Why Aren’t Sanctions Working on Russia?

In my recently published book Hybrid Warfare: The Russian Approach to Strategic Competition and Conventional Military Conflict, I discuss the sanctions placed on Russia by Western nations. The United States, NATO, and affiliated global allies have erected the most extensive sanctions regime of the modern era. And yet, the Russian economy seems to be weathering trade and financial isolation quite well (Gabuev, 2023). How is this possible?

1.0 The Destruction and Reconstruction of Global Trade

Prior to World War II, the great powers of Europe traded within mutually exclusive empires. The colonial trade network was a product of the leading nations of Europe developing deep water navigation technologies. Each nation could utilize foundries, fisheries, plantations, mines, shipyards, natural resources, and labor from their respective colonial trade networks to facilitate economic development and industrialization (Fox, 2023).

Maintaining an overseas colonial trade network required several things that countries like the United Kingdom or France had in spades: a sophisticated blue water navy to protect the network, investment capital to develop colonial infrastructure and train the workforce, a large merchant fleet to support commerce, and a large enough domestic consumer base to make the business of colonial trade profitable. If a country needed new resources, then the easiest way to gain them was to simply invade territory from a neighboring empire, creating a vicious economic incentive to war.

World War II shattered the colonial trade system. In 1944, prescient American leaders recognized that Europe’s economies would need to be rebuilt—otherwise desperate European citizens might accept Soviet Communism and authoritarian rule as a plausible economic and political model. At the Bretton-Woods conference Western economic leaders agreed that the US Dollar would become the world reserve currency. All other currencies would be convertible to the US Dollar. The World Bank was established to facilitate investment into undeveloped economies in the Third World, and the International Monetary Fund was established to facilitate global liquidity and convertibility to the US Dollar (Fox, 2023).

1.1 Post-WWII

At the end of World War II, the US economy constituted approximately 50% of global Gross Domestic Product (GDP), so it would now serve as the consumer market of last resort, allowing European powers to export their way back to prosperity. The US Navy was then larger than all of the combined navies of the planet, so it would take the responsibility for patrolling the global commons (Fox, 2023).

The massive restructuring of global trade and finance changed the incentive structure for great powers. Colonies were now expensive symbols of a bygone era. Militaries were expensive symbols of national pride. War was no longer profitable.

2.0 Newfound Centrality of the US Economy

The other major consequence of Bretton-Woods was the apotheosis of the United States as the world’s preeminent military and economic power.

“For the first time in history, high-value-added European firms like Mercedes-Benz could import raw materials like rubber and iron from countries like Malaysia in exchange for U.S. Dollars (by converting the Deutschmark into Dollars and then Dollars into Ringgit), produce a finished good, and then export that good to spend-thrift consumers in the United States. Shipping raw materials and finished goods from remote parts of the world to consumers in the West was protected through all phases by the U.S. Navy…”

Hybrid Warfare: The Russian Approach to Strategic Competition and Conventional Military Conflict by Curtis Fox

By 1973, the United States had also established a diplomatic understanding with the Gulf States. Major oil producers like Saudi Arabia or the United Arab Emirates would only accept payment in US Dollars. All future finances related to the sale, production, and distribution of oil would be conducted in the US Dollar, further enhancing the enormous power of the currency.

3.0 The Sanctions

Following the February 2022 invasion of Ukraine, the United States, EU, UK, Japan, Korea, and other leading democratic nations erected an extensive sanctions regime which effectively cut Russia off from the US Dollar and associated second-tier currencies like the Euro, Pound Sterling, Yen, Canadian Dollar, Australian Dollar, and Won (Fox, 2023).

The Russian central bank held over $600 Billion in American and European Banks. All of these assets were frozen. Russian banks were also banned from accessing the SWIFT banking/transfer system, denying Russian creditors and debtors the ability to move money through existing global financial pipelines (Fox, 2023).

Russia was also cut off from Western technology and industry. Sanctions have severed the access of Russian manufacturing firms to any and all intellectual property developed in the United States, EU, UK, Japan, Korea, etc. This has crippled Russian supply chains, particularly in relation to the production of high-tech goods and services. Russia imports almost all computer and micro-electronics, software, pharmaceutical products, batteries, etc.

