Russia: How should we fight back?

Russia’s attack on Ukraine has rightly outraged most of us. Leaving aside the history that brought us to this present conflict, Russia’s attack is totally unjustified. Our natural instincts are to help Ukraine resist its aggressor. As we watch the destruction of lives and property, it is natural to want to send in our boys or planes to help. Surely, we can stop this by using the might of our military and advanced weapons. Wars tend to look like that in the beginning. Vietnam, Afghanistan, Iraq (I still can’t sort out what Bush/Cheney thought was America’s interest in attacking Iraq) looked like slam dunks going in. The realities were invariably very different by the end. How should we help Ukraine?

The U.S. and Ukraine’s NATO neighbors have been supplying Ukraine with weapons but left them to fight on their own. This was my assessment a month ago: “Ukraine-Russia-NATO”  As much as it strains against our impulse to help, President Biden is absolutely correct in ruling out our joining the war. For most of us, war, and the incredible pain it inflicts on those directly involved, is fought elsewhere by others. It is far too easy to say “sure, lets go to war.” “Ukraine-how should we help?”

But wars can be fought economically as well as militarily. Much of the West (the designation seems relevant again) has joined together to impose severe economic sanctions on Russia. But the objectives of these sanctions are not clear. They are too late to deter Russia from its invasion of Ukraine, though perhaps they provide an example of the potential cost to China if it decides to invade Taiwan. Are they meant to pressure Russia to come to the negotiating table? But it takes two to tango–Zelensky must be there as well. I have heard no statement of what Russia must do for the sanctions to be lifted.

The sanctions seem designed to cripple the Russian economy. Sadly, the pain will fall mainly on the Russia people rather than its government. Considerable pain will also fall on those imposing the sanctions. “The war in Ukraine and globalization”

Supply chains and financial channels will be disrupted for many years. But like military wars, the collateral damage an economic war is hard to predict. China and Russia and maybe India and much of Africa are being driven together to establish new trading relationships and non-dollar payment channels that don’t seem to serve American interests. If they are not explicitly linked to accelerating a negotiated peace, what are the sanctions for?  I don’t necessarily believe that our military industrial complex deliberately promotes the perpetuation of war, but as an economist I can’t ignore the fact that they have an economic incentive to do so.  

Missing from all of this seems to be the skillful deployment of diplomacy. The first priority, of course, is to end the fighting in Ukraine. But any peace agreement must look beyond the immediate war to the conditions that will promote peace and prosperity for Ukraine, Russia, Europe, and the world well into the future. As is often the case Chas Freeman says it best: https://www.youtube.com/watch?v=0vxufUeqnuc

How to stop Russia in Ukraine?

In violation of international law, Russia has invaded Ukraine and the world is rightly outraged. Countermeasures to stop the fighting and punish Russia’s aggression do not include sending NATO armies against Russia for the very good reasons that it would significantly increase the risk of a devastating nuclear war and because our experiences with such wars in the last half century are not encouraging. What countermeasures might we (and are we) use(ing)?

Our primary tools are to economically and culturally isolate Russia in order to damage their economic ability to continue waging their war and to hurt their pride. What might that include within the limits of our commitment to the rule of law?

Each of us as individuals, companies, and governments have the right to decide who we trade and deal with. Refusing to sell to or buy from Russia can have a powerful impact on the Russian economy. Examples of companies that have ended or restricted their sales to and/or operations in Russia include Ford, GM, Toyota, VW, Volvo, Nissan, Honda, Subaru, Harley Davidson, Apple, BP, Equinor, Shell, ExxonMobil, Visa, Mastercard, Google, and Netflix. And the list continues to grow by the hour.

“Ikea, the world’s largest furniture company, is closing its 17 stores in Russia. The company said the conflict is having a “huge human impact” and “resulting in serious disruptions to supply chain and trading conditions.” In addition to pausing its retail and manufacturing operations in Russia, it will suspend all trade with the country and its ally, Belarus.” “CNN: Companies pulling back from Russia”

Sports and entertainment organizations certainly have the right to determine their members and kicking Russian teams or performers out of competitions, etc. can usefully demonstrate disapproval of Russia’s behavior.

More problematic are the announcements by Boeing and Airbus that they have suspended support services to Russian airlines flying their planes. Airbus stated that “it has ‘suspended support services to Russian airlines, as well as the supply of spare parts to the country.’” These are problematic because they might be breaking provisions in contracts these companies have with Russian airlines.  However, such contracts often provide for suspension in the event of war or other unusual circumstances. Moreover, if Russia withdraws from Ukraine in the next few weeks and the more severe sanctions are withdrawn, these reservations may become mute.

While social media platforms and entertainment companies (Disney, DirectTV, and WarnerMedia) also have the right to cut off Russian users, I am not convinced that it is always wise to do so. In my view we should all be able to view the propaganda disseminated by, for example, RT.  While I am sure that WarnerMedia’s decision to “pause the release of ‘The Batman’ in Russia,” will be devastating for many Russians, they do have more challenging issues to worry about at the moment.

