The cost of Russian sanctions on the US

Since the Russia-Ukraine conflict began, the US, EU and their allies have imposed strong financial sanctions on Russia. They have frozen $300 billion in Russian foreign currency reserves, removed Russian institutions from SWIFT and banned foreign investment in the country.

The impact of these sanctions – which have cut Russia off from the global financial system – has been severe. Inflation in Russia has risen to more than 17% and is likely to continue. There are severe shortages of food, medicine, medical equipment and IT equipment.

More than 750 companies have announced plans to suspend or end investments and operations in Russia. The European Bank for Reconstruction and Development predicts that the conflict will cause the Russian economy to shrink by 10% this year, a staggering drop in economic activity.

The sanctions are so devastating because of the current US dominance of the global financial system. The US dollar is the primary currency used for international trade and global financial transactions, and is also the foreign exchange reserve held by most central banks. Since the vast majority of international payments are made by correspondent banks in the US, they are subject to Washington’s rules. The US also has significant influence over SWIFT, a payment system that processes trillions of dollars every day.

The benefits the US enjoys from the current system are enormous, from abundant capital flows to the ability to borrow cheaply from abroad, and from the lack of foreign exchange costs or risks for most trade transactions to the ability to use financial sanctions as a powerful “weapon” against adversaries.

The United States sees sanctions as an effective, low-risk tool that can inflict serious damage on another country’s economy without military intervention. So far, US sanctions have targeted a wide range of targets, from foreign regimes to Swiss banks, and from Chinese technology companies to staff at the International Criminal Court investigating whether US forces committed war crimes in Afghanistan.

These sanctions could have two significant consequences.

The imposition of these unprecedented sanctions could prompt some countries to look for alternatives to the current US-dominated global financial system. Russia and China have developed their own financial systems that they claim are alternatives to SWIFT, although uptake has been limited so far.

In 2019, Russia and China agreed to use their national currencies in cross-border transactions between the two countries to replace the US dollar. China has also signed currency swap agreements with several countries participating in the Belt and Road Initiative, including Russia. The development of digital currencies could also be a step toward dethroning the US dollar.

In addition, US sanctions could lead to a decline in global currency reserves. Before the Russia-Ukraine conflict broke out, there was a clear push among countries to reduce their reliance on the US dollar as an international reserve currency. The share of global reserves held in the US dollar fell from 73% in 2001 to 59% in 2021. About a quarter of the shift away from the US dollar went to the Chinese yuan.

While no other currency is likely to completely replace the US dollar as the global reserve currency in the near to medium term, the trend towards a multi-reserve currency system is gradually being established and the recent extraordinary sanctions against the Russian central bank may accelerate this shift.

The next consequence is polarization. As global reserves diversify, there will likely be a new impetus for the development of an alternative financial system alongside the US-dominated one. This will lead to polarization as the world divides into blocs, destabilizing global monetary relations. In a polarized system, more transactions will take place outside of existing regulatory channels, making it less likely that regulators will be able to monitor and control illicit transactions.

The sanctions against Russia have sent a strong message that violations of global norms established by the United States and its allies and partners will not be tolerated. But the West will also pay a price for these sanctions. It is likely that non-Western countries and some Western countries will also reassess the risks of continued dependence on the US-dominated global financial system. As a result, their ability to leverage their economic power in the future and the integrity of the US-dominated global financial system are being challenged.

According to Tin Tuc Newspaper