Planet Money - 'Fortress' Russia put to the test

Episode Date: March 2, 2022

The U.S. is putting Russia's defense plan against sanctions to the test. Meanwhile, Russia's role as a huge exporter of oil and natural gas could cause ripple effects throughout the global economy. | Subscribe to our weekly newsletter here.Learn more about sponsor message choices: podcastchoices.com/adchoicesNPR Privacy Policy

This is Planet Money from NPR. This is Planet Money. I'm Darian Woods from The Indicator podcast. And we are, of course, keeping a very close eye on the situation in Ukraine. We're working to understand what this all means for the global economy and what it means for people living in Ukraine and Russia. The U.S. and Europe and its allies have imposed very harsh sanctions on Russian financial institutions, as well as on Russian President Vladimir Putin himself. Ukraine and Russia. The US and Europe and its allies have imposed very harsh sanctions on Russian financial institutions, as well as on Russian President Vladimir Putin himself and

other Russian elites. And two new sanctions rolled out over the weekend dealt an especially big blow. They strike at one of the big ways that Putin tried to make the Russian economy immune to Western sanctions. They get at the billions of dollars worth of cash, gold and other assets held by Russia's central bank. After the break, I talk with Indicator co-host Adrian Ma about how to target Russia's financial fortress. Stay with us. We are watching devastating scenes in Ukraine as Russian trucks and tanks invade the country from the north, from the south, and from the east. It's war, but it's also a financial war. And Russia has been building a financial defense system for something like this for years.

You might have heard of it recently. It's called Fortress Russia. And at the core of Fortress Russia is massive foreign exchange reserves. That's officially about $640 billion worth of cash, other governments' bonds, and gold that Russia's central bank has amassed over the years. The idea is that these reserves could wait out the sanctions. Russia needs foreign currencies for imports, and they import a lot. The reserves were built up so that Russians could still exchange their rubles for dollars and euros to buy cars and furniture and phones, even in the rough times.

Think of Russia's reserves like a rainy day savings account. About $5,000 worth for every man, woman, and child in Russia just sitting there waiting to prop up the Russian ruble if needed. But that fortress is freezing up after a financial attack. Leaders from Europe and North America announced unprecedented sanctions over the weekend. The ruble has lost about 30% in value against the dollar. And on Tuesday, the Russian stock market closed for the second day in a row. On all, this financial fortress Russia has tried to build is starting to look more like a cage. To explain why, we called Michael S. Bernstein, an economist at Stanford's Hoover Institution.

Hello, Michael Bernstein. Hello, hello. How are you? Michael has worked for the Russian Central Bank and in Ukraine. And he says he first started thinking about global finance about 70 years ago. It was just after World War II in Soviet Russia. Michael had fallen sick as a young child. My parents needed to buy some antibiotics on the black market. The black market was the only place to buy antibiotics because the Soviet currency wasn't able to be freely exchanged to buy imports like penicillin. But Michael's grandmother had a trick up her sleeve.

She was a dentist, and she used gold and silver for teeth fillings. She exchanged that silver and gold for penicillin. So I learned high finance very well at the age of four. Learning high finance at the age of four, Michael could see that currencies were only as valuable as what you could exchange them for. Today, Michael has been analyzing whether Russia's financial fortress can support the ruble enough so that Russians can keep importing products like antibiotics. We asked Michael on Monday what he thought about the fortress. Can those assets be used to prop up the Russian economy? As of days ago, yes. As of today, no.

The reason is that over the weekend, European and North American leaders announced extraordinary new sanctions against Russia. Western leaders announced two super-sized sanctions in particular. First, they blocked some of Russia's big banks from accessing the Swift Bank messaging system used for bank transfers. And that is huge, right? So the Swift messaging system is basically the completely dominant way for banks to talk to each other when they transfer money. It covers about 11,000 global banks. And without it, a lot of money can't move across borders. You're effectively shut out of the global financial system.

And second, Western leaders sanctioned the Russian central bank. And that is just unprecedented action against an economy the size of Russia's. Now, there is one giant loophole here. Payments for Russia's big exports, oil and gas, are still being allowed from some banks. But even with this loophole, the sanctions announced over the weekend are so large that not even Russia's $640 billion fortress is enough to protect its economy. We'll explain why these sanctions make Russia's financial fortress look more and more threadbare by going through all its components. You don't need a calculator. You don't need an abacus. All you need is just a few numbers. First number? Roughly $250 billion.

