Plain English with Derek Thompson - Russia’s Economic Meltdown, Putin’s Big Mistake, and the West’s Financial War Against Vlad and the Oligarchs

Episode Date: March 1, 2022

Things are moving very, very fast in Vladimir Putin’s war against Ukraine—and in the global response to punish Russia. The U.S. and Europe are not engaged in a literal war against Putin, and hopefully nothing like that will come to pass. But this weekend, they announced a series of unprecedented sanctions and economic penalties that could destroy the Russian economy. These policies are designed to get Putin to end the war before he conquers Ukraine. But they could crash the Russian economy and trigger more global crises. To explain the sanctions, discuss their pluses and minuses, and predict their ripple effects, Derek is joined by Noah Smith, author of the newsletter Noahpinion, and Nicolas Véron, a French economist and senior fellow at the Peterson Institute for International Economics and the European think tank Bruegel. Host: Derek Thompson Guest: Noah Smith and Nicolas Véron Producer: Devon Manze Learn more about your ad choices. Visit podcastchoices.com/adchoices

Head into the Ringerverse to stay up to date with all things superheroes and nerd culture entertainment. Hosted by a rotating lineup of superfans at The Ringer, including Mallory Rubin and Van Lathen, shows will provide instant reactions to blockbuster releases, insightful backstories on canon, and mind-bending theories, as well as fresh takes on the latest news and rumors. Check out The Ringerverse on Spotify or wherever you get your podcasts. Today, the latest on the war in Ukraine. On previous episodes of this show, we talked about. various scenarios for the end of the conflict,

those ranged from Russia's retreat to the beginning of a great power struggle. And we discussed some of the wars potential ripple effects in the US, China, and around the world. I still think those episodes hold up very, very well. But over the weekend, several things happened that demand our fresh attention. In the last 72 hours, the US in several major European countries

announced a series of financial penalties and sanctions against Russia. These penalties are unprecedented. It was a historic weekend. First, we announced our intention to cut off several Russian banks from access to Swift. Swift is an acronym. It stands for the Society for Worldwide Interbank Financial Telecommunication. This is a messaging platform for banks to communicate about trades.

Second, we announced sanctions for Russia's central bank. This was perhaps the most severe punishment announced this weekend. We also put pressure on Russian oligarchs with promises to find and freeze their assets as well. These policies have already kicked off a spiral of chaos in Russia. There have been bank runs across the country, long lines that have emptied ATMs of all their cash. The ruble, Russia's currency is collapsing. The country itself might be close to defaulting on its debt and cut off from the world. Russia is rapidly approaching a financial crisis.

In response, Vladimir Putin has put Russia's nuclear weapons arsenal on high alert. Now, a brief aside, I remember when Donald Trump was first elected, the comedian John Mulaney said his presidency was like a horse loose in a hospital. He said, you think everything is going to be okay, but no one knows for sure what's going to happen next because no one's ever seen anything like this before. You can find experts who say, oh, I saw a bird loose in an airport once, but that's not the same. That's not expertise.

This is a horse in a hospital, and so on and so on, anyway. The current crisis is similar, except with 100 times the threat of a mass death event. This is like an angry bull loose in a nuclear power planet control room. It is strange. It's historic.

It's unprecedented. But it's also terrifying. We are all in the danger zone right now. In almost every way you can imagine. Putin seems to have achieved the opposite of what he wanted. He wanted a quick war in Ukraine, and he got a fight. He wanted to expose the West as divided and weak, but he made the West united. Instead of reversing NATO expansion, now more countries like Finland are actually asking

to join NATO. And instead of demonstrating Russian strength, his actions have torpedoed his economy. So, yes, you could say the West has Putin, cornered right now, has Putin in a headlock. But with enough nuclear weapons to end humanity as we know it, Putin also has a gun aimed at us, aimed at the head of the entire human race. We need to find an off-ramp here. And as you're about to hear, the sanctions we've imposed on Russia will, in time, destroy its economy and potentially that of many others. The goal cannot be to inflict maximal pain or to take delight in the suffering of Russians. The goal is a peaceful Ukraine,

a prosperous Russia, and if one can dream, the end of the mad reign of Vladimir Putin. I'm Derek Thompson. This is plain English. There are three things we might want to accomplish with sanctions, and only two of those make a lot of sense. That's Noah Smith. He's an economics writer, and the author of the newsletter, No Opinion. The first thing we might want to accomplish is to make life difficult for all of Putin's allies and cronies within Russia,

