather, it is held by central and commercial banks in New York, London, Berlin, Paris, Tokyo and elsewhere around the world.

In countries like Russia, where the currency is not so stable, the ability to convert to a strong and trusted one like the dollar or the euro is crucial. It is evidence that the home currency — in this case the Russian ruble — has value. Russia’s vast store of foreign exchange backs up that value. It assures households and businesses that they can convert their rubles whenever they want, and makes sure that the nation can protect its exchange rate with other currencies.. The reserves also lubricate the day-to-day transactions of Russian businesses that export and import.

But once workers and managers, owners and financiers worry that they can’t trade their rubles for dollars or euros — because banks won’t be able to access their foreign exchange reserves — they lose confidence.

It is a point that Lenin himself reportedly made more than a century ago, which was repeated by the legendary economist John Maynard Keynes: “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.”

The Bank of Russia can try to prop up the value of the ruble by using its reserves to buy up rubles that people are selling. But it can only do that as long as it has access to foreign reserves.

The question is how long it can make those transactions. According to Mr. Bernstam’s calculations, Russian individuals and companies have deposited $268 billion in foreign denominations in Russian banks.

Yet the central bank has just about $12 billion of cash in hand — an astonishingly small amount, he said. As for the rest of Russia’s foreign exchange reserves, roughly $400 billion is invested in assets held outside the country. — Another $84 billion is invested in Chinese bonds and $139 billion is in gold.

The central bank could trade in some of those bonds for renminbi, which would enable it to buy goods from China, but not from other countries. It could also sell gold, although Mr. Bernstam argues that there will be few buyers for the massive tons that Russia has on hand.

Other estimates put the amount of assets held outside at Russia closer to $300 billion. The potentially dire consequences for the economy are the same.

“If the ruble collapses, it could usher in severe inflation and exacerbate a brewing recession,” Robert Person, an associate professor of international relations at the United States Military Academy, said, noting that his views were his own and not those of the government or military.

“The economic consequences of these measures could turn out to be far more severe than other measures that have gotten more attention in the media,” he added. “This gets at the Russian government’s basic tools to manage its macroeconomy.”

The United States and some of its allies have previously imposed similar sanctions on Venezuela, Iran and Syria, but they all have much smaller economy’s than Russia.

The Bank of Russia took steps on Monday to restore confidence, and more than doubled interest rates to 20 percent from 9.5 percent in order to offset the rapid depreciation of the ruble. The bank also released an additional $7 billion worth of reserves that had been set aside as collateral for loans and closed down the Moscow stock exchange for the day. Meanwhile the foreign ministry moved to order companies to sell 80 percent of their foreign currencies, in a bid to gin up demand for rubles and prevent them from stockpiling dollars and euros.

Mr. Bernstam warned that the West’s attack on the Russian ruble needed to be handled with care. “We don’t want to destroy them,” he said. “We don’t want the political system to collapse.”

As more details emerge, it may also turn out that the banking sanctions have several exemptions and workarounds. But as Adam Tooze, the director of the European Institute at Columbia University, said, perceptions alone can be very powerful: “Maybe the name of game is rhetorical, like Putin’s nuclear warning.”

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