The West Weaponizes Russia’s Central Bank Against Putin

(Bloomberg Opinion) -- Vladimir Putin came to power on New Year’s Eve in 1999 after an economic meltdown, rampant corruption and political uncertainty had clouded Russia’s prospects. Putin brought the promise of equity and order to a country rocked by pell-mell privatizations of state-controlled companies, fears of domestic terrorism and a plunge in the value of its currency, the ruble.

Putin, a former intelligence officer who also oversaw the transfer of state assets to the Russian Federation, fashioned himself a student of his country’s history and economy. Stung by the loss of standing that greeted the Soviet Union’s dissolution, and understandably disgusted by the first generation of oligarchs’ thievery, he pursued policies informed by resentment, cold-blooded rationalism and his own sense of patriotism.

So it’s remarkable that a man guided by realpolitik and thuggery has launched an invasion of Ukraine that is likely to re-create the same devastating economic dislocations in Russia that led to his rise — and may now sow the seeds of his downfall. Whatever course Putin’s military predations follow, the basket of financial sanctions the West introduced over the weekend — in particular its assault on Russia’s central bank — are likely to unravel Russia’s economy.

There are other potent features of the new sanctions, including unplugging Russia from SWIFT, the messaging system that knits together global banking transactions, and an overdue willingness by the West to crack down on Putin’s freshly minted band of loyal oligarchs. But the central bank sanctions? Wow.

Standard analyses of Putin’s ability to withstand sanctions (including my own) have highlighted as evidence the Kremlin’s fortress balance sheet and its huge $630 billion stockpile of reserves. Experience has taught Putin the merits of having lots of money in his central bank vaults. The value of a falling ruble can be stabilized only if the Kremlin has the financial wherewithal to intervene by regularly buying the currency. Crises that Russia encountered in 1998, 2008 and 2014 were magnified by its central bank’s inability to respond because of a shortage of reserves.

The 2014 crisis came about after falling oil prices and milquetoast sanctions spurred by Putin’s annexation of Crimea buffeted Russia’s economy. Since then, Putin has gone about making sure he has ample cash and other liquid assets on hand, a meaningful portion of it in gold. Russia now has the fourth-largest stash of reserves in the world after China, Japan and Switzerland. Putin plays the long game, and he correctly saw those reserves as insulation should sanctions follow a Ukraine invasion that only he and perhaps some close advisers knew was inevitable.

But here’s the rub: Most of Russia’s reserves are in institutions outside of the country. As my Bloomberg News colleagues have charted, 78% of that $630 billion is held in China, France, Japan, Germany, the U.S., the U.K. and elsewhere. And the West just told Russia that it plans to block its central bank’s access to those funds. Think about that. The West is attempting to disarm Russia by crippling its financial autonomy. It’s a move Putin may not have anticipated and should give him pause.

I was a reporter in Moscow in 1998 when the ruble cratered. The savings of average Russians withered, and they were forced to buy closets full of hard goods to protect themselves from their rapidly eroding purchasing power. The price of trading overseas skyrocketed, sideswiping Russian companies. It was distressing to witness. Russians obviously haven’t forgotten how ugly things can get when the ruble is rocked. Over the weekend, long lines formed at ATM machines in Moscow, and some of them were reportedly emptied in less than an hour.

That’s just one scenario Putin may have hoped to avoid by deploying his currency reserves to protect the ruble. And he still has wiggle room. China, which houses about 14% of Russia’s reserves, is likely to backstop him. But the West, finally dispensing with the magical thinking that has guided its policies toward Putin for too long, won’t.

Bloomberg News estimates that in a worst-case scenario, Russia will retain access to only $230 billion of its $630 billion hoard. Does that give Putin enough firepower to continue waging financial warfare while he vandalizes and terrorizes Ukraine? Yes, it does, particularly as Russia continues to haul in revenue from oil and gas sales. But, at a minimum, it drastically shortens how long Putin can continue marauding without economic and political consequences at home.

That presumes, of course, that Putin sympathizes with the hardships that average Russians are about to endure — which he won’t, if history is any guide. But the political advisers, corporate titans and military leaders who have bowed to him may soon be of a different mind, and that spells possible trouble for him.

Putin hasn’t been behaving like a rational actor, as his Ukraine war and nuclear threats illustrate. So predictions of what happens next are built on sand. How this plays out will also depend on the military and financial backbone the West is willing to demonstrate. Locking Russian banks out of SWIFT had been considered the financial equivalent of the nuclear option, especially given that its economic impact will also boomerang on Europe and the U.S. Yet SWIFT’s doors are starting to close, a move Japan has also endorsed.

Banks hailing from financial capitals such as London, Frankfurt and New York, along with offshore money laundering havens, have long been averse to measures that would have made it more difficult for Russian oligarchs to pillage. Hard lessons over the years from scandals such as those involving the Bank of Credit and Commerce International, the Bank of New York, Deutsche Bank and the Panama Papers came and went, with little appetite for joint actions that closed financial hideaways or simply expropriated ill-gotten gains. Yet the West is now cracking down.

The obscenity of Putin’s invasion of Ukraine has set these changes in motion, and the mechanics of how the West will go about freezing out Russia’s central bank still have to materialize. But this has all the makings of a violent financial awakening for Putin, one he will have to be incredibly dexterous, ruthless — and fortunate — to recover from.

More From Other Writers at Bloomberg Opinion:

• Putin’s Refugees Will Make or Break Europe: Andreas Kluth
• Putin Can Win the Battle in Kyiv But Not the War: Clara Ferreira Marques
• Putin Won’t Sportswash His Way Out of Ukraine This Time: Bobby Ghosh

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Timothy L. O'Brien is a senior columnist for Bloomberg Opinion.

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