So $250 billion are now unavailable because those are United States government bonds, government bonds of the European Union, Japanese bonds, British bonds. And all those government bonds from Western-aligned countries pose a problem for Russia. Because, well, it's not like the days before computing, where you could get, like, a physical certificate that another government owes the money to the bearer of that certificate. Instead, it's a digital entry in the ledger of a country's treasury or central bank. And so, in order to withdraw them, you need the ledger of a country's treasury or central bank. And so in order to

withdraw them, you need the goodwill of people and institutions. And Russia does not have the goodwill of Western aligned institutions. So given the sanctions on the Russian central bank, these bonds are frozen. The US, EU, Japan,.K. haven't confiscated the bonds, but these bonds cannot be redeemed or sold for cash right now. That brings us to our second number, which is $150 billion. That's the rough value of what Russia has in savings accounts in banks all over the world. And in peacetime, this might make sense because, you know, why not earn a bit of interest on your cash? But that whole equation breaks down now that Russia has invaded Ukraine. Now European and North American banks aren't allowed to let the Russian central bank touch its own savings. That means that $150 billion is basically useless for as long as these sanctions last.

The rule number one is you have to understand, you don't fight the country where you keep your money. That basic rule seems like a bit of oversight from Putin's government. Maybe they didn't actually expect these sanctions to be so severe. Yeah, certainly not from Europe, especially. And that brings us to a country that is not as aligned with North America and Europe. It's China. Russia has $84 billion worth of Chinese government bonds.

But even if China allows Russia to sell these bonds back, they're denominated in yuan, the Chinese currency. The Chinese currency in the minds of the Russian people is not a kind of world currency. No one is using it. No one has ever seen it. Michael says if the point of this fortress is to reassure everyday Russians they can keep confidence in the ruble,

it doesn't do a very good job of that. You want to convince citizens that they'll still be able to convert the rubles into global currencies at some later date. But average Russians today are used to dollars and euros, not yen. The fourth part of Russia's fortress is more old school. It's gold. Gold bars. That's estimated to be valued at about $130 billion.

Gold bars can be sold to any remaining friends of Russia's, right? Like maybe Iran or Pakistan might want some? Or maybe just like Michael's grandmother's gold, you know, maybe you could trade it on the black market. But Michael says the logistics of selling this much gold in a rush are just unrealistic. You don't see a train of gold bars going from Moscow to Beijing. No, it's possible. It's possible, but it takes time and it's not much. So that just leaves cash. Actual hard physical banknotes locked in a secure basement in Russia somewhere.

Michael estimates that to be around $30 billion of large denomination bills, right? Like euros, pounds and dollars locked in a vault. denomination bills, right? Like euros, pounds, and dollars locked in a vault. And so when you zoom out, this $640 billion fortress that Russia has spent years amassing kind of just boils down to $30 billion of cash. No one now wants to get under the U.S. sanctions. That's how powerful these financial sanctions have been. Yeah, absolutely. They are the weapons of mass financial destruction. The weapons of mass financial destruction. They destroy their currency. Then they destroy the banking system.

Then the supply chains break down because the companies want dollars. And then the most difficult thing is how do you govern? How do you govern a country in economic freefall facing colossal sanctions? That's a dangerous weapon. The weapon of mass financial destruction is very dangerous. Now, the big thing about Russia's economy that we haven't gone into too much depth so far is Russia's energy exports. So far, those have largely been spared by US and European sanctions. So when we come back, Adrian Ma, Stacey Vanek-Smith and I are going to discuss that, as well as other economic indicators to watch in the conflict between Russia and Ukraine. So in this part of the show, Stacey Vanek-Smith, Adrian Ma and I are going to discuss three Russia-Ukraine indicators, three economic stories that can shed light on what's

going on. Adrian Ma, what is your indicator? So this indicator has to do with, no surprise, crude oil. This is pretty top of mind. Russia is one of the world's biggest oil producers, and oil is by far its biggest export. Now, most of that oil goes to China and a handful of European countries like Germany and the Netherlands. And so after Russia began attacking Ukraine, what happened was the price of Brent crude oil surged past $105 per barrel. And just for perspective, that is the first time that it's gone that high in about seven years. And just to clarify, Brent crude, that is basically one of the most widely traded kinds of oil, one of the main benchmarks for world oil

prices. That's right. And all this is happening at a time when the global oil market is already really tight, right? So just like thinking back during the pandemic, when things started shutting down, a lot of the world's oil producing countries also ramped down production, which makes sense, right? People were hunkering down, entire countries were blocked down. But then as the pandemic has begun to ease up, there's been this huge demand for oil again. And the problem is, well, there's a couple of things, right? So some of the countries that had slowed down their production, they're struggling to get back up to speed. But also OPEC, you know, that cartel of oil producing nations, which includes Saudi Arabia and the United Arab Emirates.

