The fact that central bank assets are now in play will almost certainly hasten the adoption of cryptocurrencies by rogue states. Photo / Sergey Ponomarev, The New York Times
OPINION:
Just a few days ago the international sanctions against Russia in response to its invasion of Ukraine amounted to little more than a peashooter. Now western countries are rolling out the heavy artillery: freezing the Russian central bank's assets, kicking the country's lenders off Swift and preventing them from accessing dollar clearing.
In today's globalised economy, no financial sanction is foolproof and there are clearly holes in the net now being thrown around Russia. Certain central bank assets will be held beyond the purview of western organisations and the lack of access to Swift will make global payments harder rather than impossible.
Indeed, some gaps have been left open intentionally. The EU is yet to follow the US and UK lead by imposing restrictions on euro payments and energy transactions have broadly been exempted from the wider financial crackdown.
But, despite the lack of a single knockout blow, the combination of punches will nevertheless be debilitating: taken together, these measures amount to the most draconian clampdown ever imposed on a G20 country's financial system.
It's clear they are already causing Russia to reel. When the first rather limp sanctions were announced last week, the markets hardly budged. Following the far more stringent interdictions over the weekend, the rouble crashed by nearly 30pc against other currencies and long lines of people started queuing outside Russian lenders in order to withdraw their savings - the first sign of an incipient bank run.
The Russian central bank was forced to almost double interest rates from 9.5pc to 20pc in order both to discourage withdrawals and to head off inflation caused by the sharply devalued currency. For another indication of their efficacy, look no further than Vladimir Putin's reaction: he claimed the sanctions were illegitimate and placed his nuclear forces on a heightened level of alertness.
The decision to eject certain Russian lenders from Swift, has garnered most of the headlines in the last couple of days but, while certainly important, this isn't the real game-changer. The Belgium-based member-owned organisation is effectively a messaging system that allows financial institutions to communicate efficiently and securely. There are other, more cumbersome, methods of making global payments. A rough analogy would be if email went down and you were forced to use fax - annoying but doable.
The far bigger step change is going after Russia's central bank and shutting its lenders out of dollar clearing. To understand why it's worth remembering Russia has been living under Western sanctions ever since it illegally annexed Crimea eight years ago. It has reacted to this partial isolation by developing what it calls a "fortress economy".
The keystone to its defences has been a budget that would remain balanced even if the oil price fell to US$40 a barrel. Anything above this was ploughed into a national war chest of over US$600bn in foreign reserves, equivalent to over a third of the country's GDP last year.
Russia has spread its risk by buying euros, yuan and gold instead of just dollars. But the fortifications have a weakness. These foreign reserves aren't sitting in bank vaults in Moscow. A good proportion of the assets are thought to be held on the books of international financial institutions - including other central banks - most of whom will comply with western sanctions because of the mighty greenback.
Every single payment in dollars not made with actual banknotes passes through the NY Federal Reserve. Given the high proportion of global trade that is denominated in dollar, the US Treasury can target criminal enterprises, terrorist organisations and rogue states by effectively forcing global banks to become its eyes and ears. Even famously neutral Switzerland has suggested it is prepared to freeze Russian assets.
Without access to its foreign reserves, the Russian central banks will be unable to prop up the rouble or the nation's lenders. Fearing a rout, the Moscow stock exchange failed to open on Monday. However, the London-listed shares of Sberbank, Russia's biggest lender, plunged by as much as 74pc.
There's very little precedent for this kind of action. The UK government has prevented Venezuelan President Nicolás Maduro from accessing £1.4bn of gold stored in the Bank of England but that is on the basis, upheld by the Supreme Court in December, that he is not the country's legitimate head of state.
The fact that central bank assets are now in play will almost certainly hasten the adoption of cryptocurrencies by rogue states. Two years ago Harvard University hosted a wargame where policymakers were asked to work out how they would respond to the threat of North Korea developing a nuclear missile funded with digital yuan. The participants, several of whom are now in the Biden administration, concluded the cryptocurrency posed a bigger threat to US national security than the warhead.
Such possibilities are no longer hypothetical. In recent years, Russia has looked at developing a digital rouble, explicitly saying this would make it more resistant to foreign sanctions. According to the UN, North Korea has used ransomware attacks to steal cryptocurrency in order to fund its nuclear programme. Iran is also thought to have used digital currencies. It is widely believed that billionaire oligarchs close to Putin might be trying to do the same.
This is why Mykhailo Fedorov, the vice prime minister of Ukraine, has asked cryptocurrency exchanges to block the addresses of Russian users. On Monday, Binance, the world's largest, said it wouldn't, adding that cryptocurrencies provide "financial freedom" and unilaterally banning access would "fly in the face of the reason why crypto exists".
Which may well be true - among the benefits of the distributed ledgers on which cryptocurrencies are based is that they allow relative anonymity for users and cut out financial intermediaries. But how crass does it sound to be talking about our financial freedoms when Ukranians are fighting in the streets for their actual freedom?
You won't have to go far to find those who resent the "exorbitant privilege" of the US dollar. And it undoubtedly allows Washington to impose its will on the world in all sorts of petty ways. But are we prepared to countenance the alternative - that Moscow gets to impose its will?
Putin's naked aggression is a wake up call that will force us to make a variety of tough choices. A world in which unregulated cryptocurrencies undermine the potency of the dollar is a world in which despots will find it easier to get their way. Financial freedom is important. But surely not at any cost.