The sanctions the United States and its European allies have imposed on Russia, which now include an American ban on Russian energy imports, are the most restrictive ever imposed against a major economic power. The speed with which they were put in place, against a country whose economy ranks among the dozen largest in the world, was remarkable.
The sanctions are so strong that they were described as an “all-out economic and financial war” by Bruno Le Maire, the French economic minister, a comment so frank and potentially inflammatory that he immediately walked it back.
The measures, which include sanctions targeting Russia’s financial system, the wealth of powerful individuals, and Russian fossil fuels, are designed to punish Vladimir Putin and the oligarchs who support and depend on him, and hobble the Russian economy. They make it impossible to conduct normal business in Russia.
In the short term, that means a massive economic slowdown: The Russian stock market has been shuttered since the invasion, and many Russian companies with shares listed abroad have seen their equity values all but wiped out. The Russian ruble, which plunged as the war began and sanctions were rolled out, is now near an all-time low.
Sanctions are a uniquely powerful foreign policy tool in American hands because so much of the world economy is conducted in US dollars and ultimately subject in some way to US law.
In Washington, DC, sanctions are sometimes wryly referred to as the “first resort of US foreign policy,” sanctions researcher Edoardo Saravalle said in an interview. “The rules of the US financial system are, to only slightly exaggerate, the rules of the global financial system,” he said. “And Washington [can] kind of weaponize this.”
That uniquely American power to regulate global commerce through the US dollar system has grown stronger as the world’s economy has become more intertwined. Globalization has meant that more and more economic activity flows through an extremely small number of chokepoints, controlled by the United States and its close European allies. Over many years, the US has also built out a significant regulatory apparatus, controlled by the executive branch, to police those chokepoints very effectively. So any sanctions policy the US puts in place can be carried out quickly and with great effect.
Right now, Russia is now feeling the full power of those chokepoints being turned off by the US and its allies, but sanctions’ power is so uniquely American that the US can even go against its putative allies’ wishes, as the Trump administration did with Iran after it pulled out of the nuclear deal, without leaving the rest of the world much recourse.
In the coming weeks and months, Russian companies will have to adjust their operations to the reality of a shrunken economy and try to find ways to do business within the new constraints they face.
Russia’s economy will shrink 35 percent in the second quarter of 2022 and 7 percent for the entire year, JPMorgan estimates. Overall, the US bank expects the economic impact of sanctions on Russia’s economy to be on par with the slowdowns it experienced in the financial crisis in 2008 or the Covid-19 pandemic. Russia is also dealing with additional complications, one being a wave of corporate withdrawals from its economy, reflecting executives’ reluctance to be anywhere close to the red line of sanctions. And unlike in those earlier crises, large portions of the rest of the world are not acting to, say, rescue the global economy.
Instead, the Western world is working in remarkable unison to punish Russia economically in the hope that waging war against Ukraine will ultimately become so expensive and ineffective that Putin will seek a negotiated end to his invasion.
The aim of the sanctions is clear. “We are inflicting pain on Russia and supporting the people of Ukraine,” President Joe Biden said in his State of the Union address. “Putin is now isolated from the world more than ever.”
It’s tempting to think that such a sudden slowdown cannot be sustainable, but badly damaged economies can stagger forward in quite a diminished state for an extended period, Cornell professor and sanctions expert Nicholas Mulder has pointed out.
For sanctions to truly work as a means to their intended end, Western policymakers “must also promptly outline clear conditions for the removal of sanctions to encourage de-escalation and an end to this catastrophic war,” he wrote. It’s not yet clear what outcome would be considered sufficient to end the sanctions — either the official variety or the voluntary actions taken by businesses that now range from Visa to McDonald’s.
How financial sanctions work — and why crypto can’t overcome them
The sanctions put in place by the US and Europe fall into two broad categories: financial, meaning they deal with the banking system and capital markets; and economic, meaning they affect the rest of Russia’s economy.
On the financial front, Russian President Vladimir Putin and 11 other top Russian government officials have been hit personally with sanctions by the US Treasury Department. Their names have been added to the Specially Designated Nationals list, a compendium of entities and individuals that includes terrorists, drug cartel leaders, and government officials from countries like North Korea, Iran, and Venezuela. Being included on the list effectively means that any assets held in the global banking system are frozen and Americans are legally barred from doing business with those individuals.
Several Russian oligarchs are also facing sanctions, and the US Justice Department and some European law enforcement agencies are working to confiscate non-financial assets like real estate and yachts from those billionaires.
The financial sanctions go well beyond individuals and any companies they may use to hold assets. The US has also placed sanctions on Russia’s central bank and “immobilized” the reserves it held in the US financial system. The European Union put in place similar sanctions, meaning it has been impossible for Russia to use its $630 billion in reserves to help prop up the ruble by, for instance, selling US dollars or euros it holds and buying its own currency, or from using those reserves to make purchases to further the war effort.
The US also cut off Russia’s largest bank, Sberbank, which holds a third of the country’s banking assets, from the US banking system. It froze all assets held in the US financial system by VTB Bank, Russia’s second-largest bank, which holds a fifth of the country’s assets, and barred Americans from doing business with it.
Russian state-owned companies, including Sberbank and Gazprom, the oil and gas giant, are also now blocked from accessing US bond and equity markets.
One action by the European Union with US support has gotten the most attention: removing the banking sector from SWIFT, the main messaging system used in the international banking system.
SWIFT (named after the Belgian group that runs it, the Society for Worldwide Interbank Financial Telecommunication) is sometimes mistaken for the banking system itself because of its importance. But it doesn’t touch individual bank accounts — instead, it is the electronic messaging system that is used to send and receive cross-border payment instructions between banks. More than 11,000 different banks use SWIFT, and it was used in about 70 percent of transfers in Russia; while Russia has worked to develop a parallel system in order to reduce the impact of exactly this type of sanction, it is not widely used.
