Waging War by Other Means: Juan Zarate Explains the New Sanctions on Russia
Waging War by Other Means: Juan Zarate Explains the New Sanctions on Russia
"This is the most accelerated and expansive sanctions regime levied against a major economy in the last 20 years, if not the entire post-World War II period. "
MONEY
In the week since Russia invaded Ukraine, unprecedented sanctions against Moscow, Putin, and his allied oligarchs have been central to the West’s response. Impacting everything from geopolitics to gas prices, the new sanctions are far-reaching, highly technical, and complex. To understand what they cover, how these sanctions are different from those of the past, and what might be next, I caught up with one of the world’s leading experts on the subject, Juan Zarate—a former assistant secretary in the U.S. Treasury Department, where he where he led the federal government’s efforts to dismantle terrorist financing following 9/11 and expand the use of Treasury powers to advance U.S. national security interests.
Octavian Report: Explain the new sanctions imposed in the last week.
Juan Zarate: This is the most accelerated and expansive sanctions regime levied against a major economy in the last 20 years, if not the entire post-World War II period. These are efforts by Western countries to cripple the Russian economy, to unplug Russian financial institutions from the international system. And they’re being backed by private-sector actors moving on their own.
OR: How are these measures different from those the United States has used before?
Zarate: Three categories of things have been done. You have the targeting of Putin himself and the oligarchs around him, and an effort to hunt down their assets. That’s one thing that’s qualitatively different. Second, you have the restriction of transactions with the largest Russian financial institutions (apart from those related to oil and gas). In concert with the restrictions on transactions with the central bank, that makes this really dramatic. Those institutions are being unplugged from the international financial system, from their assets, which is starting to wither away their ability to operate.
The third part is the unplugging of Russia from SWIFT. Except in the cases of North Korea and Iran, Western policymakers had been loathe to inject SWIFT into any international debate, because the SWIFT messaging system is seen as part of the international financial infrastructure. So leaders had always handled it very delicately in the past. The fact that we see Europe in concert with the United States aggressively unplugging seven major Russian institutions from SWIFT is a signal of real financial isolation and a real attempt to cripple the financial and commercial system of Russia.
There are all sorts of other things. There are sanctioned entities, there are export controls. Finally, as I mentioned, you have the private sector taking steps, such as BP and Shell deciding to divest from their oil interests in Russia, or Maersk deciding it’s not going to ship anything in and out of Russia, or Apple not selling its products there. All of that feeds into this very quick and aggressive isolation of Russia financially and commercially.
OR: How much of the Russian Central Bank’s $630 billion in reserves can it no longer access? And do you think the Russians saw this coming?
Zarate: I do think the Russians anticipated that sanctions would be levied if they went into Ukraine. They stocked up on gold—2,300 tons. So they were preparing. But I don’t think they imagined the dramatic unanimity and aggressiveness of the sanctions. I think they’re shocked that their central bank and seven other banks have been deSWIFTed. In 2014, the Russians said that if their banks were taken off the SWIFT system, they would consider it an act of war. So I think they assumed it was a red line the international community was not going to cross.
As for how much of the central bank’s reserves are now choked in the international system, I don’t have those figures, but as you know, most central bank reserves aren’t held in a pile of cash in a vault in Moscow. They’re held in financial instruments, government bonds and the like, outside the country. So I would say the bulk of the $630 billion or is probably locked up in some way. And what makes it even worse is the Russians can’t leverage that money for trading and other things they want to do. They can’t transact with it. So it starts to limit their flexibility to finance different things.
OR: What about oil and gas sales, which were excluded from the sanctions? Some critics have said, “Well, that’s a large percentage of Russia’s budget, so doesn’t that undercut everything else the West is doing?”
Zarate: It is a hole in the sanctions regime. But that won’t undermine the effect of all the other steps. In fact, a lot of the other steps are going to complicate the oil and gas trade. The ban on the export of technologies needed in the oil and gas industry will affect its ability to produce downstream, as will the pullout of BP and Shell. So there will still be an enormous effect on the economy. But the Biden administration has been very clear that while we’re going to impose sanctions aggressively, we’re going to do it in a way that doesn’t undermine our economy or hurt the Europeans or exacerbate things like oil prices or inflation. That’s a hard needle to thread.
OR: Do you think the Russians view our cautiousness as weakness?
Zarate: I think the Russians have always thought of their oil and gas resources, and Europe’s dependence on them, as a sword and shield in their confrontation with the West. That’s why they’ve invested so much in creating the dependencies in Europe, why they invested so much in Nord Stream 2, why they have paid for so much lobbying in European parliaments and so on. It’s a major problem. A lot of us have been talking about this for a while, saying, “We need to be aggressive in thinking about our energy dependence, because this limits our ability to squeeze Russia.”
OR: We’ve already seen a huge impact on the ruble, and Russia has been forced to close its stock market. But when do you think the sanctions will really start to bite?
Zarate: In the past, we’ve designed sanctions to squeeze more tightly over time and in different ways in different sectors. That’s not what’s happened here. This is more of a shock-and-awe approach, again with the oil and gas sector being left out. Ordinarily I’d say it’s going to take four to six months to see the effects, to see reserves fall, to see the currency drop. But in this case, a lot of that’s going to happen right away. They’re not opening the Moscow Stock Exchange, for example, because when they do there’s going to be a massive selloff. There’s going to be a major dip in confidence and a collapse of the fundamentals of the economy.