to ruin them, put them under threat of ruin so that they either pressure Putin to give up the attack or simply somehow remove him from power. The second thing we might accomplish is to actually hobble the Russian war machine because, you know,

it does take money to fight a war, to pay for a war, and it does take, physical resources, imports especially, to pay for a war. And so if we can cut that off, we might be able to make it actually harder for Russia to bear down Ukraine to keep sending material into that country and fight. And the third thing, which I personally think is a bad idea and other people I've talked to think is a bad idea, is to cause pain to the Russian economy, to cause pain to the

average Russian. So that's the grand strategy. Squeeze the oligarchs, jam up the war machine, and hurt the economy. For the rest of this episode, we're going to look at the specifics, starting with the U.S. and European plan to kick certain Russian banks off of Swift. What's Swift? So basically what Swift is is a messaging system. It allows banks to say very securely.

It's sort of like international Bloomberg, right? Bloomberg has these terminals. You know, bond traders can say very securely and safely and secretly, like, hey, I need this many bonds, you know, of this maturity, blah, blah, blah, and some bond trader, somewhere halfway around the world will say, okay, I've got those bonds. You want to trade, and then they haggle. And so that's what you use Bloomberg for. Swift is kind of like that for banks. Banks say, okay, we need to borrow this much money overnight, blah, blah, blah, to maintain our operations. We need to stash our assets with you. We want to swap rubles for dollars.

All the things that banks do, like all the plumbing of the financial world. So when you cut them off from this, there's no good way to send messages. Of course, banks, you know, you could just use WhatsApp or something like that, but it's not designed to handle the volume. It's, you know, it's difficult to verify identities. You can get some guy, you know, saying Russian mafia, saying like, you know, new phone, who this? I am, you know, spare bank. And then, you know, it's, it's hard to verify identities. So I'll just say that Russian banks will find it very, very difficult to do business with any banks in the West at this point. We've used this weapon before.

Several years ago, Iran was kicked off of Swift to punish that country for its pursuit of nuclear weapons. The effect was devastating. After Iranian banks were disconnected from Swift, the country lost almost half of its oil export revenues and 30% of foreign trade. Now, we shouldn't necessarily expect the same effect in Russia. For now, it seems, Europe is continuing to pay Russia for its energy exports. But the effect on Russia could still be disastrous. Nobody with alternatives is going to want to do business with a bank that's been kicked off the global messaging system that is the communications backbone of finance. Russia's financial system has essentially been ostracized from the global community.

Anybody who can get their money out is going to try to get their money out. You know, you're going to see bank runs. You're going to see people trying to pull their money out of banks that are no longer able to use. Swift because not being able to use Swift really sucks for a bank. Okay, so not being able to use Swift really sucks for banks. In sort of the same way that not being able to use SMS or text with someone would really suck if you were trying to sell a chair on Facebook marketplace. Complex exchanges require private communications. We've booted a lot of Russian banks off of this essential communication service. So nobody wants their money in a bank that's been kicked

off Swift. That's why you might begin to see bank runs. What else could we see? A second thing that you see is a crash in the ruble, which is the Russian currency, a value of the ruble. And the reason this happens is the following. If you can't, one of the main things you have to do for international trade is swap currencies. If Russia wants to buy something from Germany, they need euros to buy it because German companies need euro. That's what they transact in. You need euros to buy it. And so just like if you're going to pay for a pizza at an American pizza restaurant, you need dollars to buy that pizza because the pizza restaurant people have very

little use for roubles. And so you need the euros to buy whatever you're importing from Germany. Like, you know, munitions components to like make rockets to throw at Ukrainians or oil drilling machinery to keep up drilling for oil, things like that, replacement

parts, all kinds of stuff like that. You need to buy from overseas and to do that, you need overseas currency. And to get overseas currency, how does Russia do that? How does any country do that? You swap your currency. for the foreign currency. It's a currency swap. You do that.

So Russia goes, a Russian bank goes to a German bank and says, you know, hey, we got some rubles. Give us some euros in exchange for these rubles. The German bank says, okay, here's our rate. And you exchange them, just like you would at the, you know, aircraft, I'm sorry, airport counter, you know, when you're going to exchange your currency and when you travel. It's the same thing but with banks.

So if Russian banks, individuals, investors, or cut off from normal currency exchanges, what will they do? Well, imagine what you would do. If you were desperate for euros in, let's say, France, and the currency exchange counter was closed, you'd start to get pretty desperate. You might go to black markets, underground channels. You'd be like, here, please, take as many dollars as you can.

