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13 April 2022

Russia’s looming default is Putin’s choice

The Russian president no longer has any interest in running a market economy or in spreading Russia’s wealth.

By Maximilian Hess

Russia and the West are engaged in a geo-economic war, launched as part of the West’s response to the Kremlin’s unprovoked invasion of Ukraine. Although a conflict of this scale has not occurred in modern memory, geo-economic conflicts are hardly new. Understanding the field of battle, and the respective armaments of each side, may prove as important to the outcome of Russia’s invasion as an analysis of its kinetic war effort.

The term “geo-economics” was first coined by the strategist Edward Luttwak, who used it to predict the basis for geopolitical competition in 1990, a time when he argued “the waning of the Cold War [was] steadily reducing the importance of military power in world affairs”. Robert Blackwill and Jennifer Harris, of the Council on Foreign Relations, have since summarised it as “war by other means”’, adapting Clausewitz’s famous phrase.

Yet kinetic and economic warfare have been intertwined since states first emerged: in 2400 BCE Mesopotamia, the city of Lagash cited neighbouring Umma’s unpayable debts to justify invading.

More recently, the US used debt claims to build its quasi-empire in Latin America throughout the 19th and early 20th centuries. Today, China is often accused of “debt trap diplomacy”, for example in Sri Lanka, which is struggling to repay $5bn in Chinese loans. For its part, Russia attempted to impose a debt trap on Ukraine in 2013, as Kyiv’s pro-Western revolution gained steam.

Such traps are one geo-economic instrument; debt bans are another. For example, the German chancellor, Otto von Bismarck, barred Russia from German capital markets in 1887, hoping to pressure the Kremlin but he instead pushed it into France’s embrace.

[See also: Do sanctions and soft power really work?]

State borrowing enables long-term investment, but it also allows capital to move across sovereign borders. Today’s Russia is not heavily indebted, but among the most significant impacts of the Western sanctions regime is the imminence with which Moscow is expected to formally default on its foreign debts, for the first time since 1918. That came at the hands of the Bolsheviks, who not only saw the Tsarist debts as odious but also saw building their envisaged workers’ paradise as a war on Western capital, not a way to develop it.

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Back in 2022, Russia is technically able to pay: it is flush with foreign cash, thanks to cratering imports and continued hydrocarbon sales. However, Vladimir Putin has made the choice to default, the latest evidence that he no longer has any interest in running a market economy or in spreading Russia’s wealth.

Russian Railways became the first state-owned enterprise to formally default, on 11 April. It will not be the last. The government is set to default on 4 May. In the best of times, emerging from such a default is a costly and difficult process. When accompanied by such a geopolitical cleavage, it can take decades to cure.

The West, meanwhile, recognises that forcing Russia into a messy default gives it long-term leverage, or at least believes it does. Venezuela’s frozen debts are another recent example of this form of geo-economics. The UK just repaid a decades-old trade debt to Iran to secure the release of Nazanin Zaghari-Ratcliffe, the British-Iranian charity worker accused of spying. New trade remains frozen, however, given US sanctions.

Trade restrictions are perhaps the best-known form of geo-economic warfare. Whether they be in the form of individual blacklists applied to Russian companies involved in the war, or bans on technology exports to Russia, governments have been restricting trade with their opponents for millennia as well.

Athens’s Megarian Decree blocked the Spartan client state of Megara from trading in its allied ports. To what extent this sparked the subsequent Peloponnesian War remains a matter for debate, but such complete trade-blockade sanctions are often seen as threatening war.

In July 1941, the US invoked the Trading with the Enemy Act, threatening Japan’s ability to finance imports. Tokyo reacted to this financial siege as it would a military blockade – five months later, it bombed Pearl Harbour.

Tokyo felt threatened because it was wholly dependent on external commodity supplies. Russia today is in the opposite position; its economy is dependent on selling its commodity surplus abroad. It has attempted to use this position to return fire in its geo-economic war with the West, given its lack of debt leverage.

Putin’s Kremlin has a long history of politicising food and drink – ask any Georgian or Moldovan. Its crucial position in grain markets enables it to exert pressure. The Kremlin has even banned grain exports to its allies in the “Eurasian Economic Union”, part of its strategy to pressure them to stay in line over its war in Ukraine, even as Russian wheat exports to the rest of the world continue apace.

It has also used its gas sales to try to avoid being completely severed from the wider financial world, hence its demand that importers pay for gas in roubles. The move is not about Russia’s balance sheet, but ensuring there is still external demand for its currency.

[See also: What Assad can teach Putin about surviving international isolation]

Currencies are another area of geo-economic conflict. Sanctions can heavily restrict their convertibility. Trade in the Russian rouble has fallen precipitously as demand has dried up, but it is not yet at the nadir reached by Cuba, which is forced to operate both an inconvertible domestic peso and a convertible one.

This is perhaps the most important, and novel, battlefield in the Russian-Western geo-economic war. Restrictions on foreign coinage have also existed but, historically, money took its value from the base metal it was made of – foreign monarchs’ visages could be melted off. This is no longer the case – as University of Cambridge’s Geoffrey Ingham explained, today “money is a form of sovereignty and as such it cannot be understood without reference to an authority”.

This has in large part been enabled by the movement of money across borders, which accidentally emerged from the collapse of the Bretton Woods system in which the US was supposed to be the gold provider of last resort. If you can exchange your paper money for someone else’s that represents a better store of value, there is less need for gold and silver.

Russia has not yet lost this war, even once it defaults. Its currency remains convertible, though it could still be shut off if Europe gains the courage to act on oil and gas sales. But Russia is undoubtedly losing: its commodity tools are no match for the West’s debt bans in terms of economic impact.

Even if Russia proves victorious in the battle for Ukraine, it may well lose the war if it is defeated economically.

[See also: Economic crisis helped Putin rise to power. It could also be his downfall]

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