A rather different category of sanctions are those taken by and/or imposed on others by governments. For example, all Russian airline flights are now banned from EU, U.S., and Canadian airspace. As a result, or perhaps for other reasons, the Russian delegation to the World Telecommunication Standardization Assembly (WTSA-20) of the International Telecommunications Union now underway in Geneva didn’t come. This important meeting is held every four years to allocate spectrum and set other global telecom standards. By its absence Russia has lost all opportunities to nominate and elect chairmanships of any study groups and task forces for the next four years.

Most payments in dollars, Euros and most other currencies have been forbidden by the issuers of those currencies with specific exception. Russia has been blocked from using S.W.I.F.T. for sending payment instructions. The most important economic exception is that Russia may continue to sell oil and gas to Europe and to receive payment for them. Another is that Russia may continue to make debt service payments on Russian debt securities held abroad. The assets of all Russian banks outside of Russia, including its central bank, have been frozen. I am not sure how these two are reconciled. “BBC News”  

The approach of blocking economic activity by blocking payments for them is a bit similar in spirit to Anti Money Laundering (AML/CFT) restrictions, which attempt to stop illegal activities by stopping the use of the proceeds of “crimes” that haven’t been proven, rather than stopping the illegal activities themselves. The effectiveness of blocking payments in key currencies depends on how widely they are supported. A UN resolution condemning Russia’s invasion of Ukraine was supported by 141 members. Only 5 countries voted against (Russia, Belarus, Eritrea, North Korea, and Syria). China and India and 33 other members (including, surprisingly, Cuba) abstained. Germany completely reversed earlier policies and is sending serious weapons to Ukraine and is increasing its military expenditures above NATO recommended minimums. While the extent of support is impressive, the abstainers open sufficient holes to undermine the impact of financial sanctions. None the less, the dramatic shrinkage of trade and real economic interactions will be devastating. Russia will be flattened and isolated.

More recently some countries have seized the assets of private Russian citizens.

The Russian Oligarch Igor Sechin’s yacht was seized Thursday by French Authorities while docked for repairs in La Ciotat, near Marseille. On the same day “Germany seized the Russian billionaire Alisher Usmanov’s 512-foot mega yacht Dilbar, which is valued at $600m, which was moored in Hamburg.” “Russia sanctions superyacht seizures”. To my knowledge, neither of these Russians committed any crimes in France or Germany or anywhere else outside of Russia. The legal basis for these seizures, unless they are being held temporarily pending a court determination of whether crimes have been committee, is very questionable.  

Imposing harm on Russia and Russians of the types discussed above, will have costs to us as well. This by no means suggests that we should not use them. Properties and businesses abandoned in Russia and goods and services no longer sold there or purchased from there will impose costs on the western companies involved.  Western owners of Russian securities are likely to incur losses. Some Russian debt will default. But Russia’s aggression must be stopped, and future aggression strongly discouraged. Watching the Soviet tanks crush Hungarian and Czech demonstrators in 1968 without our military intervention to help them was very painful but was the right thing to do, just as our nonmilitary approach now is the right approach, as long as we apply sanctions lawfully.

Putin’s reckless war in Ukraine is destroying Russia. Let’s hope that the good and long-suffering people of Russia will not allow him to also destroy the whole world.

Sanctions

About 5 days ago, on February 24, Russia illegally and without provocation and cause attacked the sovereign country of Ukraine. It is in everyone’s interest (with the exception of the military industrial complex) to end the fighting and establish a sustainable peace as quickly as possible. I explored options in my blog Saturday.  “Ukraine-Russia-NATO”  

Sanctions are being piled on as the main counter weapon of choice around the globe, along with supplying Ukraine with military equipment. But which sanctions of what activities (use of SWIFT, banning access of Russian airlines, banning any travel across Russian borders, banning trade in military products, banning all trade, etc.) should be imposed? If all or almost all countries joined together to shut down all trade, travel, and financial flows between Russia and the rest of the world until Russia ends this war and fully withdraws it troops, the impact on Russia (and hopefully to a lesser extent the rest of the world) would be devastating. While it is hard to predict whether the Russian people would primarily blame the U.S. and the West or Putin’s government for the hardships imposed—it is unlikely that Russia would withstand such isolation for long. Russia seems well on its way to such isolation.

While sanctions have historically not been a very effective tool for changing a country’s behavior, such total isolation, if it can be achieved, would almost certainly be more effective than the more limited sanctions normally imposed. “A new history of sanctions has unsettling lessons for today”  Putin will have to back down or escalate. Putin would indeed be boxed into a very difficult position and there is no knowing how he might react. It is hard to imagine Russian military escalation beyond Ukraine’s borders, but it is possible, especially in the ambiguous ways often favored by Moscow (e.g., cyber-attacks). If Putin is squeezed too hard, the risk of nuclear war could no longer be ignored. This is a dangerous period.  “Just short of nuclear–the latest financial sanctions will cripple Russia’s economy” Such comprehensive sanctions should be largely removed as soon as Russian troops are withdrawn from Ukraine territory.