Just give me some euros. Please, I'm desperate to get this money off my hands. Take these giant chunks of cash. Please, just give me euros. Well, with so many companies and people rushing to exchange their rubles for foreign currencies, they'll be dumping rubles on the market. What happens then? When you dump something on the market in mass quantities, its price goes down.

So the value of the ruble will crash. And in fact, today it already crashed by 40%. What does the ruble crashing mean? It means it's harder for Russian companies to afford imports. It means it's also harder for Russian people to afford imports. Russians import food. You know, they're going to find themselves cut off from foreign foods. And so it's going to hurt rich Russians, but it's also going to hurt average Russians quite a lot.

And that's the kind of thing that I am a bit scared of hurting the average Russian very deeply. But it is. This is going to crash the Russian economy. It already is crashing the Russian economy. This all sounds rather dramatic, extremely dramatic. But remarkably, the swift cutoff isn't even the most dramatic. economic weapon, we've unleashed in the past 48 hours. So sanctions against individual Russian banks, cutting them away from Swift, are a huge deal.

But in a way, the sanctions against the Russian central bank and the freezing of their foreign reserves is even bigger. That's Nicholas Veron. He's a French economist and a senior fellow at the Peterson Institute of International Economics and Brugel, a Brussels think tank. I asked him to explain to me how big a deal it was that the West has frozen the foreign reserves of Russia's central bank. His answer? It's a BFD. This is massive, and it's massive because there was a perception that this is something that just cannot be done,

because this is not the way the world financial system operates. The Russian central bank is a fully paid up member of the international central banking community. it's a member of the bank for international settlements. I'm not going into all kinds of infrastructures that are really important, but not well-known to the public. The point is this is not Iran. It's not Venezuela. It's not a peripheral country.

It's a country that was maybe not at the very core of the international financial system, but in the inner group. And having it cut off from the system in such an abrupt way is incredible. It's amazing. It's something I didn't expect to see. The Central Bank of Russia is like their Federal Reserve, just as the Fed, in the U.S., is responsible for stabilizing our currency and keeping an eye on inflation, the Central Bank of Russia has its own strategies for protecting the ruble. Now, when the ruble plunges, as it might during normal sanctions, the central bank wants to step in and buy up rubles that will prop up its value. Well, how do you buy rubles?

You can't buy rubles with other rubles. That doesn't make any sense. you have to buy rubles with other assets, like euros or American dollars. So the central bank needs a stash of these foreign assets that it can use in case of an emergency. This stash is called its foreign exchange reserves. We saw this just eight years ago. In 2014, Putin invaded Ukraine. We sanctioned Russia.

The ruble got a little wonky, as people lost faith in some Russian banks. But the Russian central bank stepped in. It converted a bunch of its reserves. into rubles, and it stopped the damage. Essentially, it paid for water with these foreign reserves and poured water on the currency fire. But here's the catch. The Central Bank of Russia holds these reserves,

perhaps $300 billion, in U.S. and European banks. And the policy announced this weekend said, those assets are frozen. So for the moment, it's as if that money doesn't exist. Russia thought it had $300 billion worth of water to fight the fire of foreign sanctions, and the U.S. and Europe essentially said, oh, no, actually, you don't have $300 billion. You have $0.00 worth in those accounts. Your money is gone.

Your currency is on fire, and the water store isn't taking your credit card. I think the biggest triple effect, kind of first round effect is inflation and possibly hyperinflation in Russia. And this is precisely because there is this loss of confidence in the currency. So the Central Bank of Russia can print money, use the printing impressors, print rubles, and satisfies the demand for roubles. That's not in question. But that demand for cash is going to – is already accessible. because people want not to hold roubles. They want to buy stuff.

They don't trust the ruble as a good way of storing their wealth. And this creates inflationary dynamics. One definition of inflation is too much money chasing too few goods. And this is exactly what you will have if people don't want to keep their rubles in a bank account or even as cash under the mattress. Imagine you live in Russia. You know your economy is getting cut off much of the world. You know your ruble is collapsing.

So what do you do? You go to the ATM to take out a bunch of rubles, suspend them on essentials, ASAP, because your currency is losing money every day. Well, so do your friends. So do your friends' friends' friends. So do your friends of friends of friends. Everybody's going to the ATM. Everyone's trying to spend their rubles immediately on essentials.

