The Costs of Russian Sanctions on US Citizens

Russian and U.S. state flags fly near a factory in Vsevolozhsk, Leningrad Region, Russia, on March 27, 2019. Anton Vaganov/Reuters

Commentary 

Like most readers of this newspaper, our wish for the Ukrainian people is for peace, prosperity, and self-determination. In an attempt to punish Russia for its invasion of Ukraine, the United States has put in place sanctions that are making life more difficult for many Russians and especially for its wealthy oligarchs. In a previous article, we wrote about the costs those sanctions would have on inflation in the United States and in particular about the additional costs for energy and food. In addition to increasing inflation, the U.S sanctions may also have the devastating impact of reducing the status of the dollar as the world’s primary reserve currency.

Why Preserving the Dollar as the World’s Reserve Currency Matters

Having the world’s reserve currency means that other countries hold dollars as a way to safeguard sovereign wealth. It means that many purchase agreements between other countries get priced in U.S. dollars. An example is the petrodollar, which refers to the worldwide practice of pricing oil in dollars even if the United States isn’t one of the parties involved in the sale. In addition, when traveling, I’ve found that many foreign businesses are just as happy or happier to get paid in dollars than their local currency.

The benefit of that to the United States is it creates enormous demand for dollars. In many ways, dollars are the top export of the United States, and foreign demand for dollars is a key reason we’re able to run $5 trillion annual budget deficits (plus another $4–$5 trillion of future liabilities that don’t count against the current national debt). It’s the status of the dollar as the world’s reserve currency that allows the United States to live far beyond its means. Loss of this status means weaker demand for the dollar, and in turn, means that we will need to live on a much more frugal budget.  Given that the government won’t have the ability to insist on an additional $5 trillion in taxes each year, spending would need to come down.

Freezing of Russian Dollar Reserves

In February, the United States froze the dollar reserves of the Russian Central Bank. At first glance, this action seems to make sense. If the Russians are going to invade another country, reducing their capacity to pay for expensive military actions would be an effective way to discourage that behavior. The problem isn’t so much that the United States impounded Russian money. The real issue is that the United States sent a message to the rest of the world that the dollar doesn’t represent “hard” (reliable) currency; but rather, is only available for use as long as a country is on friendly terms with the United States and acts in accordance with U.S. policy.

It’s a short step for other countries to recognize that incurring the displeasure of Washington could mean their assets are seized next. In general, the percentage of foreign reserves being held in U.S. dollars has been declining for years, and freezing Russian assets denominated in dollars will only accelerate that trend. Any country questioning its level of adherence to U.S. preferred policy has to be looking at holding a greater variety of foreign currencies for reserves, or just holding sovereign wealth in gold.

Already, Saudi Arabia is in discussions to price future oil transactions in Chinese yuan. Russia has put a floor price on gold in Rubles. Russia has also indicated it will only accept Rubles or gold for oil and gas being sent to Europe. The EU has said it won’t accommodate that demand, citing the existing contract terms specifying payment in euros and dollars; however, it’s difficult to enforce a trading contract with a nation engaged in war. Europe needs Russian oil and gas, and Russia needs the money. It’s not clear yet what currency will be mutually acceptable, but we can see that U.S. policy is affecting the desire and willingness of other countries to continue to transact in dollars.

The Russian ruble crashed at the beginning of the conflict, falling to a level of over 140 rubles required to purchase a single dollar. As of this writing, the ruble has almost completely recovered to it pre-war level.

A graph showing the decline in value of the Russian Ruble vs the U.S. Dollar at the beginning of the war and subsequent recovery. Data from Investing.com

Denial of Access to the SWIFT System

SWIFT is the messaging system used for international money transfers.  Shortly after Russia invaded Ukraine, the United States cut many Russian banks off from the system. The thinking was this action would weaken key Russian financial institutions and possibly cause them to fail. Instead, these Russian banks quickly linked to the newer Chinese system. Currently, the Chinese system doesn’t carry the volume that SWIFT does. Still, the end result is that instead of causing Russian bank failures, we’ve strengthened the Chinese system as they attempt to create a greater sphere of economic influence for Chinese interests.

Attempts to Crash the Credit Card System Failed

Once the Russian invasion started, Visa and American Express quickly exited the Russian market along with many phone-based payment systems. The western media enjoyed showing photos of the chaos in the Russian subway system as riders were no longer able to use their cell phones to pay. Years ago, in order to avoid these exact circumstances, Russia put in place its own payment system. Visa and American Express still did business there, but those companies were using a Russian system for payments. That allowed Russia to quickly shift to Chinese UnionPay credit cards again, and in turn, handing more volume and influence to the China-based systems.

Has Anything Worked?

In our opinion, the most effective sanctions have been the denial of parts and technology to Russia. The unwillingness of Boeing and Airbus to provide parts for plane maintenance could soon ground much Russian commercial air travel in a country that covers more land mass than any other on the planet. We also think many of the financial sanctions have succeeded in creating temporary disruption in Russia, forcing them to find other options.

The people implementing the sanctions mean well, and Russia should exit Ukraine and negotiate a mutually agreeable security pact. We’ve previously expressed our concern that the White House isn’t communicating the costs of the sanctions to American citizens who are getting increasingly unhappy with rising food and fuel prices. Further, there are few people in Washington of either party who have given much thought to what happens to the standard of living in the United States if our politicians continue to find ways to weaken the value of the dollar as the world’s reserve currency.