The West’s sanctions on Russia

Jesús Fernández-Villaverde, professor of economics and director of the Penn Initiative for the Study of the Markets, discusses the severity of the sanctions, the effects so far, and the potential reverberations for the rest of the globe.

A line of people wearing winter coats and hats extends down a sidewalk in St. Petersburg, Russia, as they wait to use an ATM
People stand in line to withdraw U.S. dollars and euros from an ATM in St. Petersburg, Russia, on Feb. 25, 2022. Ordinary Russians faced the prospect of higher prices and crimped foreign travel as Western sanctions over the invasion of Ukraine sent the ruble plummeting, leading uneasy people to line up at banks and ATMs. (Image: AP Photo/Dmitri Lovetsky)

The European Union, the United States, the United Kingdom, and Canada have leveled harsh sanctions on Russia as retaliation for its attack on Ukraine, targeting the country’s central bank and Vladimir Putin himself.

Penn Today spoke with Jesús Fernández-Villaverde, professor of economics in the School of Arts & Sciences and director of the Penn Initiative for the Study of the Markets, to discuss the severity of the sanctions, the effects so far, and the potential reverberations for the rest of the globe.

What are some key things to know about the sanctions imposed by the West?

They are much harsher than what anyone expected. When the first round of sanctions was mentioned on Feb. 24, some journalists in Europe called them ‘the embarrassing sanctions’ because they were quite mild. The reason they were mild is because Russia is one of the main trading partners of many European Union countries, and a lot of these countries thought Ukraine was going to be conquered in just a few days, so what was the point of imposing the sanctions to hurt themselves for very little gain.

Paradoxically enough, the fact that Ukrainians did a much better job at defending themselves than anyone expected, and that the Ukrainian president is very charismatic, really made a difference within the European Union. There was a meeting where the Ukrainian president joined through teleconference with European leaders, and he changed a lot of hearts and minds.

The second sanctions package was much tougher—much tougher than Putin ever thought would go through and much tougher, in fact, than what most insiders within the European Union thought would go through. One surprise in particular was canceling the access of most Russian transactions from SWIFT.

The average person doesn’t think much about SWIFT, but it is the way in which banks make international payments. Let’s say you go to London for a vacation, and you go into a restaurant and you pay with your credit card. Something as simple as that is processed through SWIFT. So suddenly, very simple transactions like that from Russia to the rest of the world are going to be extremely difficult. As late as Friday, Europeans didn’t want to cancel the access of Russia to SWIFT, so that was a very large change.

What is the significance of freezing Russian central bank assets?

Russia had a foreign debt crisis in August 1998 under Boris Yeltsin, and the aftereffects of that crisis were what put Putin in power at the end of 1999. Putin always sold himself as a good economic manager, and his economic policy during the first 12 or so years of his presidency was quite cautious. One of the things he did was build a large buffer of foreign reserves to protect Russia against a repetition of this financial crisis. So, for instance, if I’m the Central Bank of Russia and I have an account at the Central Bank of Germany in Frankfurt, when there is a problem in the foreign exchange market, I operate from that account. Which means that if the Central Bank of Germany says, No you cannot do this, I’m freezing this account, then you lose all of your reserves.

That’s what European central banks have been doing, and I think that’s something that Putin did not expect to happen. It’s left him in a very tough spot.

What about sanctions on gas?

The line the European Union has not crossed yet is canceling gas purchases. Europeans are still buying gas from Russia, and they are still paying for that gas. That will be the ultimate sanction because a lot of European Union countries will then have serious energy-supply problems, and there will need to be some type of energy rationing. That’s something that will be difficult to sell. Those within the European Union who want to cross that last ultimate red line are arguing that spring is coming, and the use of gas goes down very dramatically then, not only because you don’t need to heat houses but also because a lot of the renewables, in particular solar, start producing more energy, and Germany could put back online some of its nuclear power plants.

A combination of these things, plus large shipments of gas from North Africa and from the United States, could make the canceling of the natural gas something that is feasible. But for some European countries like Austria, which is extremely dependent on Russian gas, things will be pretty tough.

What have been the effects so far on the Russian economy?

