By Tim Shanks
The use of economic sanctions as a weapon is an ancient practice. The first recorded instance was in 423 BC, when Athens banned traders from Megara to strangle the rival’s economy. However, it was only in the 20th century that economic sanctions became a regular feature of international relations.
After World War II, the predominant architect of economic sanctions was the United States, which imposed them on, among others, Cuba, Libya, North Korea, Syria, Vietnam and recently Iran.
The sanctions imposed on Russia in the wake of the invasion of Ukraine are unlike anything we have ever seen; this is less due to the scope of the sanctions than the nature of Russia itself.
Russia is a powerful country with the largest deposits of natural resources in the world. It has abundant oil, natural gas, timber, copper, diamonds, zinc, bauxite to make aluminium, nickel, tin, mercury, gold and silver. At a time in history when we have already exceeded the limits of what we can sustainably extract, these deposits give Russia an economic power that far exceeds the modest size of its economy. Furthermore, Russia has the world’s second-largest arsenal of nuclear weapons, making it a formidable foe that cannot be conquered by conventional warfare.
These factors are of great importance when assessing the effects of economic sanctions on Russia. There is a significant chance that the sanctions could lead to the collapse of the global monetary system. To understand why, we need to take a step back and understand how the global monetary system is presently designed.
The U.S. dollar as the global reserve currency
The cornerstone of economic sanction is the United States, by virtue of the fact that its currency, the U.S. dollar, has a prominent role in international trade. The U.S. dollar is the de facto global reserve currency, the currency that is used for the settlement of all global payments. With very few exceptions, the U.S. dollar is accepted as payment everywhere in the world.
This goes back to the Bretton Woods conference at the end of the Second World War, when a global monetary system centred on the U.S. dollar was instituted. While the UK and other countries wanted a neutral global reserve currency, the United States insisted it should be the U.S. dollar. At the time, the United States was the largest creditor in the world, with an impressive trade surplus, while all other countries, devastated by war, were indebted and economically weak. Due to this superior negotiating position, the United States position was accepted, and the dollar became the currency used for international trade. It was fixed to gold at the rate of USD 35 per troy oz., and all other currencies were linked to the dollar at fixed exchange rates.
Then in 1972, with significant expenses for the Vietnam war, President Richard Nixon decided to untether the U.S. dollar from the gold standard and let it float freely. The United States would no longer exchange U.S. dollars for gold, and all the currencies linked to the U.S. dollar were allowed to float freely. One would have thought that this would have eliminated the U.S. dollar as the global reserve currency, but that did not happen. Instead, the United States suddenly had the best of both worlds. Its currency was still the dominant currency for settlement of global payments, while it was no longer linked to gold. This gave the United States a considerable advantage compared to all other countries, in that it, in effect, could import goods from the rest of the world free of cost. The United States indeed pays in U.S. dollars, but as the Federal Reserve Bank can create U.S. dollars in infinite quantities without any actual cost, the imports are essentially free. In fact, the entire budget deficit of the United States is financed by its trade deficit.
Realising the enormous importance of maintaining the dollar as the global reserve currency, the United States has, throughout its history, aggressively protected this privilege. While there are many instances of this, a few examples are listed here:
· When the United States invaded Iraq the second time, it was not because Saddam Hussein had weapons of mass destruction. As subsequently was confirmed, he had none. Saddam Hussein’s actual crime was that he had offered to sell oil in euros instead of U.S. dollars, which would have undermined the dollar’s hegemony as the global reserve currency. The United States was willing to go to war to protect its undeserved privilege.
· Moammar Gaddafi made a similar mistake by urging African nations to adopt the dinars, a currency backed by gold, and insist that they would only sell oil in that currency. Two years later, CIA instigated an uprising in which the government was deposed and Gaddafi was killed.
· In 2001, Venezuela announced that it would start selling oil in Euros, and two years later, there was a coup attempt, which is believed to have been backed by the CIA.