For almost any other major trading power this would have been the kiss of death, but Russia is different.

4.0 Unique Russian Resilience

There are few peoples on Earth more capable of enduring hardships for the collective good than the Russians, but apart from the stubbornness of the Russian people themselves, Moscow had a few cards to play.

Russia is one of the world’s largest oil and gas exporters. The advanced economies of Europe, particularly Germany, have relied heavily on Russian energy to fuel industries. Russia is also the world’s largest grain and fertilizer (nitrogen and potash) exporter, and the primary buyer of Russian grains include the Central Asia, China, Middle East, and Africa—regions of the world that lack the capacity to meet their own needs in caloric production (OEC, 2021). So badly are Russia’s fertilizers needed, that Germany actually increased imports of nitrogen-based fertilizer in the first 9 months of 2023 by 7.6% despite current sanctions (Geopolitical Futures, 2023).

If Germany were to be severed entirely from Russian energy exports with immediate effect, then all lights would turn off and all factories would shut down in 9 months (based on estimated stored energy reserves) (Zeihan, 2023). If the Middle East and Africa were cut off from Russian grains or fertilizers with immediate effect, then well over 1 billion people would starve. Russia is also an important exporter of dozens of other raw commodities, including: titanium, cobalt, manganese, pig iron, raw aluminum, nickel, copper, silicone, and neon (OEC, 2021).

4.1 Sanctions vs. exports

The sanctions regime erected against Russian oil and gas also reduced global supplies, elevating global prices. This phenomena of sanctions-related supply and demand fluctuations actually generated greater surpluses for Moscow than before the war for several months (Zeihan, 2023). Additionally, European firms still need fuel and they are perfectly willing to pay a premium, so even though Russian exports to Europe are throttled, Moscow is able to export its product through middlemen like India, Turkey, and Kazakhstan. This creates a paradox where prices are elevated, but Russia can still get its product to market.

By early 2022, the world knew that Russia was sitting on at least $135 billion of declared gold reserves at the central bank (Zeihan, 2022). Russia may have another $100 billion of undeclared gold assets in the national reserve, plus raw gold ore and gold concessions. Russia also produces around $20 billion of gold annually. Thus, even though much of the Russian central bank’s hard currency reserves were frozen, it retains the ability to leverage against its gold reserves with pretty much anyone who’s competent enough to maintain a balance sheet (Fox, 2023).

Head of the Russian Central Bank, Elvira Nabiullina, has also somewhat arrested financial decline by setting in place ruthless capital controls. The Central Bank seized all foreign currency within Russia’s borders. Whenever Russian firms were paid for services rendered or goods delivered abroad, they were required to hand that hard currency over to the Central Bank in exchange for Rubles (Fox, 2023).

4.2 Trade substitution

The Russians have also been successful at trade substitution, sourcing goods and services from morally ambivalent partners like the BRICS trade bloc (Brazil, Russia, India, China, and South Africa). BRICS membership has recently expanded to include Egypt, Ethiopia, Iran, and the United Arab Emirates (UAE). These countries are all emerging or frontier economies, and they are all are either hungry for energy (China and India), agricultural produce (Egypt, Iran, Ethiopia, UAE), fertilizers (Egypt, Brazil, Ethiopia, UAE, South Africa), or raw materials to feed heavy industries (all of the above). Russia’s trade with the other BRICS members has doubled since 2022, and now they collectively constitute 40% of the Russian trade portfolio. Additionally, while 85% of all settlements within the BRICS bloc are in national currencies, BRICS members are more likely to accept payment in currencies other than the US Dollar–which for Russia is vital (Geopolitical Futures, 2024). 

5.0 Chinese Substitution

China has become Russia’s most important trading partner. Russian state media reported that Chinese imports of Russian goods increased 12.7%, totaling $129 billion in 2023 alone (Geopolitical Futures, 2024). China and Russia have engaged in low-level cooperation on a large number of geo-strategic and trade issues. They both have permanent seats on the UN Security Council and frequently work together to check American diplomatic initiatives. They are also both founding BRICS trade bloc members.

Chinese domestic energy production hardly meets 20% of the country’s own consumption, so Beijing is eagerly purchasing excess Russian production. This alone would create a marriage of convenience.