And if everyone's trying to get rid of rubles at the same time, it's only rational for people selling bread or toilet paper to say, well, I'm going to raise prices because I want rubles in my hand too. And this sort of panic combined with the total collapse and confidence of the currency, this is what we tend to see in the early innings of an awful inflationary spiral. But that's not the only thing that Nicholas Ferran is looking at. Another thing which is massively important for the world, not only for Russia, is the attitude of China.

And China clearly has been taken, you know, off base, by the, they didn't see it coming either. Xi Jinping presumably trusted Putin that Putin wouldn't do something as reckless as invading Ukraine. And that's what he communicated when he made this big joint declaration at the beginning of the Winter Olympics,

Xi Jinping and Putin together saying, you know, the West sucks, basically. Well, now that doesn't look very smart because Russia is doing something extremely reckless. And, you know, China will don't, want to jump off the bridge. together with Russia, they're much more conservative and risk-averse than that. So that's a hugely important space to watch.

At this point, China is not going to tell us what they think about at all. That's not their style. But look at what they do, and whether they support Russia or not, in the next few days, weeks, months. And I think this is massively consequential. There's a third leg to the U.S. strategy to cripple the Putin regime, and that is to bolster an international manhunt for oligarch cash. turning up the heat on cronies around Putin.

The White House has announced a, quote, multilateral transatlantic task force to identify, hunt down, and freeze the assets of Russian oligarchs. Noah Smith says, you have to see this strategy in the context of all the other sanctions. All these sanctions are adding up,

and it's going to mean that Russian rich people are essentially trapped within Russia in this collapsing economy, unable to exercise their riches. And appealing to Putin will give them no leverage. There will be nothing they can do about it by just appealing to Daddy Putin because he's already sending his whole war machine to Ukraine

and there's just nothing else he can do. The point is not just to punish, but to persuade. If we make life miserable for a bunch of Russian oligarchs, but Russia still destroys Kiev and still conquers you, Ukraine, we will have failed. We will have destroyed the Russian economy and also lost Ukraine. As Noah says, goal number one should be to jam up Russia's war financing system so that

Russia can't execute this war. But how would that work? So suppose you're a Russian defense manufacturer. You make rockets. All right. What do you need to make rockets? You need materials to make the rockets. You need machinery to put the materials together to make the rockets.

You need workers who need to be paid in roubles so they can buy bread. Those are the things you need. You need financial capital, physical capital, labor, and material inputs. So this is a great overview. Tell me how these sanctions are designed to make it harder for Russia to get all of these things. So financial capital, obviously, if you're not a lot of these things. If banks are imploding, it's hard to get a loan. Physical capital, Russia does not make a lot of machine tools that it uses to make rockets.

It gets those from, it buys those from Germany. Your machines break down, you know, you're running them hot, you're saying, make more rockets, make more rockets. Oh, we lost a little, our drill bit wore out. Where do we get a new drill bit? Oh, it's this fancy kind of drill bit that only Germany makes. Well, let's just call up the Germans and get them to send us, oops. Nope. Can't do that anymore.

And so those are the ways in which the Russian defense apparatus will be affected. Put it all together. The swift policy, the central bank asset freeze, the sanctions that avengers force for hunting down oligarch assets, the West's policies amount to a kind of collective suffocation of the Russian economy. As Russia tries to besiege Kiev surrounding the capital, of Ukraine, cutting it off from essential resources, you can kind of see how the international community, especially the West, the U.S. and Europe, are racing to besiege Russia, surrounding it,

shutting it off from access to foreign resources, companies, and trade in the West. We are trying to deprive the Russian economy of just enough oxygen that it forces Putin to the negotiating table. But there are huge risks. After all, we are suffocating an entire economy. And the goal should not be to destroy Russia. It should be to save Ukraine from Putin, and perhaps even to save Russia from Putin too.

To spare the Russian people, we have to find a way to offer Putin an off-ramp and out some incentive to come to the table. So I asked Noah, where do you see an off-ramp to these policies? I have no idea and neither do experts I talk to because the reason is because essentially, you know, the only people who expected him to invade were people who were paying very close attention to the intel that said he would invade. Everyone else said, this is nuts and it is

nuts. Why would he ever do this? And it's true. Why would he ever do this? He is being nuts. It's hard to find anyone else who's enthusiastic for this war besides the one person of Vladimir Putin. This is the tragic irony of the war in Ukraine. Putin invaded with delusions of grandeur, and he's reduced his economy to rubble. Mr. Putin has built his legitimacy. He arrived, he took the reins of Russian power in 2000, just a few years after that traumatizing episode.

