Imagine that you get up one morning and the credit card does not work. You wanted the bank to take out some cash to buy at the grocery store. There you found a queue of hundreds of people, and on the door was a sign: “Up to 1,000 shekels per customer.” It turns out that everyone has a similar problem and the bank does not have enough banknotes to cover but a small portion of the deposits. So you asked to print some good old-fashioned checkbooks, hoping they would be received at the supermarket. But after waiting five hours, you are told that it will take at least a month until you receive the one notebook allotted to you.
Now imagine that all this is happening simultaneously not only to consumers but also to all businesses, companies, banks and institutions in the economy. No one can pay, collect, import, export, invest or even sell financial assets on the stock exchange. This is more or less the situation that is happening and coming upon Russia in the coming days and weeks. What President Vladimir Putin and his associates probably did not fully understand was that in a modern, computerized and connected world, physical violence is just one type of force. Another type, and no less destructive, is the economic war.
Queue for ATM in Moscow / Photo: Associated Press, Pavel Golovkin
The opposition that Putin might have anticipated, and the one that caught him by surprise
In the past, sanctions have been imposed on Russia, as well as on Iran, Syria and many other countries, and they have survived. So Putin and his people probably assumed that by the time the West moved Ukraine would fall, and then they could easily deal with some weak sanctions on the part of some of the divided Western countries. In this assessment there was thus a double error.
Ukraine’s stance may have surprised commentators in the studios, but not those familiar with history. In late 1943, during Operation Dnieper, Stalin’s huge Red Army liberated eastern Ukraine. The Red Army was accompanied by horrific Han-kah-wa-de-de units (then the main body for internal security and policing in the Soviet Union. The Ukrainian National Army (UPA) numbered about 200,000-150,000 fighters and launched a guerrilla war against them, and in February 1944 a UPA unit killed General Nikolai Vototin, the commander of the entire front, the hero of the Soviet Union, and one of the army’s most senior field commanders. The fighting against the UPA units continued into the 1950s, killing more than 120,000 Ukrainian rebels and more than 100,000, including family members, arresting and deporting them to camps in Siberia. The Western insistence and its immense power, even without firing a single bullet.
Less than a week has passed since the Russian invasion of Ukraine and all Western countries, including neutral Japan, Sweden, Sweden and Finland, have joined hands in far-reaching sanctions aimed at disconnecting the Russian economy from the world economy. At the forefront of the effort is Russia’s disconnection from the global financial system that is the oxygen pipe of the entire economy. The move began with the disconnection of parts of the banking system from the global Swift system, and the imposition of sanctions by central banks. Swift is not a bank or payment system, but a type of communication system based in Belgium, which allows banks to communicate with each other securely for the purpose of transferring money between them in a relatively efficient and fast manner. The system is a basic tool for international trade and is essential for any country seeking to participate in the global economy. But as far as disconnection from the system can disconnect Russia from the world economy, sanctions by central banks are even more severe. They could cause the entire Russian banking and financial system to collapse and go bankrupt.
Foreign trade accounts for almost half of the Russian economy
Russia’s gross domestic product (GDP) was about $ 1.5 trillion in 2020 and about $ 1.7 trillion in 2019. In 2020, Russian exports were about $ 379 billion, of which almost 240 billion are energy-related products (oil). , Gas and coal). Imports amounted to about $ 305 billion, mainly cars, pharmaceuticals, aircraft and food. In other words, almost half of GDP, directly or indirectly, is related to import or export activity. All of these will be severely affected by the combination of Swift and central bank sanctions.
Take for example a Russian company that imports products from abroad. Its revenues from the domestic market are denominated in rubles, its expenses for purchasing the products abroad are denominated in dollars, euros or other foreign currency. Since mid-February, its expenses have jumped by about 40% due to the ruble crash. But this is the smallest of its problems. The foreign currency required for the purpose of importation must be purchased from the local bank.
Russian banks have about $ 65 billion in foreign currency deposits, which they will use to meet that demand for foreign currency. Currency depositors will have a balance recorded in their account, but this is nothing but a right, ie a claim for receipt of this currency. But neither the bank nor the depositors were concerned that the foreign exchange would not be available. Before the crisis, the Russian central bank had about $ 630 billion in reserves, and thus was able to easily assist commercial banks in supplying foreign currency as required.
This knowledge reassures all players. The depositors are not worried that they will not receive their money, the exporters agree to continue to deposit the foreign exchange consideration in their bank account, and the importers are willing to conduct business and order and commit to suppliers abroad. But what will happen to the entire system if it turns out that the bank does not actually have any foreign currency and does not have any backup for receiving such currency from the central bank?
What are the bills worth when the foreign exchange balances disappear
A report by the Russian central bank from the end of June 2021 shows that about 22% of the balances (which then stood at about $ 592 billion) were held in gold bullion stored somewhere in Russia. An additional 14% was held in China in the local currency, the yuan. The rest of the reserves are invested in cash or bonds in various Western countries and international institutions. The freezing of Russian assets by central banks means that these reserves do not really exist in terms of the Russian banking system.