Despite the clear privilege that the system awards the United States, there has generally been a global consensus to allow the U.S. dollar to remain the global reserve currency and consequently allow the U.S. Federal Reserve Bank to act as the global central bank. However, and this is important to understand, the U.S. dollar retains its status because other countries allow it. Knowing that it gives an unfair advantage to the United States, other countries accept the arrangement for two reasons. First, there is no readily available alternative, and secondly, the consequences of trying to break out of the system are severe, as Saddam Hussein and Moammar Gaddafi discovered. Due to this, not even powerful nations such as Russia and China have actively tried to upend the global order.
This is now changing.
The effect of Russian sanctions
Economic sanctions are generally effective when the target for the sanctions has been small enough to avoid causing any problems. While there are many types of economic sanctions, such as trade embargoes, export controls and travel bans, the most potent sanctions are asset freezes and seizures. The Federal Reserve Bank, which controls and monitors the transfer of U.S. dollars between banks throughout the globe, can effectively freeze any dollar deposits in any bank anywhere. They can furthermore block inflows of dollars to any country and effectively cut the country out of the global clearing system. That is what the United States has done to Russia since the invasion of Ukraine.
Until the recent sanctions, Russia, like all other countries, had agreed to play along with the global monetary system, in which the United States, through the U.S. dollar, effectively controls worldwide trade and finance. After having hundreds of billions of dollar-denominated assets frozen, being forced to default on its foreign debt, and being barred from the global SWIFT payment system, Russia has nothing more to lose. Any economic sanctions the United States could impose on Russia have already been implemented. That means that regardless of what Russia does, it is almost impossible to put more financial pressure on Russia now. Realising this, Russia is now forging ahead in ways that would have been inconceivable only a few months ago.
The most significant of the steps Russia has taken is to sell its oil in roubles instead of U.S. dollars. Why would Russia sell energy in U.S. dollars to have their money frozen by the US Federal Reserve Bank? That would be just like giving their oil and gas away for free.
Russia has largely been successful in this attempt. As more and more nations and companies agree to pay for energy exports in roubles, the rouble has increased by 40% against the U.S. dollar since January. As of June 2022, the rouble has become the strongest currency in the world.
Even if Europe completely stops importing gas and oil from Russia, Russia can most likely find other buyers, including China and India. Since the imposition of sanctions, China and India have drastically increased their importation of Russian oil and gas, and have so far more than compensated for the reduction of supplies to Europe. Furthermore, the sanctions push up energy prices, which only favours Russia and punishes the rest of Europe. Presently, Russia is earning USD 20 billion a month from energy exports. With those windfalls, Russia can offer attractive discounts on its oil and still make more money than if the sanctions had not been in place.
While the short-term consequences of Russia evading economic sanctions might be irritating for those trying to impose them, the long-term impact on the global monetary system is far more significant. Having gotten away with selling oil in roubles, Russia is never going back to accepting payments in U.S. dollars. This creates a demand for roubles abroad, which means that Russia will be able to buy foreign goods in roubles instead of U.S. dollars. Other countries will surely observe this phenomenon. While India has so far paid for imports in roubles, an agreement is currently being worked out in which Russia will accept Indian rupees in payment. If China, the world’s second-largest economy, starts to sell goods in its currency, the renminbi, which is what they always have wanted, it will further weaken the hegemony of the U.S. dollar and the entire global monetary system.
Creating an alternative global reserve currency has long been the goal of China, which, in cooperation with other BRICS countries (Brazil, Russia, India, China and South Africa), it has been working on for many years. The sanctions on Russia might just be the extra push needed to make this happen.
While the fall of the U.S. dollar as the global reserve currency historically is bound to happen at some time in the future, the imposition of sanctions on Russia may just have accelerated the process. In the past, the United States has always put the interest of the U.S. dollar first. This time, U.S. leaders chose other priorities and, in their attempts to punish Russia, weakened the protection of the U.S. dollar as the global reserve currency. It is a decision the United States may live to regret.