The ethics of sanctioning Putin are a given, but at what price to vulnerable countries, the reserve currency system, and international trade and payments arrangements? The consequences of sanctions haven’t been thought through, they cannot be contained to Russia and they threaten the whole post war system which is fracturing.
The humanitarian catastrophe unfolding across Ukraine has triggered a tsunami of sanctions on Russia, unleashing seismic disruptions across the global economy, currency arrangements and the infrastructure of global payments. It is more damaging than the banking and the sovereign debt crisis of a decade ago. Here’s how the IMF sees it:
“…The economic consequences are already very serious. Energy and commodity prices…have surged, adding to inflationary pressures from supply chain disruptions and the rebound from the Covid 19 pandemic. Price shocks will have an impact worldwide, especially on poor households for whom food and fuel are a higher proportion of expenses. Should the conflict escalate, the economic damage would be all the more devastating.”
The IMF continues:
“The sanctions on Russia will also have a substantial impact on the global economy and financial markets, with significant spillovers to other countries.”
There is little indication that the ‘spillover’ effects of escalating sanctions have been thought through by the EU and, even less so, by the US. In the rush to ‘Punish Putin’, there has not been time. So the question remains unanswered, at what cost to the rest of the world, particularly trade-dependent low-income countries?
It is not alone the shock of Russia’s invasion of Ukraine after a six-year hiatus. Nor the impact of an increasingly embedded war on an already vulnerable global economy that is challenged by rising inflation and supply- side shocks. Even more, it’s the fact that settled post-war assumptions regarding trade, the security of global payments and trust in the dollar as a reserve currency suddenly look vulnerable. It is a (deeply) negative sum game. Everybody loses. Everybody.
When the global banking crisis rolled over Western economies from 2008/2010, governments and international organisations responded in an ad-hoc, chaotic and sometimes repressive manner in their efforts to dampen the fires of contagion and reestablish a kind of stability. It didn’t work out well, especially for some countries, as supranational authorities scrambled to ‘fix’ the problems they hadn’t been anticipated with policy responses they had not thought through. Sound familiar?
The dangers are far more significant this time around, and unpreparedness is even more apparent. There is no Plan B to address the unanticipated consequences of sanctions
When peace comes – as it will – the most urgent economic priority will be international reforms in the governance of global currency arrangements, international trade, and the security of payments systems. Reforms are imperative to begin to rebuild trust in the economic values that shaped international economic governance at the Bretton Woods Conference at the end of WWII – the same values that underpinned European economic co-operation. They are now fractured under the unanticipated consequences of the tsunami of sanctions, on top of existing embedded structural weaknesses.
War, once started, does that. Continued, and escalating, military destruction and a fixation on sanctions that are bringing chaos and a crisis of consequences across the globe, cannot be the answer. It is deeply concerning that there is no strategy of how to rebuild a stronger, less skewed system. Rebooting the status quo is delusional.
The dilemma is this. The ethical case for penalising President Putin’s Russia for its invasion of Ukraine and its devastation is a given. The question is how far is it ethical to weaponise global trade, payments and currency arrangements for this purpose, without considering the impact, not just on Russia and on the EU, but on poorer, including emerging countries, but also on the principles underpinning global economic governance. Ad-hoc and conditional assistance to such countries have a contribution to make, but they are no substitute for a better system.
The Financial Times’s Martin Wolfe recently warned that ‘…a new world of currency disorder looms’ (Financial Times, 29th March 2022). This will resonate with those who lived through the 1970s when the stability of the Bretton Woods fixed exchange system, based on the convertibility of the US dollar into gold, collapsed. The consequences were massive instability and disruption for Western as well as emerging economies. What the West’s sanction regime has done, in an astonishingly short time is to reverse the post-war reserve currency payments and trading systems.
Russia’s invasion of Ukraine has triggered round after round of unprecedented trade, transportation and financial sanctions. This continues apace in Brussels and in Washington, in real time. These sanctions have impacted the Russian economy at every level notwithstanding the data point of a recovery in the rouble and a restoration of the effective domestic monetary policy in stabilising the economy, albeit with a significant loss of output. At the same time, sanctions are also impacting the EU economy and threaten significantly greater costs to households and serious even permanent damage to businesses in the coming years.
The capital costs of re-building EU energy systems to eliminate dependence on Russian oil and LPG are, quite simply, enormous. The EU’s Green Energy policies are shredded.
Quiet reflection and even common sense point to the uncomfortable reality that in punishing Russia, Western sanctions are doing great damage to the West itself and turning International Trade Theory on its head.
Many people believe that ‘it is a price worth paying’. Others wonder whether they can afford the price, and where will it all lead to – the stuff of nightmares.
But at least as important is the fact that escalating sanctions have also ricocheted upwards and outwards. They have corroded trust in the reserve currency system, in the welfare gains from international trade and in the security of global payments systems. The West is turning its back on seventy years of institution – building aimed at putting in place resilient and trustworthy systems of economic engagement among nations. As the IMF points out, low-income countries are at the sharp end of this implosion.
The moral case for sanctions has repeatedly been made in many forums. The indignation and emotional responses are understandable. But what has not been thought through is the impact of sanctions, not just on Russia and, by extension, the EU but on the wider global economy, which underpins living standards, food and energy security for hundreds of millions of people. Commodity prices for food have risen globally over 35%, and are forecast to rise more sharply as the full impact of sanctions hit home. This impact falls disproportionately on food deficit countries, and particularly on low income families. Food, energy and trade are the pillars on which they rest.