But while it is foolish (i.e., contrary to American interests) to keep Russia as an enemy in the long run, and it was foolish to have made it one in the first place, the Kremlin should pay a price for its attack on Ukraine.

Sanctions impose a cost on their target but also on those imposing the sanctions. If, for example, Russia is denied access to western products, the sellers are also denied the sales. Moreover, for many if not most economic sanctions, the people of the sanctioned country tend to suffer more than the government that is the real target. For post conflict sanctions, thought should be given to the most effective ways to sanction Putin and his friends specifically with minimal damage to the Russian economy. The borders and trade should be reopened to all but a small list of Kremlin officials including Putin. Putin’s properties and other assets abroad should be frozen or confiscated to contribute to Russian reparations for damage now being inflicted on Ukraine. “Russia’s military attack on Ukraine will have consequences for Putin”

Yesterday (2/27.22 6:37 PM), Edward Luttwak tweeted: “Putin’s agreement to talks with Zelensky’s reps is an abject surrender: by now the Russians should have been in control in Kiev and across the Ukraine with Zelensky dead or exiled. Frantic to divert attention, Putin has placed Russia’s nuclear forces on high alert. Meaning: zero”

Let’s hope that he is correct.

Every action should be carefully measured against is costs and benefits both short term and long term. Another protracted cold war would be a costly mistake for everyone. All measures should ultimately contribute to peaceful and secure relations between all countries.  Greenwald–War propaganda about Ukraine

Ukraine–Russia–NATO

Russia has surprised most of us with an all-out attack on Ukraine. What should the U.S., NATO, and Ukraine do now? Each possible answer implies different possible consequences. We would be wise to understand them as well as possible. We should try to evaluate the probable long-term effects as well as the immediate ones.

The fact of the matter is that that we made serious errors since the disbanding of the Soviet Union (the expansion of NATO, establishing Aegis Ashore missiles in Romania and Poland, etc.) that began on Christmas 1991. The effect was that Russia walked away from NATO rather than becoming a member. While all of this is very regrettable, it is nonetheless history. We are where we are now because this history has inevitably influenced the present and thereafter the future of Russian relations with the rest of the world.

While Ukrainian resistance appears stronger than Putin expected, Russia may well take control of parts of Kyiv and other western Ukrainian cities within days or weeks. However, following earlier examples of Russian incursions and given the inadequate size of its forces, it is likely to quickly withdraw after flexing its now stronger muscles in negotiating an agreement with the U.S., NATO and Ukraine.

According to Edward Luttwak tweeting on the afternoon of Feb 24 “Air strikes can reach any target but Russian troops are much too few to achieve a coup de main, the single act that both starts and ends a war. Yes, they control airfields & some city centers. Beyond them individual soldiers & volunteers will start killing Russian soldiers w/o end. They had a missile strike plan viz Ukraine air force, very weak in any case. Russian troops too few to control the country beyond airfields, central Kiev, Odessa, etc., nothing for hostile W Ukraine. Ukrainian soldiers & volunteers will fire & kill Russians. Final result: the end of Putin.”

President Biden has wisely stated that the U.S. will not send troops into Ukraine, which is not a NATO member. While he has rightly condemned Russia’s illegal attack, and together with our European allies has significantly increased economic sanctions on Russian banks, businesses, and officials, though still with significant carveouts, he has correctly, in my judgement, concluded that the cost to our already overstretched budget to fight a war over Ukraine is not in America’s interests.  We care about many people and things in the world for which it is not justified to spend our financial and human resources rather than focusing them initially on our own domestic needs. Some among us may want to rule the world but we can’t afford it either financially or morally. Our military industrial complex, which profits from wars, probably disagrees.

Luttwak claims that “close[ing] the road and rail connections between Germany and Russia… would be the most powerful of all sanctions.” This could be done unilaterally by Poland or the Polish people. “Polish peace demonstrators [could] stop the unceasing traffic of trucks delivering Western European exports to Russia.  German cars, Dutch vegetables, French luxury exports.  That very powerful sanction does not require NATO or EU approval, just some people who care. ‘No bypass’”

More generally, sanctions have historically not been a very effective tool. “A new history of sanctions has unsettling lessons for today” Trade is win win. Both sides benefit. Thus, blocking trade is loss loss. Both sides suffer. Moreover, it is very difficult to design sanctions that hurt the target government more than its people. “Econ 101-How to help Afghans”

Ukraine is more important and relevant to European security than to ours (though one may argue that if Ukraine falls and the democracy in Europe suffers and crumbles, this affects the United States in the long run as well). In addition to financial and military aid to Ukraine, one or more European countries could, outside of the NATO context, send their troops to help defend the existing government of Ukraine.