However, China and Russia are also strategic competitors, particularly in Central Asia. Western sanctions have put Russia in a difficult position, and in order to gain Chinese cooperation in mitigating and ameliorating the impacts, Russia has been forced to recognize Chinese headship in their relationship.

5.1 China and Russian technology

While it goes unreported, China has been slowly acquiring Russian defense technologies in every category imaginable: surface-to-air missiles, diesel-electric submarines, jet engines, electronic warfare complexes, radar systems, etc. Russia has been reluctant to sell its partner premier systems—most likely because Beijing prefers to buy a single demonstration model, and then build unlicensed domestic copies. With Moscow vulnerable, Western observers would do well to consider what technologies of war Russia has been forced to hand over to China.

China also enables Russia to circumvent sanctions. China not only produces many of the high-tech goods and services that Russia can no longer obtain from Europe (computer-electronics, software, etc.), but China (and the other BRICS) are able to serve as middlemen to supply chains in the United States, Europe, Japan, and Korea. This is how Russia continues to source Western components for advanced weapons systems to support its war in Ukraine (e.g., Kalibr cruise missiles, Tirada-2 electronic warfare complex, 3M22 Zircon hypersonic cruise missile, Su-35S fighter jet, etc.).

6.0 Sooner or Later

Despite Russia’s unique resilience, Western sanctions are taking a heavy toll. It’s unclear how long Moscow will hold out.

Russian oil and gas fields in places like East Siberia and Irkutsk have always exported to China, but they were already operating at capacity well before the West levied sanctions (Zeihan, 2022). However, sanctions are slowly forcing the Europeans to wean themselves off of Russia’s most productive fields in West Siberia and the Ural Mountains. These fields were re-tapped after the fall of Communism by Western super-majors (Exxon, BP, Chevron, Shell, etc.). However, due to sanctions, not even environmentally blacklisted petroleum service companies like Schlumberger and Halliburton are operating in Russia now.

The West Siberian and Ural oil and gas fields are too far away to easily run new pipelines to Chinese refineries, especially without qualified support from Western firms, so excess production has to be shipped to China on supertankers by sea. Russia must utilize ports in the Black Sea (which is an active warzone), the Baltic Sea (which is a NATO lake), or the hazardous Arctic northern sea route (which is closed by ice for more than half the year) to get excess oil to non-European markets. This is expensive and impractical, and cuts deeply into Moscow’s profit margins—but the Russians have no choice (Zeihan, 2022).

6.1 Russian oil

Compounding difficulties in physically getting the oil to market, the G7 has set a price cap of $60 per barrel on all Russian crude. The Europeans have realized how difficult it is to wean themselves, so they are simply refusing to pay full price (Konig et al, 2022). This announcement infuriated Moscow, but there’s little the Kremlin can do. Oil wells in the Urals cannot simply be capped and then re-tapped later. If the Ural wells are stopped, then Russian technicians lack the expertise to restart them again. They would need assistance from Western petroleum service firms. This puts Moscow in a real bind. They cannot stop producing, but their captured customers in Europe refuse to pay market rates.

40% of the Moscow budget comes from oil and gas export revenues. The Russian Ministry of Finance reported that oil and gas revenues in 2023 had declined by 23.9% from 2022 (Geopolitical Futures, 2022). To cope with the pressure that this price cap is putting on Russia’s budget deficit the Russian Finance Ministry and Central Bank announced in January 2024 that they will dramatically increase foreign currency sales in order to arrest the decline of the Ruble (Geopolitical Futures, 2024).

Unlike in the case of oil, the Europeans have been remarkably successful in finding new sources of natural gas (Norway, Algeria, United States, Qatar, Nigeria, and others). Russian gas exports declined 55.6% in 2023 (Reuters, 2024). Natural gas exports to Europe have collapsed by 85% in relation to pre-war levels (Zeihan, 2023). Many of Russia’s existing natural gas facilities were built and operated by foreign firms (BP, Exxon, Mitsubishi Energy Group, etc.), and it’s not clear that Russia’s workforce is capable of operating these sites in the absence of Western corporate participation.

