Vladimir Putin’s Strategy Undermined – Russia’s Financial System on the Brink of Collapse

The worst is yet to come for the Russian financial system.

Banking panic, the collapse of the ruble against the US dollar, downgrading of Russia's debt to junk status by S&P, suspension of trading on the Moscow Stock Exchange, flight of investors... While they have not yet fully taken effect, the sanctions announced this weekend by the West are already pushing the Russian financial system to the brink. The strategy imagined for several years by Vladimir Putin is shattering.

The freezing of the assets of the Russian Central Bank has shattered the fortress built by Moscow in recent years. Between 2018 and 2021, oil and gas revenues had swelled the Russian Central Bank's reserves by 40%. With $631 billion in reserves at the Central Bank and $185 billion in assets held by the national sovereign wealth fund, the Russians thought they would have enough to sustain themselves for a long time even if international sanctions were imposed.

More than 60% of Russian reserves are already unusable

The problem is that Vladimir Putin underestimated the unity that Western countries could still show in difficult times.

Almost 470 billion of Russian reserves are in foreign currencies, in the form of securities or deposits. Of course, the share in dollars has been reduced, and the share in yuan has reached 17%, which is very important compared to other central banks of the world's major economic powers, where the yuan accounts for only 2-3% of reserves. In addition, Russia has more than 130 billion dollars of gold.

Despite all this, it can already be considered that 61% of Russia's reserves are now unusable.

In other words, Russia can no longer sell its assets in international currencies (euro, dollar...) to buy ruble assets and thus support its currency, as it did since the beginning of the conflict. Speculators on the exchange market have rushed into the breach, betting down against the currency. The ruble is in free fall against the US dollar:

Vladimir Putin tries to resist these sanctions by counter-attacking

Faced with the seriousness of the situation, the Russian Central Bank was quick to counterattack by raising its key rates from 9.5% to 20%, its highest level in 20 years. The move calmed the markets. For the moment ...

Those betting on the downside, mainly hedge funds, must now pay 20% to borrow in rubles. This increases the risk of such operations. If the funds are not right soon, they can suffer significant losses. The central bank's strategy is no less risky. By raising rates to 20%, it is suffocating its economy. This cannot go on forever.

The question is who will last longer, the central bank or the funds.

With a weak ruble, the Russian monetary institute will soon be faced with a dilemma. The country imports a large part of its consumer and capital goods, and as these are becoming more and more expensive in rubles, inflation will soon take off. This will encourage the government to raise interest rates further and further stifle the economy. By limiting currency fluctuations to a certain range, the Russian authorities hope to limit the damage.

Vladimir Putin has also taken another shocking support measure: exporting companies will have to convert almost all of their international currency receipts into rubles. And the measure is retroactive to January 1, 2022.

The banking system is on the verge of collapse. “Bank runs” are multiplying.

Another self-fulfilling problem often at work in financial crises is “Bank runs”, i.e. withdrawals by investors panicked by the fragility of the banking system. Ruble-Bitcoin trading volumes reached a 9-month high on March 1, 2022:

Proof that the Russian people see Bitcoin as a safe haven to protect themselves from a possible collapse of the Russian banking system. This has allowed the price of Bitcoin in US dollars to rise by 20% in a few hours.

The international activity of banks without access to SWIFT may be reduced to a trickle. The risk is that the Central Bank will quickly be unable to provide liquidity in euros or dollars to commercial banks faced with massive withdrawal requests from depositors. Here too, Russia has reacted quickly by imposing a form of capital control. Brokers were prohibited from selling securities held by foreigners as of Monday, February 28, 2022, on the Moscow Stock Exchange.

However, it is not necessarily in the interest of Westerners to let the Russian financial system collapse completely. Between the subsidiaries of Western banks and the assets held in the portfolios of investors around the world, the consequences could be painful. The blocking of the central bank's assets will not necessarily be total. One can imagine that access will be granted in dribs and drabs, to keep the financial system afloat, while maintaining such pressure that it will remain on the verge of collapse for a long time.

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Some reading

• Don’t Dream Too Hard – Vladimir Putin Won’t Bet Everything on Bitcoin To Survive US and EU Sanctions. Bitcoin will be one option among others, but probably not the number one for Putin's Russia.

• Wanting More Privacy and Anonymity Than Bitcoin Can Give You at the Moment? 3 Privacy Coins To Consider. An opportunity as an investor as well, as these coins should see a resurgence of interest in the months to come.

• Russians See Bitcoin as a Safe Haven – Volumes Explode, and the Bitcoin Price Rises 20% in 24h. Is this the spark Bitcoin was waiting for to start a new bullish wave?