It is very unlikely that Putin would escalate the fighting further, though it is not clear how rational Putin is these days and Russia has nuclear weapons. He was close to crazy to have launched the war now underway in Ukraine. Such European military intervention would likely save the Zelensky government and the negotiated peace (which should have been negotiated a month or two ago on the basis of Putin’s eight demands last December) would still need to mutually satisfy the interests of Russia, Europe and Ukraine.

If Ukraine receives no military help, it might still hold off the Russian army from toppling the Zelensky government. Russia might then be forced to be satisfied to hold the eastern, Russian dominated piece of the pie. The final settlement might take a bit longer in this case, but it might contain similar provisions. As Luttwak has argued above, a full Russian victory is unlikely and is expected not to last for long and would be a huge drain on Russian resources. Russia will surely pay a very high price for (presumably) gaining a government subservient to Moscow.

The longer run (five to ten or more years) consequence of one or another of the above scenarios is, of course, hard to predict but it should be taken into account. If the Zelensky government survives largely on the basis of its own efforts, it might be hoped that Zelensky’s far from complete efforts to clean up and reform his government will continue and be strengthened. A Russian victory (replacing Zelensky–dead or alive–with a Moscow puppet) would surely perpetuate and strengthen the corruption Ukraine has suffered for decades. Putin’s original eight demands would still have to be resolved and agreed in a mutually acceptable way. Doing so in January, of course, would have saved everyone a lot of lives and treasure, but discussions of these issues were hard to find in the American press.  

How this war is settled will also have consequences for American, EU, and Russian assessments of each other’s strengths and interests and thus how to deal with one another in the future. Will Russia revert to an enemy in which we keep our defense industry happy with another cold war or will we undo the NATO inflicted damage of the last twenty years that turned a potential friend to a costly enemy? China has decided to stay out of the fray neither supporting the US-Europe alliance nor the Russians which is a wise decision on their part.

The initial reactions in Russia have not favored Putin. The Russian population was not prepared to shift from seeing Ukraine as part of the family to an enemy that its sons and daughters were dying to overturn. A Russian defeat or even stalemate “victory” could be the end of Putin.  I am predisposed to believe in happy endings, which is perhaps why no one pays me for my forecasts.

We must never lose sight of the fact that Russia is more than Putin, Ukraine is more than Zelensky, and NATO is more than Secretary General Jens Stoltenberg. If I had said Biden (or Trump) you would have understood instantly. And among the population are many factions. The U.S. seems rarely to take such domestic realities into account when it decides to march into and take over countries.

In an email February 26, Chas Freeman said: “Regrettably, the place of Ukraine in Europe, which might have been decided through negotiations between Moscow and Washington in consultation with Kyiv, will now be decided through interactions by Russian dictation to Ukrainians without reference to either the United States or NATO.  Russia’s coercive diplomacy failed to elicit an offer to address its longstanding, oft-expressed concerns about the possibility that Ukraine might become part of an American sphere of influence on its border under circumstances in which the United States has officially designated Russia as an adversary.  So, Moscow made good on its ultimatum, and used force.  As it did so, it moved the goalposts.  Now Russia appears to seek the subordination of Ukraine to its domination rather than simply its denial to the United States. This is a tragedy that might have been avoided.  Now we are left to hope for a resurrection of diplomacy when there is no clear path to it.”

On February 25, Pavel K Baev stated that: “Now we know that Putin’s obsession with Ukraine — which constitutes a threat to his regime not because of hypothetic NATO missiles, but because of its choice for democracy and closer ties with Europe — prevailed over common political sense and strategic risk assessments.” “Implications of Russia’s invasion of Ukraine–Brookings Brief”

But the almost last word should go to Edward Luttwak who tweeted on Feb 26: “Having invaded with too few troops to pull off a fait accompli, with many Russian troops killed because of incautious tactics that presumed no real resistance, Putin has also closed the door to talks with Pres Zelensky: ‘I will not talk with drug addicts and neo-Nazis’. Sanctions.   Not too late to send large numbers of small arms and point & shoot anti-tank weapons to Ukraine via Poland or Slovakia. There are warehouses full of both (+ their ammo) across NATO because of the drastic reduction in force-levels. Ukrainians are resisting bravely and deserve help”

And the final word goes to Thomas Pickering (former US Ambassador to the Russian Federation and other places): “The end result must be respectful, fair, and balanced for the people of Russia and for all other parties. It will take wisdom, time, sacrifice, and persistence. To get there, the U.S. must lead, help to finance, and participate extensively in an international coalition — through the United Nations if possible, outside it if necessary — and listen to all like-minded states.” “Implications of Russia’s invasion of Ukraine–Brookings Brief”

President Putin’s welcome to Crimea

Anyone interested in current events in Ukraine should read Russian President Putin’s address to the Russian people on March 18, 2014 welcoming Crimea back into Russia: “Putin’s speech on Crimea”. It is very clever in playing to the insecurities of the Russian people while also speaking to the international community. Putin says many things we can hardly disagree with along with (and often packed in) some amazing lies and some embarrassing truths.