Western sanctions aim to suffocate the Russian economy, to stymie its global trade relationships while cutting off access to Western financial institutions and capital markets. Over and above these sanctions, half of Russia’s external reserve assets – over $350 billion – have been seized by the West.
This has never happened before. All countries hold such assets, largely in the form of ‘reserve currencies. The stated intention is to reinforce further existing pressures on Russia from NATO’s long-standing military assistance to Ukraine and from its most recent response in the form of escalating military assistance into what is no longer a proxy war between NATO and Russia but a military confrontation, that has no obvious firewall, even nuclear.
The immediate and narrower problem is that the burden – the economic costs – of ‘punishing Putin’ have not, and cannot be, contained in Russia. The spillover effects are already washing through every interface of a vastly complex and interconnected set of economic relationships that bind countries, and where real-time efficiency and, above all, trust is everything.
This requires reflecting upon. The dollar is by far the main global reserve currency. It plays a pivotal role in facilitating international trade and payments, operating through a network of Western banks and the global SWIFT payment system controlled by Western Governments and banks and from which Russia has been excluded.
In principle, all countries benefit from using a widely accepted reserve currency such as the dollar as ‘international money to price, invoice and settle transactions. However, the US benefits most since its national currency is used widely in financial and trade-related transactions. It means that the US Treasury can finesse the dollar exchange rate and thereby its international competitiveness. For an extended period, it can also fund its Balance of Payments deficit by issuing, in effect, national IOUs that are convertible into dollars and can be held by Governments for payments and for investment purposes.
Reserve currency status confers enormous benefits on national currencies. It gives countries economic as well as political leverage. It is efficient, but it is also an asymmetrical system, skewed towards the hegemons – the US, the EU and the renminbi – whose currency is used. Reforms might include an authentic international currency that was issued and managed as a global ‘Public Good’ rather than on national IOU’s and payments system that were proof against weaponising for political purposes, might be a start.
It pivots on trust. Sanctions by the US Treasury that effectively weaponise the dollar are not new. What is new and unprecedented is the scale, scope and swiftness of the sanctions imposed by the US Treasury, supported by the EU, on Russia and any political, financial and commercial entity with whom it engages in what was just months ago an ostensibly open global economy.
Countries holding dollars as the core part of their external reserves have suddenly been made aware that their assets can be sequestered. They can find themselves cut off from access to these reserves held in what they formerly regarded as trusted global financial institutions and intended to manage external debt, as it falls due. Solvent and well-managed economies can even be forced into default. They observe that sanctions have now blocked two-thirds of the Russian banking sector.
This has always meant that countries using reserve currencies and third party financial institutions have been vulnerable but haven’t thought about the risks. Suddenly, US sanctions have laid bare their vulnerability. The US Treasury has more power and global ‘reach’ than national Central Banks or even the IMF.
This now creates a powerful incentive for large countries to diversify out of the dollar as a key strategic objective, bypassing the post-war multilateral arrangements and adopting bilateral, country-to-country trade settlement. Russia and India have, for example, recently adopted a Rupee/Rouble currency arrangement to facilitate mutually beneficial trade – circumventing Western sanctions in the process.
Large countries are now acutely sensitised to their vulnerability to external control and seizure, something they had previously no reason to anticipate. Smaller and emerging countries don’t have options and can be strong armed. Large advanced countries, notably the BRICS, with significant natural and resources do– and can face down threats.
All of this represents an unprecedented burden on the post-war economic order – a push-back against trade liberalism and multilateral engagement built on trust. What we are looking at is a descent into autarky, and that is a very big deal.
The welfare costs of financial and trade ‘disintermediation’ – the fragmentation of what has been so laboriously built up over decades – are enormous. Moreover, these welfare costs fall on all countries, especially smaller including emerging countries and those far removed from the tragedy unfolding in Ukraine and a fully fledged war between Russia and NATO.
The evils that have attended Russia’s invasion of Ukraine are unequivocal. The response in the form of unprecedented sanctions by Western powers has to date, been driven, at least in part, by understandable emotionally-driven political considerations. They have proved the catalyst for enormous and unanticipated collateral damage that has perhaps been too little considered from the outset.
The Russian invasion of Ukraine has demonstrated, once again, the human suffering and economic devastation triggered by war. St John Paul II best articulated the immorality of a resort to violence.
“War is not always inevitable. It is always a defeat for humanity. International law, honest dialogue, solidarity between States, the noble exercise of diplomacy: these are methods worthy of individuals and nations in resolving their differences. I say this as I think of those who still place their trust in nuclear weapons…’
We are back to conversations that should have taken place. Had the West responded with more foresight to the political hiatus in post-Soviet Russia, our world would not be in this parlous position. Had Russia not invaded Ukraine…Had the EU and G7 invested a fraction of the political effort that is now going into suborning the global economic infrastructure by engaging with Russia’s concerns at being encircled by Nato. The root cause of this war lie in conversations that could, and should, have taken place. Sanctions are no substitute. Now the consequences resonate globally across a world that is bearing the burden.
The resort to weaponising the multilateral trade and payment system has not been thought through. It is impelling larger countries towards autarky and our world towards the impoverishment of tens of millions of people globally.
There is no Plan B in place. It’s a hard message and an unpopular one, but history is insistent that re-building peace requires a willingness to reflect, to reach out beyond short-term aggression and punitive political pressures, to engage with the effects of our actions on the welfare and stability of the wider global community. Peace requires gritted teeth as well as grace.