“The costs of aggression will be high,” Prime Minister Rutte said on Wednesday in the House of Representatives about a possible Russian invasion of Ukraine. “A high price” also predicts Annalena Bearbock, the German foreign minister. Her American counterpart Antony Blinken speaks of “enormous consequences”, and his president Biden predicts a “disaster” for Russia.
This is not about military retaliation. For the defense of Ukraine, the West does not opt for military deterrence. People prefer to threaten economic sanctions, especially at their unprecedented magnitude. That is the modern way of continuing diplomacy by other means.
1 What Western sanctions against Russia are there already?
Many sanctions have been in place since Russia’s 2014 invasion of Ukraine and the annexation of Crimea. From restricting the trade in arms and goods that can be used for the arms industry, to restrictions on access to the capital market in Europe and the US. From Russian access to ‘certain’ (i.e. not all) technologies for the oil and gas industry to, in the case of the EU, sanctions against 48 companies and against 185 persons from the Russian political and economic top. Being with the U.S. Office for Foreign Assets Control (OFAC) similar US sanctions can also be found, down to the person.
2 Are economic sanctions effective?
In theory yes. On paper, Russia is a military superpower. On that same paper, it’s an economic dwarf. The gross domestic product – the size of the economy – is equal to that of the Benelux at 1.450 billion euros. Apart from the exploitation of mineral resources, relatively little is produced and the dependence on imports is therefore high. That makes it all the more likely that the West is going to attack Russia with economic means, not with military means. Because on the battlefield the proportions may be equal, but economically the US and the EU are together a factor of thirty larger than Russia itself.
3 But have the previous sanctions, after Crimea, worked?
The Atlantic Council, an American think tank, drew the conclusion last year that yes. The main evidence: Russia’s economy faltered after sanctions were imposed in 2014. But it is difficult to separate the extremely slow Russian economic growth at the time from the collapsed oil price, which dropped to an average of 50 dollars a barrel after 2014. That is at or below the so-called ‘break even’ price at which oil extraction is still profitable for the state.
The oil price has now risen sharply, to USD 88 per barrel this week. That is the highest level in more than seven years. The Russian economy is growing at an average of one or two percent – not unhealthy. Apart from oil and gas, the prices of other raw materials that Russia extracts from the soil have also risen sharply. Tin has doubled in price in a year. Cobalt is 87 percent more expensive, nickel and zinc are a third higher. This partly explains President Putin’s self-confidence. Russia, or better: the Russian state, is in good shape. Moscow considers itself resistant to the kind of pinpricks that have been handed out so far. And so the West will have to climb the escalation ladder considerably to impress with sanctions.
4 How many rungs are there on the escalation ladder?
Addressing individual Russian banks is a possibility. In addition, the US can limit the export of technology to Russia. And then there is the big asset Nord Stream 2 – the second gas pipeline through the Baltic Sea from Russia to Germany. It is ready and about to be opened. Berlin opposed keeping Nord Stream 2 closed as a sanction, but now seems willing to discuss the sanction, Chancellor Scholz said on Wednesday. But if all that doesn’t work, then the very tough sanctions task remains: completely isolating Russia.
5 Why are the heaviest resources not used immediately?
That has two reasons. First of all, the world has become highly globalized and interdependence has greatly increased. Russia is an exporter of many of the raw materials the world needs, from cobalt and zinc to nickel and copper. And oil and gas of course. Moscow supplies a third of the gas for the EU. The hold is mutual in that regard.
The second reason is that large-scale, general sanctions mainly affect the population. Punishing those in power and the clique around them is, also from the point of view of public relations, more effective. They have been able to make a fortune thanks to the weak rule of law at home. They then deposited their money in the West, where the rule of law does exist and protects their assets. Freezing those assets with sanctions then seems effective.
This evolution of sanctions, from general to specific, is also apparent from the Global Sanctions Database, which is being built by scientists.
6 If total economic isolation is undesirable, what can be done?
A financial isolation. And this is done by denying access to Swift, a network in which banks pay each other across borders. Worldwide, 35 million transactions are performed via Swift every day, with a total value of EUR 4.420 billion. Swift is based in Belgium but, importantly, the largest data center is in the United States. Without Swift, financial traffic with foreign countries will quickly come to a standstill.
Unplugging Swift will definitely affect the Russian economy. The risk is a fall of the ruble, the lack of income from abroad and in the long run a lack of hard currency. But Russia has ample reserves: the result of the commodity boom. According to the Finnish central bank, who closely monitors the Russian economy, Putin has $614 billion in currency reserves and gold, including not only dollars, but also euros and Chinese renminbi. In addition, the state investment fund, where part of the raw material revenues goes, is fuller than ever, with $ 185 billion. Still, the Swift option is going to hurt a lot.
7 Shut down Swift then?
Germany is also very much against this – because how do you pay for Russian gas, for example? But the US, which in practice rules Swift, still doesn’t rule it out. Still, the Swift option may not be in America’s best interest either. The US has long used the central role of the dollar and the attractiveness of the US capital market as a big stick for sanctions. Allies must participate in order to continue participating in the US financial system. Example: President Trump re-imposed sanctions against Iran over its nuclear plans. Although against the EU’s wishes, European banks adhered to US regulations for fear of becoming persona non grata in the US. But the Americans cannot use this weapon too often, because sooner or later a financial system will develop outside the US.
8 Countries other than developing their own Swift?
That is already happening. China knows that a Swift exit is a possible US sanction if China takes military action against Taiwan. It has therefore been working on CIPS, a Cross Border Interbank Payment System for payments in Chinese yuan, since 2015. CIPS is still relatively small, but is growing rapidly and according to Beijing already has more than 1,100 participating banks.
Russia is also working on its own Swift: the System for Transfer of Financial Messages (SPFS) for the Eurasian market. Even the Europeans, annoyed that Trump could just impose his own Iran sanctions on them, decided at the time for a special payment system outside the US: Instex. So far, that has not led to a very flourishing existence – especially because Tehran does not seem to keep to the agreements. But it’s the start of a regional alternative to Swift.
9 So the ultimate sanction against Russia may not exist?
A Swift exit is known as the ‘nuclear option’. But it’s also a Doomsday Machine, which also destroys the one who presses the Big Red Button. The US itself then helps to further erode its financial preponderance in the world. So perhaps there is nothing at all on the highest rung of the Russian sanctions ladder.
A version of this article also appeared in NRC on the morning of January 21, 2022
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