Here is one example of the former: “I would like to reiterate that I understand those who came out on Maidan with peaceful slogans against corruption, inefficient state management and poverty. The right to peaceful protest, democratic procedures and elections exist for the sole purpose of replacing the authorities that do not satisfy the people. However, those who stood behind the latest events in Ukraine had a different agenda: they were preparing yet another government takeover; they wanted to seize power and would stop short of nothing. They resorted to terror, murder and riots. Nationalists, neo-Nazis, Russophobes and anti-Semites executed this coup. They continue to set the tone in Ukraine to this day.” Perhaps Putin’s virtual shut down of a free press in Russia has kept the Russian people from knowing of his suppression of political opposition there. Or perhaps he thought that the recent release from prison of Mikhail Khodorkovsky (after over ten years of political incarceration) and Pussy Riot demonstrated that the “right to peaceful protest” was alive and well in Putin’s Russia. His statement that the murder of over 100 Maidan demonstrators was at their own hand is just a bald faced lie.

Examples of embarrassing truths include President Obama’s pledge not to bomb Libya. Quoting Stephen Cohen, a professor emeritus at New York University and Princeton University, on the Charlie Rose show:  “The United States said to Russia, support of the United Nations’ [authorization of] a no-fly zone over Libya so that Gaddafi can’t take his planes up and attack the insurgents.  Russia said, so it’s just a no-fly zone?  You’re not going to bomb Gaddafi?  [But] we did and it led to his assassination. From that moment on, Putin never trusted anything that came out of the White House.”

I had intended to start the previous paragraph with the often repeated claim that, to quote former U.S. defense secretary Robert McNamara, ‘‘the United States pledged never to expand NATO eastward if Moscow would agree to the unification of Germany.’’ According to this view, ‘‘the Clinton administration reneged on that commitment when it decided to expand NATO to Eastern Europe.’’ Quoted in Mark Kramer: TWQ article on Germany and NATO. Recently available documentary evidence cited by Kramer clearly refutes this “myth.”

I want to share an account of a famous meeting I attended in Tashkent on May 20-21, 1992. The account was written by me many years ago but never shared until now. It presents the truth of another mini lie in Putin’s speech contained in the following passage:

“The USSR fell apart. Things developed so swiftly that few people realized how truly dramatic those events and their consequences would be. Many people both in Russia and in Ukraine, as well as in other republics hoped that the Commonwealth of Independent States that was created at the time would become the new common form of statehood. They were told that there would be a single currency, a single economic space, joint armed forces; however, all this remained empty promises, while the big country was gone.” The following account reveals just how committed Russia was to “a single currency” for the newly independent Former Soviet Republics.

Tashkent, May 20 1992

A.   Background: Monetary Babylon

The sudden formation of 15 central banks out of Gosbank in the Former Soviet Union created a strange and ultimately unsustainable situation. One monetary system suddenly had 15 suppliers of “rubles.” The ruble banknotes supplied by the new Central Bank of Russia (they were initially the USSR ruble notes that had already been printed by the Central Bank of the USSR) were issued in their respective areas by each of the 15 FSU central banks. In addition, ruble deposits with banks where used in payments throughout the entire FSU region using the settlement accounts each bank maintained with its newly independent central bank. When payment orders from FSU republics outside Russia began piling up at the Central Bank of Russia in Moscow, we were forced to start sorting out what was wrong with the “system.”

Initially the payment system continued to function as it had previously under Gosbank. The system was decentralized. All that was needed under that system was to verify that the sender (payer) had sufficient funds in its account with its bank. As there was only one bank in the Soviet system, Gosbank, there was no issue of the sender’s bank having enough money in its “settlement” account. All deposit transfer payments were in effect “on us” (i.e., intrabank transfers). Thus a valid payment order could be and was safely accepted at which ever branch or office of Gosbank it was delivered to (the one closest to the recipient of the payment). However, with the introduction of a two tiered banking system several years earlier, the adequacy of a depositor’s bank’s settlement account with the central bank potentially became important.

In early 1992 we were confused by the system being described to us. It was very difficult for us to understand how it really worked. Our counterparts who were explaining the system to us, either didn’t really understand the system either or understood it in terms of its functioning in monobank days. On top of this, the system we were trying to understand was being described to us in Russian and then being translated into English for us by interpreters with no real knowledge of the subject they were interpreting.

Under the old, inherited system, a payment order was sent directly from the central bank branch office used by the sender to the central bank branch office used by the receiver. We were concerned with the potential for credit creation by overdrafts that seemed to be automatically generated when payment orders were accepted wherever they landed without being able to verify the sending bank’s settlement balance with its respective central bank. Bruce Summers of the Federal Reserve Bank of Richmond, complained that each of the fifteen central banks created out of Gosbank needed to centralize the information on account balances if they were to avoid accepting payment orders that might result in overdrafts. Furthermore, something was needed to ensure that net payments among the fifteen central banks did not result in unauthorized overdrafts.