But not only are the foreign exchange assets non-existent, the huge gold reserves are also of no real value. Relatively, like China, in the hope that it will agree to exercise these holdings for Russia.
This exercise is not only dangerous but also impractical in no reasonable time frame. In the absence of real foreign exchange reserves in the central bank, even the foreign currency accounts in the commercial banks become worthless, while their owners seek, but doubtfully succeed, to get them back to them. In the absence of central bank reserves and backing together with huge difficulties in obtaining new foreign exchange exports, Russian imports may reach an almost complete halt in a short time. Commercial banks will not be able to meet their obligations to foreign currency deposit holders, and most import businesses account for 18% of the economy , Will close soon. Which of course will create a devastating domino effect on the entire economy.
Credit clearance has been blocked, and there is not enough cash
But not only are central banks and the Swift system suffocating the Russian economy, credit card companies Visa and MasterCard also announced on Tuesday that they will block access to a number of major Russian financial institutions. The list also includes the Russian central bank and some of the largest lenders in Russia. In the absence of access to clearing systems, not many days will pass and most of the credit cards commonly used in Russia will fall out of use.
If the sanctions against the central bank and the blockade of Swift will almost completely stop imports and severely hurt exports, then blocking access to the credit card clearing system will cause chaos at the level of the local supermarket. In 2019 only about 31% of transactions in stores and retail trade in Russia were in cash. Technically it is doubtful whether there are enough cash bills to replace the clearing with the credit cards required to carry out the retail trade. Even if the banking system continues to function normally.
All of this could lead to massive disruptions in retail trade. Customers will not be able to pay retailers except for the most essential products, these will not be able to pay suppliers to suppliers of products that have already been purchased, and will have to cancel orders that have already been purchased. Suppliers and manufacturers will not be able to order raw materials and pay wages, etc. etc. The road from here to an almost complete collapse of the economy and with it the standard of living to which most Russians are accustomed, especially in the big cities – is very short.
Trade with Russia becomes impossible
But not only are the financial institutions closing in on Russia, many international companies have also announced that they will leave the country. Over the past week, energy giants BP and I have announced that they have sold or will sell their investments in Russia and will stop operating there altogether. This is after three decades of investments in development in the Russian energy economy, the country’s main export industry. On Wednesday, the energy company Axon Mobile, the largest energy company in the world, joined the leavers. These companies have made a huge contribution to the Russian energy industry, both in investments and in knowledge and expertise. Decades of hard work of building shared infrastructure went down the drain in one week and what has been built over 30 years will be very difficult to rehabilitate years ahead.
Abandonment of Russia, cancellation of joint projects, cancellation of investments and cessation of the transfer of products and knowledge are spreading like wildfire. The German trucking company Daimler has announced that it will sell its holdings in the local trucking company Kamaz, which was also joined by Mercedes, which also owns parts of the company. British and American investment firms have also joined the outreach and so have international accounting firms and lawyers. All this will make the availability of investments and credit extremely difficult, especially at a time when the Russian economy is collapsing and suffering from immediate suffocation and a severe shortage of credit.
Currency Exchange in St. Petersburg / Photo: Associated Press, Victor Berzkin
It is not just government sanctions that are creating this exodus. Public sentiment also brings into action many companies that are not committed to it. For example, Apple announced on Wednesday that it would stop selling its products in Russia, joining Google, Ford, Harley-Davidson and others.
Trade with Russia will be almost impossible not only financially, during the week three of the largest shipping companies in the world announced that they are suspending most types of shipments to Russia. The blockade imposed by the West, including the US and Canada, on aircraft traffic from Russia is now also joined by a naval blockade. Also harm to oligarchs and their glorious yachts.
Good morning, you returned to the USSR economy in the 1970s
The combination of all these moves and more to come in the coming days, their speed and scope, will suddenly bring back the 21st century Russian economy to the days of the Soviet Union in the 70s of the last century. This is similar to trying to reverse a vehicle traveling at 90 mph while driving.
The size, power, and speed of this economic boycott are unprecedented, but the West still deliberately left several openings in the wall. These may go and close as horrific images of massacre of civilians, a probable result of fighting in the crowded urban areas, will begin to flow in the coming days and weeks.
Putin personally may somehow manage to survive the economic war but it is highly doubtful whether Russia will be able to. So the really big question remains, who will win the internal battle that is the key not only to ending the war but also to the lives and well-being of tens of millions of Russians. The Russian people or Putin?
The writer is a lawyer by education who deals with and is involved in technology. Manages an investment fund in cryptocurrencies, and lives in Silicon Valley. Author of the book “A Brief History of Money” and recorder of the KanAmerica.Com podcast