a look at the impact of war on the economy of a nation
Albert Einstein once said, “I know not with what weapons World War III will be fought, but World War IV will be fought with sticks and stones.” while it is inaccurate to characterise Russia’s incursion into Ukraine as the third world war, the result of its actions appears set to leave its citizens with more or less sticks and stones to their names at least in the short term. the United States, European Union, and several other parties have hit the country with economic sanctions, the consequences of which are being felt on the ground in real time.
what are these effects and why is the Russian central bank raising the interest rate in order to mitigate them?
Russian citizens are being hit hard by both external as well as internal forces. economic sanctions from outside have seen the value of the Rouble plummet 30% to a record low, trading as low as 119 Roubles/1 US Dollar. most Russian banks have also been cut off from the SWIFT (Society for Worldwide Interbank Financial Telecommunication) system which severely hampers the nation’s ability to access its overseas currency reserves.
this is significant as Russia heavily reliant on SWIFT for its key natural resources trade, especially payments for its oil and gas exports. it cuts off access to the $630 billion reserves that Russia had built up since the last round of sanctions in 2014, as most of it is stored overseas in foreign currencies.
when a country’s banking system is cut off from access to money, naturally the end-consumers are also affected. citizens were rushing to ATMs to try and withdraw money before what was available ran out. in response, the central bank banned Russians from sending money overseas in order to preserve the liquidity that was available. it also initiated a direct purchase of gold without any limit on the quantity in order to put liquid (easily transactable) money into the hands of people in place of a relatively illiquid asset such as gold.
but perhaps most significantly it raised its key interest rate to 20%. this works in two ways. it encourages Russians to keep their money in the system since they’re getting higher interest, thereby reducing pressure on the limited reserves. consider for you had 100 Roubles in the account, which has depreciated 30% in value due to the sanctions, and therefore has 70 Roubles worth of buying power now. with a 20% interest rate, if you keep your money in the bank, you will end up with 120 Roubles, which even at the depreciated value has a purchasing power of (120 * 0.7) = 84 Roubles.
regardless of these measures, one indisputable fact seems to be that often there are no winners in war and it’s the common people that suffer the most. this event playing out in the age of social media only helps us understand the dynamics of its impact on economies better. an interesting note here is that cryptocurrency advocates are quoting these measures on both sides as an example of why a decentralised system where people, not governments or central banks, have control over their money must be the future.