It’s a bit early to see. You might have seen photos of Russians running to ATMs over the weekend trying to get as much cash as possible. That’s actually not a big problem in the short run for Russia because the Central Bank of Russia can print as many rubles as they need. However, there was a big collapse of the stock exchange and a big collapse of the value of the ruble, of around 20%. But the real effects will be felt in a few weeks.

Sanctions are a weapon of economic warfare, in comparison with military warfare. If someone throws a bomb, it explodes right away, and the effects are felt immediately. If I impose a sanction on you, this may take a bit of time to really have an effect. This is just the beginning. In two or three weeks, Russia’s economy is going to start feeling the pains big time. What I suspect Putin is thinking is if he is able to wrap up the war soon, Europeans won’t stick with these very stiff sanctions. It’s a little bit of a waiting game, seeing who is going to run out of steam sooner.

This is one of those situations where the sanctions that the U.S. can impose are less relevant because the main trading partners of Russia are Germany and other Eastern European nations.

The Kremlin said today the sanctions won’t make it change course.

They are going to feel the pinch a lot. In three months, the Russian economy is going to be in a very, very tough position. When Vladimir Putin came to power in 1999, Russia was in a dire situation. The economy was in shambles. The first Chechen war hadn’t gone very well. Russia was coming out of a foreign debt crisis with a moratorium on its sovereign debt. Crime was high. Nothing was quite working. There was the general feeling that Russia was collapsing. Putin comes and tells the people, ‘Look I’m not a particularly nice person, but that’s precisely why you want me to be your president because you need a tough guy to fix this.’

He promises internal and external security. He takes down mafia crime, and he solves the Chechen war. The second thing he says he’s going to fix the economy. His economic policy for the first 12 or so years of his mandate was a good policy.

If you are a middle class Russian in 2009 and you look at the first 10 years of Putin’s presidency, you might think, ‘He may not be the person I want to invite home for dinner, but he has been a pretty good president.’ 

But as the Russian economy stagnated in 2009, he became much more authoritarian and developed a crazy foreign policy. So, the very same person who previously thought Putin was getting things done is now noticing that Putin is making their life miserable. It’s only going to get worse now.

How long can a government survive when the average person thinks that their president and their current regime is making their life miserable? Historically, regimes in that situation tend not to last a long time. He has reneged on his deal with the Russian people, and a lot of forces within Russia are going to start thinking, ‘We need a Plan B.’

In that sense, I think his insinuations about nuclear war are bluster. We’ve seen that the Russian army had turned out to be a paper tiger in terms of capabilities. They are still sufficiently more powerful than Ukraine, and they may eventually end up winning this war. But what is very clear is that, outside of nuclear weapons, Russia does not have the military capability to attack the West. Which means that the sanctions are going to hurt a lot because I don’t think a nuclear war is a rabbit hole even Putin will dare to go down. Even if he tries to do that, it would be a red line where even his own military may not follow.

What is the most important thing for people to understand about these sanctions?

First of all, these sanctions are not free for Western countries. We will need to sacrifice a little bit if we want to support Ukraine, and we will also need to pay a little bit. It’s going to be a cost in terms of higher inflation; it is going to be a budgetary cost, especially in Europe. This not going to be nice, but I think it’s a sacrifice that is within reason.

Second, everyone will need to be patient. One problem that democratic nations tend to have is that the attention of the electorate can fluctuate very quickly from one thing to the next. Let’s imagine that the war ends in a week; we want to be sure that in six months people don’t want to just move on and remove the sanctions. The sanctions need to be in position for the foreseeable future, which is very important from a credibility perspective.

And third, something that I think is very clear for the U.S. administration is that the future of Taiwan is also being adjudicated right now in Ukraine. I think that China has seen how the world has reacted to the outcome in Ukraine and how difficult it is to attack a country where the nationals are keen on defending themselves. I imagine China’s will to take Taiwan has decreased dramatically over the last week. That’s important, because China conquering Taiwan would have a ripple effect of unforeseeable consequences through all of East Asia. It would be nearly impossible to stop South Korea and Japan from going nuclear. Both South Korea and Japan could have a nuclear arsenal if they wanted in six months. I don’t think it’s in the interest of anyone.

If I were a betting person, I would say that Putin is not going to survive this. It may take six months, it may take three years, but he has cornered himself in a situation and there’s no rabbit left to pull out of his hat to get out of this.