Central banks as weapons: how the West learned from the eurozone crisis
Targeting of Russia's basic financial infrastructure is already proving effective. But this is a weapon honed in Europe over the last decade of crisis.
Customers queue outside a Sberbank branch in Prague, February 2022. Source: BBC.
Back, after an extended pause over Christmas and New Year. Scenes from Moscow and other Russian cities over the last 24 hours suggests the initial stages of a bank run, whilst the rouble fell almost 40% in early trading as East Asian markets have opened. This was the intended result of the economic sanctions announced by European powers, Canada and the US, subsequently joined by Japan, over the weekend. The sanctions are measures of an unusually severe degree, threatening potential economic devastation, but the major mechanism they use has been road-tested over the last decade of economic crisis and disorder.
What follows is a reduced version of what ended up being a significantly longer essay on the post-neoliberal, post-globalised world. As with the US/UK invasion of Iraq, there is no credible justification made for what Putin is inflicting on Ukraine and its people, and the case offered by the Putin regime is also one transparently based on lies. But the invasion and its consequences dramatically expose the shape of the world system after more than a decade of war, disorder, and pandemic since the 2008 financial crisis. Events are, obviously, unfolding extremely rapidly, however, and I wanted to put something quicker down here.
Not oligarchs, not SWIFT
First, talk of financial sanctions has previously tended to focus on the flows of Putin regime-connected and often criminal financing that make their way through Western banking systems – notably including London. Restrictions on the ability of this or that oligarch to transact as they wish, whilst important, are closer to a severe nuisance rather than applying critical pressure. Likewise the ban on “golden passports” for oligarchs: long overdue, but hardly a knockout blow.
Second, the critical part of the package is not the removal of three major Russian banks from the SWIFT interbank messaging system. There has been a significant amount of confusion over this, and of course to the extent that SWIFT is mistaken for a payments system or something fundamental to the operations of a bank, noisily announcing a sanctioned removal of Russia from the system could undermine public confidence in its banks.
But SWIFT is not a payments system, and is not required for conventional domestic transactions; it facilitates the more rapid request of money transfers between international banks, and therefore facilitates foreign trade. It is not essential to foreign trade: banks in different countries can request money off each other in different ways if they are denied access to it, even if that has to be via fax. Since 2014, after the US first threatened to pull the plug on Russian access to SWIFT, the country has been busily setting up its own interbank communications system, SPFS, operational since 2017. “Sleeving” of trades, in which a third party is commissioned to undertake provide trade credit and undertake between Russia and some country seeking to buy oil or gas, is also an option.
Russia isn’t unusual in establishing its own, alternative monetary systems. China has a separate bank payments system, the Cross-Border Interbank Payments System, operational since 2015 and providing renminbi-denominated payments services for 80 participating banks, HSBC and Standard Chartered amongst them. India is currently moving towards establishing a rupee-denominated payments system to “soften the blow of sanctions”. India, whose ties with Russia stretch back to its earliest years free of the British Empire, continues to be Russia’s biggest market for defence and security equipment. A similar system had been established by New Delhi to swerve round sanctions imposed on Iran.
Over the longer term, the political restrictions now being made to the US-centred (if Belgium-headquartered) main global interbank messaging service are likely to only reinforce the tendencies against globalisation, and towards the organisation of the world economy into regional blocks.
But the immediate impact is what matters this morning. Deprived of full access to SWIFT, trade between Russia and the rest of the world will become harder, including the crucial oil and gas trade. (S&P Global here have details on how Russia trades its oil.) That, in turn will make accessing foreign currency harder and therefore, a step down the line, might begin to threaten the stability of its banking system. As Zoltan Poszar of Credit Suisse argues, a SWIFT ban will act to further weaken the Russian economy - with some risk of financial blowback in the West. But it’s not the main financial weapon being deployed here.