They've basically been resisting calls to up their production. And not to mention, there's also a shortage of natural gas. So oil is in serious demand right now. So even before the Russian invasion of Ukraine, we were already in a situation that was just really pushing up the price of oil. And now it's much worse. Totally. And energy analysts have been saying that an invasion of Ukraine could further squeeze the world oil supply. So what this could mean for the U.S. is that prices at the gas pump go up, energy prices overall go up. And what that could lead to is the thing that we keep talking about these past months is

it could lead to more inflation. There is one way the U.S. could try to counteract the rise in oil prices, which is by tapping its reserves. And the Biden administration tried this late last year. They authorized the release of about 8% of the U.S.'s oil reserves, which is about 50 million barrels. So they put those barrels onto the market. But it didn't really stop the rise in prices from continuing. So even though that's the case, the White House says that if prices continue to spike, they would consider tapping the reserves again.

Okay, big news in the oil market. Adrienne, all right. the oil market, Adrian. All right, so Stacey, what is your indicator? My indicator is $1.7 trillion. Okay. In fact, that is the size of Russia's economy. $1.7 trillion, that is their gross domestic product, their GDP, the sum total of all the goods and services the country produces.

Okay, is that big, small, in the middle? So it's actually pretty little. Smaller than Italy's, India's, South Korea's. But I do think that this $1.7 trillion really punches above its weight. Like Adrienne was saying, Russia is just this enormous exporter of oil and natural gas. Europe gets about 40 percent of its natural gas from Russia and around a quarter of its oil. So I think Russia and Europe's economies are really intertwined. And this is a really fragile moment for a lot of global economies right now. Oil, natural gas, these are things like very essential needs for an economy and for a lot of individuals. And so I think Russia's sort of able to like leverage its economic might in a way that is much bigger, much more significant in certain

ways than 1.7 trillion. But of course, you know, oil may be sort of like the headline player here, but Darian, you're going to talk about some of the supporting commodity cast members, right? Yeah, that's right. Russia's economy is not purely oil and gas. I'm going to talk about another export that is actually really important as well. It makes up 43% of global supply. This one is one of Russia's metal exports. And along with this particular metal, Russia also exports a lot of nickel, aluminum, copper. These metals are key inputs into the global supply chain. And given Russia's attacks and tightening sanctions against Russia, the world is going to see these metals in shorter supply,

prices for these metals and everything that uses them will likely rise. Anyway, enough buildup. I want to talk about the specific metal. Yes. What is this magical metal? Palladium is the magical metal. So tell us about why palladium? Look, I didn't know anything about palladium until a year ago. I'm not expecting this is a well-known element on the periodic table, but I actually first learned about it through a friend whose Toyota Prius got partly dismantled on the street by some crook.

What? Prius got partly dismantled on the street by some crook. So there's been this spate of thefts all across the country, car thefts over the last year or two, with people tearing off people's cars' catalytic converters. Catalytic converters are these devices that clean up your exhaust. They convert carbon monoxide into a less harmful gas. And they were trying to steal the palladium inside, which is the metal that does the work of cleaning up. Okay, so what are criminals using palladium for? Like, where is the market for all of this stolen palladium coming from? You know, there are palladium dealers, police have, you know, raided facilities of just

catalytic converters piled up, and you can set it back into the black market. It's more expensive per ounce than gold these days, which 10 years ago was not the case at all. So basically the fact that there's been a push to develop vehicles that are more emissions friendly, meeting stricter emission standards, that has created a big market for palladium, which has in turn created a black market for palladium? Exactly. So as emission standards get tighter and tighter all across the world, that boosts demand for palladium. And where do you get it from? Well, apart from, you know, chop shops on the streets of LA, you'll get it from Russia, which supplies 43% of the world's supply. And look, this seems like maybe a trivial example considering what is going on right now.

But I just think this is one example of all the effects that will just ripple out across the entire economy that just show how interlinked we all are and what's going on in Ukraine is going to affect us all. No, it's true. And that's a really important thing to keep in mind, I guess, as we're watching everything unfold. If you want more quick economic stories like the one you just heard, you should subscribe to The Indicator podcast. There is a new episode every day explaining one fascinating aspect of the economy, all in 10 minutes or less. You can email us planetmoney at npr.org, or you can find us on TikTok, Facebook, Twitter, or Instagram. We are at Planet Money.org or you can find us on TikTok, Facebook, Twitter or Instagram. We are at Planet Money. The original Indicator episodes were produced by Nikki Ouellette and Viet Le with help from Isaac Rodriguez and Gilly Moon.

They were fact-checked by Corey Bridges and edited by Kate Kincannon. This episode of Planet Money was produced by Sam Yellowhorse-Kessler and edited by Molly Messick. Planet Money's executive producer is Alex Goldmark. I'm Darren Woods. This is NPR. Thanks for listening. Planet Money's executive producer is Alex Goldmark.

I'm Darren Woods. This is NPR. Thanks for listening.