In a series of quick steps, the Central Bank of Russia centralized all incoming payment orders from FSU payers outside of Russia in its Regional Branches and ultimately in Moscow. Furthermore, payment orders that had earlier been sent directly from the Gosbank office servicing the payer to the Gosbank office serving the payee, were now redirected to the new central bank of the republic of the payer, which forwarded it to Moscow (if the payee was somewhere in Russia). Quite aside from whether the bank of the payer had sufficient settlement funds, the sheer volume of payment orders now directed to Moscow overwhelmed the CBR staff there. The time for processing cross border ruble payments was measured in months.

In addition, no one seemed to know the terms under which the CBR supplied its ruble bank notes to the new FSU central banks. Under the inherited system, banknotes were shipped from the mints to the regional branches and offices of Gosbank as needed. They were issued to enterprises against debits to the enterprises’ account balances with the central bank or as credits to the enterprises. The rest was just internal bookkeeping. This arrangement continued for a while until the new FSU central banks began to realize that they were no longer part of the new central Central Bank of Russia and would need to pay for the banknotes of the CBR.

I remember being told by bewildered staff of the National Bank of Kazakhstan and National Bank of Kyrgyzstan that of course the CBR would continue sending banknotes when needed because they always had. And why should they “charge” for them as they had never charged for them before. And indeed, the CBR did continue to send their banknotes for a while and no one knew what the terms for providing them was or might be. This was new territory for everyone and no one seemed to understand exactly where the system was going or how it should work.

As almost all of the new republics had a balance of payments deficit with Russia, the settlement accounts of their new central banks with the CBR in Moscow were always over drawn. The CBR periodically extended credits to these FSU central banks in order to put the overdraft credits on a more explicit basis. But in fact, as the whole process was not really understood and the CBR’s policy not yet really established, the terms of these credits were often unspecified for many months after the fact. Russia seemed to use the undefined terms for political leverage. More politically cooperative Republics negotiated better terms than others.

Resolving the settlement problem was further complicated by the fact that the system was not designed to produce up-to-date account balances. I remember when our accounting expert, Alan Vedren Lacohm from the Bank of France, reported to me that the central bank did not seem to know the current balances of the deposits banks held with it. As hard as it was for him to believe or understand, the central bank seemed to maintain separate debit and credit accounts that were only compared and balanced once a year. An enterprise could issue payment orders against its account on the basis of a central plan authorization. It didn’t matter if it had enough money in its combined debit and credit accounts, and in fact no one really knew whether it had a positive balance or not. This astounding fact mystified us because we were seeing it from the prospective of the systems familiar to us designed for market economies. When we came to understand that the Soviet system, obviously designed to serve a centrally planned economy, was really a budget tracking tool, we suddenly understood its logic. None-the-less, it would not work for a market economy. (Alan later married my assistant after they met on my second mission to Kazakhstan and Kyrgyzstan)

When a bank did not have sufficient balances in its settlement account at the central bank, the central bank could extend it credit to permit payment settlement to proceed. However, such credit did not help when “rubles” were being transferred from Kazakhstan (for example) to Russia. The National Bank of Kazakhstan could not extend credit to its own account with the CBR. The system was designed to work with one central bank and it continued to operate throughout the ruble area as if it still had one central bank when it in fact had 15. The fact that the CBR more or less automatically extended credit to the other FSU central banks and supplied them with what ever ruble bank notes they needed (a very soft budget—balance of payments—constraint), encouraged the FSU central banks to create ruble credit at an ever increasing rate.

B.   A Blue print for monetary union

The emerging system was not viable. The USSR had been one economic and monetary space. With its break up, the ruble continued to circulate and to be used for payment through out the entire area. In the case of bank notes, a ruble was a ruble (until new versions were introduced later in the year and in 1993). But in the case of deposit rubles, 15 central banks now issued them. And they continued to be transferred from one account to another as if they were one currency in one system. As we more fully appreciated later, the ruble area of 1992 consisted of one cash ruble and 15 different non cash rubles. Each central bank was issuing its own ruble credits. A ruble claim on the National Bank of Kazakhstan was not the same as a ruble claim on the CBR even though they had the same name.

If an FSU central bank was going to create credit as it saw fit, it would need to introduce its own currency (bank notes as well as central bank account money). If an FSU republic wished to continue using the “traditional” ruble, it’s monetary policy would need to be subordinated to or coordinated with that of the CBR and any other central banks that remained a part of the ruble system. We developed a set of rules for central bank cooperation within a ruble area that we thought would be needed to make the system coherent and stable and invited the governors of all 15 FSU central banks to a meeting to discuss them. The meeting took place in Tashkent on May 20 and 21 following a heads of state meeting there as part of the Russian effort to organize the Commonwealth of Independent States (CIS).