Oil and gas will be a bit of the wild card. If oil and gas prices continue to increase, that may give the Russians a greater sense of stability in income. But in general, you’re going to see the effects of these sanctions very early, and within a month or two you’re going to see real systemic problems. They’re going to have to figure out how to get certain goods that they’re not able to import or pay for. They’re going to have to figure out how to replace certain payment systems. That’s going to create real friction early on.
OR: If the West does decide to ratchet up the pressure, what would be next?
Zarate: I think we would see the unplugging of all Russian financial institutions. So far there have been certain exemptions and carve-outs. And the West might go after more individuals tied to Putin. But the next big step would be banning trade in Russian oil and gas. And the final step would be secondary sanctions [banning third countries from trading with Russia]. That would create the ability to go after Chinese companies, for example, still doing business with Russia.
OR: How are the Russians going to try to evade all these measures?
Zarate: They could use oil and gas channels. They could mask holdings, reserves, and transactions with third-party banks. None of that is easy, and it puts certain things at risk. But the oil and gas exemptions will allow the Russians to evade some sanctions if they’re creative.
Then there’s China. The Chinese could give financing, they could trade, they could do all sorts of things that would ease the pain on Russia. But it’s not like you can take the Russian financial system and say, “Okay, let’s run it from Shanghai and Hong Kong.” It doesn’t work that way. Who’s going to buy Russian bonds? Maybe the Chinese will. But will the Chinese really want to do that? We’ve already seen institutions like Bank of China operating in Singapore say, “We’re going to implement the sanctions, despite what Beijing says.” It and other institutions don’t want to jeopardize their access to Western markets and systems.
The third issue is crypto. Full disclosure: I’ve been an advisor to Coinbase since 2014. But the crypto economy isn’t mature enough or big enough to allow for wholesale evasion. Could you see particular oligarchs put some assets into Bitcoin? Sure. But I don’t think the Russian Central Bank is going to be converting its assets into crypto anytime soon, in part because if it’s not in their control, it can get pretty uncomfortable. It’s not just the volatility of the prices, but it’s also the open architecture, and the U.S. government’s ability to trace holdings. Washington has already proven it can freeze wallets and recover Bitcoin via law enforcement and regulatory measures.
OR: Do you think that the oligarchs are really at risk from the new sanctions, or do you think that their money is not traceable?
Zarate: I think they’re really at risk. Sanctions have bitten the oligarchs before, but there hasn’t been an all-out enforcement effort. One of the qualitative differences here is the great desire to actually find their assets in an aggressive way. We’re already seeing private individuals using Twitter to track their planes, track their yachts.
The Pandora Papers and the Paradise Papers also did a lot to reveal how certain people associated with Putin have wealth that doesn’t match their stated professions. Now Western policymakers have suddenly found the right moment to act on that information. By the way, we’ve been on this trajectory for some time, dating back to President George W. Bush’s 2006 anti-kleptocracy strategy. But in recent months, the Biden administration rolled out a new anti-corruption strategy that formally declared that this is a now a key national security issue for the United States. So when Russia invaded Ukraine, Washington had already started to focus on these issues. That makes me think we’re in a qualitatively different period, where government officials see the value and importance of actually going after oligarch assets and seizing them.
OR: So much of what’s happening now depends on the fact that the United States, the British, the Europeans, and the Japanese control the world’s reserve currencies. Should we be concerned that this might change?
Zarate: I think the Chinese and the Russians already recognized the problem well before this crisis. They recognized that a key element of American predominance is the power of the dollar and of the U.S. financial system. Now this demonstration of aggressive international solidarity on the use of financial weapons is going to be another huge wake up call for the Chinese.
The lesson here is less about Washington’s use of its power, which was already a given. It’s about the fact that Europe and the United Kingdom and Japan have also been willing to wield these tools aggressively. In the past, they’ve always been dragged along by the United States. But Europe has found its role in using financial and economic tools in lieu of actual warfare. That’s an important shift. I think the Chinese will recognize it. The Russians are feeling it and that should worry the Chinese, because it’s not just the United States; it’s the Europeans, the Japanese, the Australians, the Canadians, and the Brits all willing to use extreme economic measures, even if they’re not willing to go to war. That’s different than simply using sanctions in aid of diplomacy.
OR: But what can the Chinese do about it?
Zarate: They are trying to create alternatives to the existing financial systems. They’re trying to increase the attractiveness of their economy, to force the adoption of the renminbi or the digital yuan. They’re using the Belt and Road Initiative and the Digital Silk Road to export their system. And they’re using their state-owned enterprises to extend their economic reach. They’re trying to challenge the current order, they’re trying to create alternate payment systems, and they’re trying to create new dependencies that put China’s currency, economy, and institutions at the center of gravity.
OR: Don’t they have to have a convertible currency to succeed?
Zarate: If you’re asking whether there are real deficits in the Chinese strategy, the answer is absolutely. And the Chinese are not building trust—they’re losing it. China has started baring its teeth and using its influence in ways that are making lots of countries uncomfortable. That’s not a good prescription for global adoption of the renminbi or the digital yuan. They may be able to force some actors to do so. But I doubt you’re going to see many Western economies wanting to sign up with China anytime soon.
This interview has been edited for length and clarity.
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