6.2 China

China is also not as credible a trading partner as one might think. Due to its own internal financial instabilities, the Chinese Central Bank has the country floating in excess liquidity–in short, the Chinese have been printing Yuan and putting it into circulation through state-owned banks to paper over a labyrinth of non-performing loans. In order to bleed off some pressure China will pay for anything abroad in Yuan that it possibly can. While trade with China is booming, Russia is being forced to accept payment for 75% of cross-border purchases in Yuan (Geopolitical Futures, 2023). Inversely, China would prefer to be paid in foreign currencies, particularly US Dollars.

Recall, 85% of Russia’s BRICS settlements are being made in national currencies, but it’s unclear how many of the other BRICS members are willing to accept payment in Yuan. If Beijing doesn’t want international partners sending Yuan payments back to China, then what good are currency reserves in Yuan?

While import substitution has been effective enough to keep Russia’s large state-owned firms up and running, particularly Russia’s defense industrial base, there has been little attention paid to similar import substitutions for Russia’s private sector. This problem is most acute for Russia small businesses, but it’s also been felt by small and mid-cap corporations. These firms constitute Russia’s real economy—not the state-owned enterprises and oligarch-controlled conglomerates. And while Moscow is dumping all of Russia’s state-driven economic capacity into a war, the real economy has been severed from Western supply chains, intellectual property, resources, investment capital, and consumer markets—in short, its withering rapidly.

However, perhaps Russia’s most acute problem is its own demographic decline. See the below graphic.

Zeihan on Geopolitics—https://zeihan.com/disunited-nations-maps/

6.3 The birthrate factor

Birth rates collapsed in the 1990s and they have never truly recovered. Russia does not have sufficient numbers of young people to fill out the future tax paying ranks. Nor has the Russian school system produced enough trained young engineers and technicians to maintain its future infrastructure (most Soviet-trained engineers are in their 70s). Nor does Russia have enough healthy young men to fill out the ranks of the Armed Forces. Moreover, national crises in alcoholism, tuberculosis, HIV, and heart disease have dramatically lowered male life expectancy in Russia (Fox, 2023).

This demographic crisis is pending behind the scenes of a war where 315,000+ Russian men—men who were healthy enough to meet the minimum physical and psychological requirements to be conscripted—have been killed or wounded (Strobel & Luxmoore, 2023).

7.0 A Plausible Pathway Forward for Russia

Vladimir Putin’s government is not close to achieving its objectives in Ukraine, but it’s clear that he can neither deescalate nor come to terms. The Russian people have paid an egregious price in Ukraine for their government’s military adventurism, and if Putin walks away from the war with nothing to show for it then that might be the impetus of a political crisis in Moscow.

To move the needle, Moscow really needs the West to lose interest in a Ukrainian victory. Many Western leaders have failed to make the case to their voters as to why supporting Ukraine is in the national interest, and Ukraine needs Western financing, training, and weapons in order to stay in the fight. The 24 hour news cycle will find another crisis if Moscow can just wait.

The Russian Armed Forces have squandered most of their offensive capability, and they have demonstrated an inability to engage in modern maneuver warfare. The only option left is 1914 style trench-warfare. General Surovikin first ordered Russian troops to begin entrenching their positions in the fall of 2022. Russian fortifications can now be seen from space, making a successful Ukrainian offensive implausible, and ushering in a stalemate.

7.1 Ultimate attrition

While the line of contact is largely static, Russia continues to use cruise missiles and ballistic missiles (many of which were purchased from Iran and North Korea) to conduct strikes against Ukrainian infrastructure (e.g., the power grid, railroads, bridges, ports, etc.) and the civilian population itself. The goal is to create refugees and destroy Ukraine’s economy. If there’s no annual economic output and no civilian population at home, then Ukraine will no longer be able to sustain an army in the field with funding, food, fuel, ammo, and other supplies.

This strategy does not require Russia to take risks. They just have to sit still, maintain the status quo, and wait for Ukraine’s Western allies to lose interest.

It’s anyone’s guess as to whether the Russian economy can ride this strategy out, but President Putin and his national security cadre appear undeterred.

Disclaimer: The views expressed in this article are those of the author, and do not reflect the official policy or position of the Department of Defense or the U.S. Government.

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