This meeting was preceded by building tensions between the CBR and most of the other FSU central banks as they raced to out do one another in creating ruble credit and as payment orders piled up in Moscow. The situation was further complicated by conflicting signals from Moscow. Depending on who was speaking on any given day, Russia seemed to support the introduction by the FSU republics of their own currencies (thus leaving the ruble area) or the surrender of monetary autonomy to the CBR. Either of these Russian positions was coherent. Our own proposal was meant to provide coherence and central, but collective, control of monetary policy (along the lines of the subsequent ECB), without full surrender to the CBR (These can be found in IMF [Occasional Paper 51]). The Russian terms for staying in the ruble area were cleaner, but because they required complete subservience to the CBR, we felt they would drive out (into their own currencies) even those countries that wanted to stay in a ruble area.

After helping to develop the guidelines to be discussed, I attended the meeting. Other IMF staff attending where Malcomb Knight (later the Sr. Deputy Governor of the Bank of Canada and the General Manager and CEO of the BIS), John Oling-Smee (head of the IMF’s newly established European II Department consisting of the FSU countries), Ernesto Hernadus Catan and Ishan Kapur (both from the IMF’s European I Department). Most of us met in Geneva in order to take a charter flight on May 19. We stopped in Moscow on the way to pick up Ernesto. May 19, 1992 happened to be my 50th birthday. We celebrated on the plane with a bottle of Dom Perignon. It was a memorable birthday.

We were met at the airport in Tashkent by the Deputy Prime Minister. A caravan of three Chaikas and several police cars took us to the compound in which we would stay and our meeting would be held. It was 10:00 pm when we arrived and a formal welcoming dinner had regrettably been planned that required our attendance.

Following the dinner, sometime after midnight, I slept moderately well, despite my excitement, because I was so tired. We had no idea what the current Russian position on use of the Russian ruble would be. It had been changing back and forth in the work up to these meetings almost daily. Clearly views within the Russian hierarchy were divided. Relations between Russian and most of the FSU republics had grown increasingly tense. No one trusted anyone. I had found trying to understand the existing monetary arrangements and working out principles that could make it work intellectually very challenging and interesting. I was filled with excitement and anticipation to hear the reactions of the delegates.

The meeting on the 20th was opened by the Prime Minister, Abdulhashim Mutalov, and the Governor of the State Bank of Uzbekistan. The substantive part of the meeting, which was attended by the Governors of most of the FSU central banks and the Deputy Governors of the rest, was led by John [Odling-Smee]. After a general introduction of the purpose of the guidelines, we proceeded through the sixteen points one after the other. Questions were raised by one chair or another to clarify some of the points. The general suspicion that the IMF would take the Russian position gradually melted (this was helped by the fact that we had fielded technical assistance missions to all of the FSU central banks by then and established the beginnings of relationships of trust). Very few political statements were made and everyone kept glancing at the Russian chair trying to read their position. The Russian Chair, headed by Governor Georgy Matyukhin, said nothing at all that day. It seemed that Russia was not going to challenge our proposal, which was enthusiastically supported by all of the other central banks. At the conclusion of the day it was agreed that a communiqué signed by each of the fifteen governments would be prepared that would set out the sixteen points.

Following the long day’s meetings, we were taken in a long police escorted motorcade to a lake on the outskirts of Tashkent for a celebratory banquet. Our banquet tables were on a large wooden pontoon floating at the edge of the lake. By that time I knew the routine (toasts from each governor, lots of food and lots of vodka). Between the 15 central bank representatives, Uzbek/Tashkent government representatives, and our group, there were a guaranteed minimum of 18 toasts. And indeed, we exceed the minimum. My routine of minimal sips was again subverted by yet another Russian woman sitting across the table. Nothing but “bottoms up” was acceptable. The spirit of the group was exuberant. Each toast became more friendly and gushier than the one before it. Governor’s who were barely willing to speak to each other in the morning had become the best of friends—brothers (“comrades” was no longer a forbidden term).

We arrived back at our compound around midnight. Galinda, our translator from Washington went to work translating the draft communiqué into Russian. John had asked me to be ready to respond the next morning to any questions about inter-enterprise arrears. I started down the hall to my room to brush up on my potential presentation and the First Deputy Governor of the State Bank of Kazakhstan (Mr. Tadjeokof) grabbed me and insisted that I join him in his room for another drink. I had met him two months earlier in Alma Ata (now called Almaty) during my first mission to Kazakhstan. He wished, it seemed, to thank me for our technical assistance and to explain how much they needed lots more. Mr. Tadjiokof did not speak English and I do not speak Russian (or Kazakh), but we proceeded to speak to each other and to lift our glasses of Vodka and toast whatever warm words had been said.

I had assumed that Mr. Tadjiokof had wanted company for another drink, but he persisted in efforts to communicate. It was only possible to go on as if we understood each other for a limited time. I was soon forced to seek help from one of our interpreters. Galinda agreed to suspend her translations of the draft communiqué to interpret for us. Several toasts late, I had second thoughts about the seriousness of Mr. Tajiokof’s communications, which remained focused on his gratitude for our assistance. Galinda was complaining that she needed to return to her work on the communiqué. I was beginning to lose patience and focus. As Galinda left, I spotted Ernesto in the hall. He had been taking Russian lessons and agreed to practice on Mr. Tadjiokof. It was 3:00 am and I stagger off to my bed.