And his legitimacy has always been, look, I'm the guy who will bring you stability, wealth, power, international respect, not like what you had under Yeltsin, which was a disaster. And so the fact that we have a financial panic now in Russia is particularly significant given that background. The irony goes one step deeper.

Putin sought to manipulate what he saw as a weakness in the West, division within Europe and a weak neighbor in Ukraine. But his invasion has achieved the opposite of all of that. The war has proved the valor and courage of Ukraine. It's made a hero of its president Zelensky. It's inspired courage in Germany, inspired the courage of all of Europe. The West has found its spine.

This backbone has been to a large extent stiffened or even created by the incredible resistance of the Ukrainian government and the Ukrainian people. There are credible reports that Mr. Zelensky address the leaders of the European Union a couple of days ago after the invasion had started. And the leaders became emotional. Some of them started to cry. Zelenzky said, matter of factly,

you know, maybe this is the last time you see me alive, but please do this for Ukraine. You know, this is what's happening now. You cannot disconnect things from one another. And I very much see a causal link between the ability of the Ukraine's to show resistance, a sense of national purpose, commitment to democracy against the Russian aggression, and the ability of the international community to come together around those sanctions, this unprecedented action, which really has consequences for Russia. We still don't know what kind of Pandora's box we've opened with these policies. Russia and Ukraine are critical cogs in the global trading system, carparts, wheat, sunflower oil, metals. I expect the world is going to get a chaotic lesson in economic interdependency and Eastern Europe and Russian trade and supply chains the next 72 hours.

Like Nicholas Veron says, this chaos is the nature of war. Wars change the world. Wars are events that have. have massive consequences. I can give you 100 scenarios in which the war and the developments around the war in Ukraine, including financial meltdown in Russia, trigger instability in all kinds of places, which in turn transforms the world. This is what wars do, and this is a big one.

Here's one such scenario. Tajikistan is a small Central Asian country just north of Afghanistan. It relies on remittances from Russia for more than. 20% of its GDP. That means if workers in Russia stop sending money to their families in Tajikistan, the economy would suddenly contract by 20%. That is a depression. And economic crises, as we know, can spark political crises. Tajikistan shares a border with China and its westernmost province of Xinjiang. So Tajikistan's remittance crisis that flows downstream from Russia's economics crisis could become China's crisis.

The point is not to predict anything too specifically. It's to say, what happens in Russia will not stay in Russia. This war means everything to millions of people around the world. It means life and death for smaller countries that are very linked to Russia, like Tajikistan. It's not the only one. It means life and death for big companies that have business in Russia. It means life and death or life-changing events for individuals and countless individuals which have relationships in Russia and in the countries that will be affected by Russia, starting with Ukraine, of course, but it's not the only one. We have to get used to the fact that the kind of uncertainty that is inherent in wars is affecting all of us because this is maybe a war in Ukraine, but a war with global implications in a ways that probably more.

recent wars that we have observed in Syria, Yemen, Yemen, Ethiopia, other places have not had. So we have to get used to that kind of uncertainty and massive developments happening very quickly. The West has succeeded in standing up to Russia, but that's not enough. We have to end this war without destroying Russia and without destroying the world. Noah Smith doesn't know exactly how we'll do it. but he's got an idea. I have a thought, which is we should promise a swift and abrupt economic reversal of all the, not just a reversal of all the sanctions and lifting of all the sanctions, but pumping money

and investment into the Russian economy if Putin is deposed. If it's no longer Putin, we should implement a Marshall plan for Russia to help Russia become more than just a gas station. We should refloat the Russian economy on a wave of American cash and stuff. This sort of promise we can do of not just lifting the pain, but actually giving a huge reward to Russia, once Putin is gone, as we should have done in the 90s when the Soviet Union fell. Instead of this shock therapy crap where we just let these oligarchs buy up all these assets on the cheap and run a kleptocracy. We should have been pouring investment into Russia to support real productive enterprise and the

retooling of Soviet factories to be more efficient, integrate them with the West and blah, blah, instead we turned Russia into a giant gangster-owned gas station by insisting on free market privatization BS because that was our sort of our ideology in the later days of the Cold War. If we're lucky, the policies we've discussed today will help to end this war, bring Putin to the table and even accelerate a regime change, if we're very, very lucky. We should not want to go back to the 1970s or 1980s with Cold War 2.0. But as Noah says, we also shouldn't hope to go back to the 1990s, where Russia emerged as an oligarchical gas station seeking a strongman. The delicate job for the West today is to chart a path toward the future that doesn't lead us

back into the past.