Janet Yellen may force Russia and, in some cases, the country’s corporate sector, into default.
Over the years, I’ve endeavored, with varying degrees of success, to explain that in a world where the vast majority of trade, financing, invoicing, borrowing and lending, involves the US dollar at some point, the US Treasury’s power is virtually unbridled.
For some, that simple observation is too unpalatable to countenance despite being self-evident. Critics of dollar hegemony would rather deny a tautology than concede that the sole legal issuer of a currency by definition controls that currency and everything to do with it. There are some exceptions — illicit transactions carried out in physical cash are the most obvious. But outside of the cocaine trade in the Americas as it existed from the 1970s through the mid-80s, such arrangements rarely work at scale and almost never for any appreciable length of time.
Despite years watching otherwise intelligent people deny reality, I was myself incredulous last month at the level of incredulity in the market when the West effectively seized the lion’s share of Russia’s foreign currency reserves. As it turns out, “claim” is a misnomer when what it is you’re claiming is the sole purview of someone else. Your claim is only as real as the entity which created it decides it is. (Who knew, right?)
There were two carveouts, though, one explicit and the other inherent in Europe’s beholden status vis-à-vis Russian energy. Russia could continue to service foreign currency debt, and some European nations’ reliance on Russian gas meant Moscow would retain access to hard currency — sort of. Russia is constrained in how it can use any G7 claims it’s allowed to retain.
That brings us to the story of the day. As of this week, Russia may no longer be allowed to use otherwise frozen dollars held at US banks even to make coupon and principal payments on dollar-denominated debt.
On Monday, Yellen stopped Russia’s correspondent bank (JPMorgan) from processing payments, including a principal payment of more than $550 million and an $84 million coupon payment on a 2042 dollar bond, according to a Treasury spokesperson, who told Reuters that Moscow “must choose between draining remaining valuable dollar reserves or new revenue coming in, or default.”
Russia made a series of payments since the war began, but now faces a stark scenario: Deplete the unfrozen portion of its reserves, divert export revenue, curtail spending on the Ukraine conflict or miss payments. This could affect the Kremlin’s decision calculus when it comes to demanding rubles for gas shipments. Some of Russia’s obligations have alternative payment clauses. For the portion that don’t, rubles won’t work.
As Bloomberg wrote Tuesday, Treasury’s new stance “sharpens the focus” on coupon payments due late next month on dollar and euro bonds. Those payments are due May 27, which the linked article noted is “two days after previously announced exemptions are set to run out.”
Russian corporates attempting to make payments on their own debt have been beset with logistical problems since the onset of hostilities. Citi, which provides payment services to Russian companies, reportedly spends days mired in the new, labyrinthine sanctions regime in an effort to check every box and avoid running afoul of authorities in Washington, London and Brussels.
That means some companies will likely default, not because they don’t have the money to pay, but because the sheer amount of compliance work required to clear the payments means the funds aren’t transferred on time. Indeed, that’s already happened. “Although flush with cash, the steelmaker was unable to settle a $12.6 million dollar-bond coupon within a five-business day grace period,” Bloomberg wrote late last month, describing the plight of Severstal, which was informed by Citi that the bank needed explicit permission from OFAC prior to green-lighting the interest payment. Multiple payments were similarly held up by Citi as of March 30. As one Bloomberg credit strategist put it, “They want to make sure everything is by the book with the US government.”
Effectively, Yellen is making it impossible for Russia to pay. Treasury’s decision to tighten the noose came in the wake of alleged war crimes in Bucha, which some European nations insist should be the last straw when it comes to going forward with an energy embargo. Although a phased-in ban on Russian coal was in the offing, there was still no agreement in Brussels on a move to sanction oil and gas. Germany’s opposition is becoming untenable, but after securing a victory at the polls, Hungary’s Viktor Orban will likely hold the line.
There’s been quite a bit of discussion about the purported “injustice” of financial measures aimed at cutting Putin’s Russia off not just from the global financial system, but from its own reserves. Typically, critics attempt to silo the debate — the war is so obviously wrong that it scarcely bears mentioning, so better to have a theoretical discussion about the purported right to transact and the ramifications of weaponizing the dollar in the service of foreign policy aims.
I myself have (repeatedly) argued that the biggest threat to the dollar’s reserve status is the capricious weaponization of the currency. In 2020, for example, I wrote that,
The dollar’s status as the world’s premier reserve currency is threatened more by US foreign policy than it is by any deficit, no matter how large. The constant weaponization of the USD and the US financial system through draconian sanctions aimed at punishing perceived foes along with the 2018 experience (when the rest of the world was again reminded that financial stability outside the US depends almost entirely on the Fed not erring by overtightening during a hiking cycle), are likely to be the key drivers of continued de-dollarization. Not deficits and not ‘money printing.’
In what I’ll call a small miracle, no one thought to cite my own words in arguing against my steadfast contention that de-dollarization is a virtual impossibility in the near- to medium-term.
I’d be inclined to suggest this is yet another example of why people trust what they read here. I give you both sides of the story, which in many cases means arguing against myself in order to help get at the truth. In this case, I’m afraid the truth, reduced and condensed, is more uncomfortable than almost anyone is willing to admit.
We lie to ourselves each and every day about almost everything, because to tell the truth is to strip life of any and all meaning. For example: There’s no such thing as “inalienable rights.” We made that up. It’s pure fiction. There are only our human sensibilities, which are in no way, shape or form, the product of any connection we have to the divine.
What does that mean in the current context? Well, it means that just as Putin isn’t required, by any power higher than an international tribunal, to respect Ukraine’s “right” to self-determination or even the people of Ukraine’s “right” to live at all, the US isn’t required to preserve Russia’s “right” to transact or Russian corporates’ “right” to pay debts they’re able and willing to pay.
It also means that nobody in Washington is compelled by any divine decree to avoid taking action that would cause the Russian people to experience acute suffering. Economic or otherwise.
Now that’s realpolitik.