Putin's Race Against Time: The Economy

A stalemate in Ukraine will give sanctions time to destroy the economic base of Putin's power.

Tuesday 3/15/22

In my last essay, I argued that the present US and NATO strategy of sanctions on the Russian economy and weapons deliveries to the Ukrainians is the right one, because it puts Putin in a race against time to win the war before one of the following happens: the Russian army collapses, the Russian economy collapses, or Putin’s own support collapses.

I have already written about the weakness of the Russian army, including the low strategic value of its victories in the south, and the perilous vulnerability of the “Kyiv convoy” that has been floundering northwest of the capital for the past three weeks. In addition to what I have already said, I also want to say a word regarding the Russian army’s organization into Battalion Tactical Groups (BTGs).

The BTG is the Russian answer to the American Brigade Combat Team (BCT), but is organized around armor and artillery instead of infantry. While the BTG organization might make sense for a Russian army intending to fight NATO over open ground, it is surprisingly mismatched for the war it is fighting in Ukraine. With only one or two companies of infantry per BTG, Russian armor and artillery are moving through Ukraine without sufficient covering fire from friendly infantry. This is why Ukrainian soldiers have been able practically to walk right up to Russian units and fire anti-tank missiles at close range. It is also why Russian units are staying at the edge of cities rather than going in. With so few infantry, the BTGs are incapable of urban combat and will either be destroyed in close quarters fighting or instead settle for bombarding cities from the suburbs. This is a recipe for a stalemate, which in fact may be what we are already seeing.

Let’s now turn to the issue of the Russian economy and the sanctions put in place over the past several weeks. Despite all the favorable press coverage, I really don’t think full justice has been done in explaining how devastating these sanctions are. They are more than “doing something” to stop Putin - they have the potential to destroy the Russian economy, making it impossible to sustain the offensive in Ukraine and potentially reducing Russia to “North Korea on the Volga”, a weak satellite of China shut out of the international system and forced to barter its natural resources to China at fire-sale prices.

For me, the most important parts of the sanctions are not severing SWIFT connectivity, nor the personal sanctions on Putin and the oligarchs. In ranked order, the freezing of the Russian central bank’s assets, the ban on financial transactions with leading private banks, the reduction and eventual elimination of fossil fuel revenues, and the ban on advanced technology exports are the four items that will reduce Russia’s economy to a rump incapable of supporting a modern military, much less an endless stalemate in Ukraine.

I don’t think it is possible to over-emphasize the importance of freezing between $450 billion and $650 billion in Central Bank of Russia assets. A well-functioning central bank is vital to any modern economy. It controls the money supply, sets interest rates, and generally smooths over the highs and lows intrinsic to an industrialized capitalist economy. Without a functioning central bank, a country is vulnerable to sharp changes in the business cycle, a situation Russia has already found itself in before, in 1998.

There is no sharper change to the business cycle than losing virtually all of your international trade overnight, while your currency and stock market both lose a third of their value. This is a 1929-level crisis in the Russian economy, and they now lack the tools to manage it successfully. The central bank’s assets remain tied up in London and Switzerland, and an asset that is neither liquid nor accessible as collateral is no asset at all. The Russian central bank is effectively empty. Combined with international business pulling out due to reputational risk and fear of violating sanctions on transactions, this is a crippling blow to the Russian economy. How Putin will maintain funding for his army, while also sustaining the generous welfare payments that buy off potential domestic political opposition, is anyone’s guess.

The one remaining artery for Russia’s external commerce is the fossil fuel industry, and that too is slowly being tightened to the point of strangulation. The US has already banned all exports of Russian fossil fuels, and Britain and the European Union are gradually phasing them out over the course of the year. But this does not tell us the whole story. In anticipation of future sanctions, and from fear of violating existing financial sanctions, many companies have already stopped buying Russian oil. Putin’s revenue stream from fossil fuels, valued at up to $500 million per day, will slowly contract over the course of the year, even as expenses for maintaining the army in Ukraine and replenishing its munitions and equipment will go up.

Finally, speaking of replacing munitions and equipment, that is where the ban on technology exports will really bite. The Russian tech sector is finished, depriving Putin of yet more revenue. But what is also wounded, perhaps fatally, is Russia’s arms industry. Without access to overseas suppliers, it will presumably be difficult for Russia to manufacture even the most basic personal weapons, but in particular the loss of foreign semiconductors means that it will be next to impossible for Russia to manufacture advanced weapons systems that are reliant on computers. Every tank and rocket system destroyed on the ground, every MiG and Su-fighter shot out of the sky, is a military asset that cannot easily be replaced. The Russian army is already taking nearly a thousand casualties per day. The loss of its soldiers combined with diminishing supplies of equipment means that the soldiers that survive will have an increasingly difficult time keeping up the fight.

The strength of a nation’s military is directly tied to the strength of its economy. It is no secret why the industrialized European powers enjoyed such military advantages over all rivals throughout the 19th and early 20th centuries, and why the Soviets and Americans dominated the middle and late 20th century. Russia will now find itself without the economy needed to sustain a modern war effort in the long run. The collapse of its economy will make defeat inevitable, so long as the Ukrainians are able to hold on long enough to give the sanctions time to work.

Next week: a defeated army and collapsed economy do not bode well for Putin’s political future.