Nor has oil and gas trade been directly targeted. With prices for both already shooting up, and with Russia supplying about 40% of Europe’s natural gas, the costs to those trying to apply the sanctions start to look greater than the benefits of applying them. Liquified Natural Gas (LNG) from producers including Qatar and the US now supplies about 20% of demand across the continent. But there are limits to supply, both at the production end and at LNG terminals in Europe, and European demand is only part of a global market. Any increase in demand here is competing with demands for gas across Asia and beyond. Gas stocks in Europe, meanwhile, are at a record low: were Russian gas flows to halt entirely, the continent has about six weeks’ of supply at hand. It is, no doubt, an awareness of this dependency that emboldens the Putin regime.
Weaponising central banks
There is, however, an economic weapon that can be utilised at no economic cost to those wielding it. A bank run in Moscow costs Berlin, London or Washington nothing. And so the primary weapon of the sanctions package are the restrictions on Russia’s central bank. The joint communique says:
we commit to imposing restrictive measures that will prevent the Russian Central Bank from deploying its international reserves in ways that undermine the impact of our sanctions.
Specifically, this is aimed at blocking the Bank of Russia from selling much of its reserves on international markets, these reserves being valued at around $640bn. In recent days, it has been selling these at pace, buying up roubles in an effort to preserve the currency’s international value. If Bank of Russia cannot sell its reserves, with institutions holding its assets unwilling to offload them, and others unwilling to buy them, the operation to prop up the rouble becomes impossible. The rouble will collapse, as we have seen this morning. That, in turn, threatens a bank run, as depositors look to remove their increasingly worthless roubles from bank accounts, and turn them into more valuable and stable currencies – like the dollar or the euro. A run on Russian banks may, at the time of writing, already be underway, with queues at banks reported over the weekend.
Not all of Russia’s central bank reserves have been rendered useless. Around $145bn of them are held as gold (which is physically held in Russia) and, if it cannot be sold directly – literally transferring physical bars of the yellow metal – it can in theory be converted into promises to pay them later. A further $90bn (or around 14%) of these reserves are held as renminbi, and China has consistently indicated it will not join measures against Russia.
Source: Financial Times
Bank of Russia has spent the eight years or so since 2014 busily both building up its reserves and divesting itself of dollars and dollar-denominated assets. Its $6bn holdins of US Treasuries today are far below the record high of $176bn in October 2010.
This was completely political – a deliberate attempt to minimise the potential impact of future sanctions, of the kind being applied now. Its huge current account surplus, the $19bn difference between what Russia exports and what it imports that has been built up over a decade of oil and gas sales, also provides some protection against aggressive economic sanctions. The share of dollars in Russia’s export trade has fallen from 69% in 2016 to 56% in early 2021 - still significant, but a reduction in potential exposure nontheless.
Likewise, the “swaplines” that came into their own between the Federal Reserve and major economy central banks in the depths of the 2008-9 financial crisis, providing cheap dollar funding from the Federal Reserve to other central banks when interbank markets were not able to, have been increasingly emulated by non-dollar economies. The Council on Foreign Relations has an animation, showing the growth of global swaplines since the 1997-98 East Asian crisis, here, alongside an explainer of their operations.
Source: Council on Foreign Relations
These swaplines now form the backbone of an emerging and increasingly regionalised financial system. Swapline arrangements are globally worth $1.9tr, and other “regional financing arrangements” $1.4tr. Both are hugely bigger than the IMF’s $1tr of available resources for use in financial emergency.
Source: IMF. “BSL” is “bilateral swapline”, “RFA” is “regional financing arrangement”.
China and Russia have had a renminbi swapline open since 2014, whilst China has signed more than 32 swapline deals with different countries since 2009. The declaration, just a few weeks ago, by China and Russia of a “friendship without limits” showed the direction of travel back then.
But China-Russia direct trade remains only a part of Russia’s exports. And evidence is mounting that Chinese financial institutions, fearful of “secondary sanctions” against those dealing with Russia from the US and its allies, are quietly tiptoeing away from support. China may want a post- dollar world. But Russia’s invasion of Ukraine pre-empts that goal by perhaps decades.
How the ECB deployed the central bank weapon
The economic blow from central bank sanctions on Russia will remain exceptionally severe. Bank of Russia will likely find that capital controls and dramatic interest rate hikes are what it relies on to try and defend the rouble and thus its banking system.