But there is one massive hole in the SWIFT sanctions, carved out by necessity: energy. Europe is reliant on Russia for natural gas. Last year, the EU imported 155 billion cubic meters of gas from Russia, or about 40 percent of its total natural gas used, according to the International Energy Agency. Europe can’t run its power plants and heat its homes without Russian gas, and the pipelines that send gas west have not been shut down; in fact, during the first day of the invasion, the amount of gas sent from Russia in pipelines across Ukraine to Western Europe actually increased.
And, of course, in order to keep the natural gas flowing, someone has to pay for it, and someone else has to receive that payment. As a result, Russia’s central bank, Sberbank, and the financial arm of Gazprom are excluded from the SWIFT removal because they are the main Russian institutions that receive gas payments from Europe and there isn’t a way to, for example, ban them from using SWIFT for all purposes except for gas payments.
Notably, the Swiss government has also said it will drop its long-held neutral stance and join in the sanctions by freezing Russian assets, including bank accounts.
Evading the sanctions that have crippled the traditional Russian banking system would seem like the moment crypto was made to meet — after all, the largest cryptocurrency, bitcoin, was created to allow for anonymous individuals to directly send money with no possibility of government interference.
But Putin and the Russian economy can’t survive on crypto alone for two important reasons.
The first is the overall size of the global crypto market, which is currently around $2 trillion, with bitcoin representing just over $800 billion. Compared to Russia’s $630 billion in international reserves, which the country has been prohibited from using in the Western banking system, that’s just not that much.
As Lloyd Blankfein, the former head of Goldman Sachs, succinctly put it, when it comes to using crypto to avoid wide-reaching sanctions put in place against an economy the size of Russia’s, “there isn’t enough now, and it’s not liquid enough.”
The problem for Russia’s central bank isn’t that it doesn’t have money — it’s that it cannot use any of the money it does have. Those currency reserves are frozen, so even if Russia decided it wanted to do something fanciful, like buy almost all of the world’s existing bitcoin, how would it pay for it? Russia can’t buy large cryptocurrencies for the same reason it can’t sell dollars and buy rubles: It can’t buy or sell anything.
More sanctions are aimed at Russia’s economy
The US has also put in place controls that block companies from sending a wide array of goods to Russia, including aviation, defense, and shipping components, along with higher-tech items like semiconductors and telecom equipment.
Those US export controls are intended to hurt Russia’s ability to get its hands on the kinds of manufactured goods it needs to wage a lengthy war, but they are also intended to hobble high-value manufacturing and other domestic economic activity that is not strictly related to the war effort, such as commercial aviation, which will not find it very hard to source replacement parts for its planes. There is also an almost total embargo against US companies exporting anything to the Russian military.
The US has also taken a step that even just a week ago seemed beyond what it was willing to do: The Biden administration banned the import of Russian oil, natural gas, and coal into the US.
While mainland Europe has not gone along with the US on this sanction, simply due to the fact that it is far more reliant on Russian energy imports and has basically no viable alternative, the UK said shortly after the US announced its import ban that it would seek to end Russian energy imports by the end of the year.
A host of large global corporations have also voluntarily severed business ties with Russia in recent days in a fit of what sanctions watchers call “overcompliance”: There is no legal necessity for them to cut out their Russian counterparts, but executives have calculated that continuing to do business in the country is not worth the reputational damage or operational hassle.
For instance, Mastercard and Visa have ceased Russian operations. Maersk, the global shipping behemoth, has suspended Russian bookings; ExxonMobil said it it is pulling out of a big oil and gas project in Russia and will make no new investments in the country; BP is abandoning its almost 20 percent stake in Rosneft at an expected loss of $25 billion; and Shell is shedding its ties to Gazprom, though it has purchased Russian oil on the open market recently.
Such a long and growing list of global corporations refusing to do business with a sanctioned country is not unprecedented — Western corporations have similarly severed ties with Iran, for instance — but, as with the sanctions themselves, that it has happened over the course of days and not decades, and that it is happening to the 11th-largest economy in the world, is completely new.
The dynamics that have led to the corporate withdrawal provide insight into one of the ways US sanctions can be so punitive: No large Western company can stomach being seen to do business with a sanctioned entity, even if the business it is doing is strictly allowed under the terms of the sanctions. The “reputational risk,” in corporate terms, is too high.
What comes next?
Unfortunately for Russia, the sanctions put in place by the US and the West are extremely comprehensive, and working around them to avoid a sustained economic downturn will be effectively impossible.
An influential 2019 academic paper written by Henry Farrell and Abraham Newman argued that decades of economic globalization, far from weakening the power of sanctions, has actually made them an even stronger tool because “some countries—most prominently the U.S.—are able to cut businesses or even entire countries out of these global networks, with profound economic consequences.”
Presciently, they wrote when their paper was released that “proper participation in the world economy requires access to global networks such as the dollar clearing system and the SWIFT financial network. We live in an interdependent world, but one where the dependencies are asymmetric.”
In other words, the options for Russia appear bleak. An attempt at forging greater economic and financial ties with China is likely, and because the two countries previously had lower levels of business ties than Iran and China did when Iran was recently hit with US sanctions, such a shift may offer a real growth opportunity. But even a marked uptick in Russia-China trade cannot offset American and European sanctions.
As a result, Russia will face a shrinking economy while it is on a wartime footing, with the US and Europe seemingly counting on sanctions to draw Putin into negotiations to alleviate some of the financial pain.