Central banks are the nerve centre of any currencies’ finance and banking system. Their primary function is to act as a “lender of last resort” for a currency’s banks, stepping in to guarantee that banks in financial difficulties do not fail. As an extension of this primary function, they may well have powers to (for instance) defend the value of a country’s currency – which can be seen as a subset of defending the credibility of its banks.
But this huge domestic power can be flipped, judo-style, into an overwhelming weakness where a country no longer has full control over its central bank and cannot, as a result, guarantee the stability of its banking system.
There is a precedent for the weaponization of central banking that we are now seeing play out. Documents leaked in November 2014 showed that the European Central Bank threatened the Irish government with the collapse of its banking system if it did not accept the ECB/EU/IMF bailout four years earlier. Even more dramatically, the ECB repeatedly threatened to end emergency support for Greece’s insolvent banks if the newly-elected Syriza government did not accept the bailout conditions it was offered from February 2015 onwards. These conditions included extended austerity, to which Syriza was vehemently opposed. Syriza attempted to get out of the bind with a referendum on accepting the bailout in July that year, but its gambit failed. Europe’s first radical left government in decades was brought to heel.
Both Ireland and Greece were eurozone members and politically aligned with the European institutions – ultimately, it was Greece’s unwillingness to break more fundamentally with those institutions, by leaving the euro, that allowed the ECB to threaten its banks’ collapse, and scuppered Syriza’s anti-austerity programme. Outright central bank sanctions, too, were used during the financial crisis. Britain’s freezing of Icelandic financial assets in October 2008, using the powers available under the Anti-Terrorism, Crime and Security Act 2001, saw its central bank briefly (if incidentally) targeted.
The same ECB technique – attack the central bank to undermine the banking system – has now moved from threat to application against a hostile country, presently at war with a close ally of those applying sanctions. The warhead of the weapon is the same, but the context is radically different, and radically more dangerous as a result: Putin’s lurch from dark hints to the mobilisation of Russia’s nuclear forces shows both how effective the weapon is, but also the grave consequences of actually using it. Russia cannot respond in kind to the central bank attack – Russia’s financial system is small, relative to the dollar-finance system, and weakly integrated into it - and so its government has instead responded where it has the capacity to do so. It is troublingly unclear how far this prospect of an immediate Russian military escalation was built into the Western powers’ planning.
The people that suffer most immediately from the joint powers’ central bank sanctions will, of course, be the Russian public, now contemplating the loss of an elementary utility in modern life, the banking system, alongside the serious prospect of hyperinflation. The rest of us, meanwhile, are being dragged terrifyingly closer to the precipice of nuclear war.
I was very saddened to hear, earlier this month, of the death of Neil Faulkner, archaeologist, historian, and revolutionary socialist. As the online tributes showed, Neil, like Ed Rooksby (whose anniversary has just passed) and Leo Panitch had at least as much impact in his role as teacher as in his written work. I’d met Neil many years ago, when we were both involved, in the wake of the 2008 crash, in trying to set up organisations of the left that could respond adequately to it – one of which, the People’s Assembly, had gone on to play a critical role in making the Jeremy Corbyn movement happen.
Neil had set up the Brick Lane Debates with others in 2014, which had grown, by the time of the 2015 Labour leadership contest, into an effective venue for younger leftists to meet and discuss political questions and which then fed into both Momentum and The World Transformed. Neil himself was incredibly prolific – not only as an organiser, but as an archaeologist, busily organising and running major digs over many years, and as a historian and polemicist. Even here I think his role as a teacher comes through: his metaphor of the long-run historical process as a combination of cycles in human society, and the arrow of technological development, has stuck with me, and I know plenty of others learned from him.
The last book of his I read - not his last book, Neil was nothing if not prolific - was Lawrence of Arabia’s War, a superb account of the Eastern Front in World War One and the collapse of the Ottoman Empire that brought together Neil’s huge skills as a stylish writer with his analytical grasp of the different levels in which history plays out: the raw material of economics and class conflict, the clash of institutions, the political manouvering and battlefield tactics, and the purely human, personal relationships. If you’ve not read any of his writings, this would be a fine place to start; or else the online archive of his work is being assembled over here.