I awoke a few hours later still fully dressed where I had fallen on the bed. I had one of the worst hangovers I can remember. I had serious doubts that I could clearly explain the interrelationships between inter-enterprise arrears and monetary policy. I wanted to sleep for a few more days. But the meeting resumed. No one raised the issue of inter-enterprise arrears thank God. The Russians remained silent. The text of the communiqué was agreed on and the Uzbek hosts agreed to obtain the signatures of the fifteen FSU republics.

The communiqué was never issued nor heard of again. The Russian’s had quietly killed it. In the end, Russia required each FSU republic to choose subordination to the CBT or to introduce their own currency. All but Tajikistan chose the latter. Within several months the Baltic states introduced their own currency and one year later Kyrgyzstan became the first FSU country beyond the Baltics to introduce its own currency. Most of the rest followed before the end of 1993 and the ruble crisis came to an end. Inflation in 1992 is thought to have been several thousand percent dropping to 875% in 1993 and 307% in 1994.

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The quiet disappearance of the central bank cooperation communiqué is reminiscent of the mysterious disappearance of President Yanukovych on February 22, 2014, one day after signing an EU brokered truce with opposition leaders following two days of the worst violence between demonstrators and police in 70 years in which almost 100 were killed. According to witnesses in the room, Yanukovych only agreed to sign the agreement after being instructed to do so by President Putin in a phone call during the meeting. The agreement has not been heard of since. Though Yanukovych was removed from office by an overwhelming vote of the Ukrainian Parliament on February 22, Putin and Yanukovych called it a coup.

The Future of Ukraine

Bordering Moldova, Romania, Hungary, Slovakia, and Poland to the west, and Russia and Belarus to the East, Ukraine should be well placed to benefit from the trade opportunities in both directions. Although the 47 million population of modern (post WWII) Ukraine is overwhelmingly ethnically Ukrainian (about 78%) followed by 17% Russian (concentrated in the industrial eastern and southern areas), Ukraine’s educated citizens are almost universally bilingual in Ukrainian and Russian. Ukraine’s western half naturally leans toward Europe while its eastern half leans toward Russia. The country’s presidency has shifted between favoring one then the other. The tensions between the two are real but can easily be exaggerated.

Many of us wonder why President Putin seems to want yet another unproductive, loss-making territory added to Russia’s care, something it increasingly cannot afford. As with Transnistria, the inefficient, loss-making, industrial, secessionist, eastern part of Moldova (now largely a gangster haven), the eastern part of Ukraine is saddled with former Soviet, industrial, white elephants, which sooner or later must be dismantled. Why is Putin flirting with isolation from the world community with ultimately devastating economic costs to Russia to take over more industrial dinosaurs? Why, in short, is Russia giving up joining the “civilized” world it seemed to once aspire to?  The only tangible benefit for Putin seems to be great popularity at home. Having almost totally snuffed out significant political opposition and a free press in Russia, and then convinced the vast majority of Russians that he is defending Russia from its many enemies, his moves against Ukraine have sent his popularity soaring at home.( “Putin wins in Russia only by escalating his war rhetoric” Washington Post /2014/03/14/ )

Just as President Victor Yanukovych’s brutal repression of the Ukrainian protesters following his switch from signing the Association and Free Trade Agreements with the EU to signing a trade and financing agreement with Russia backfired, resulting in his removal from office by an overwhelming vote of the Ukrainian Parliament, Putin’s thuggish maneuvers against Ukraine seem to have backfired as well. By all accounts (except those broadcast by Russian media) almost all Ukrainians, ethnically Russian as well as Ukrainian, are uniting in their opposition to a Russian take over. Just because many Ukrainians in the eastern parts of the country are native Russians doesn’t mean they want to be annexed by Russia. It reminds me of the large number of Mexicans now living in southern California. No one would imagine that they would vote in a referendum to become part of Mexico (again). “Putin’s interference is strengthening Ukraine” Washington Post /2014/03/13/, “Russia supporters in eastern Ukraine pose challenges to pro western government” Washington Post/2014/03/14/.

I found it interesting that the Ukrainian Minister of Economy, Pavlo Sheremeta, switched from English to Russian during the “Emergency Economic Summit For Ukraine” in which I participated in Kyiv on March 12, for the benefit of the two Russian panelists to whom he was speaking. The Russians, Andrei Illarionov, former Economic Advisor to President Putin, and Kakha Bendukidze, fomer Minister of Economy of Georgia, both speak English as flawlessly as does Minister Sheremeta. The real point was to show affinity with Russia and Russian Ukrainians, while criticizing President Putin’s bullying.

Ukraine has much to do to clean up its government and to liberate the entrepreneurial energies of its economy. But such reform efforts could be interrupted if Putin moves Russian troops into Ukraine beyond the Crimea. It is certainly desirable to dissuade them from doing so if possible. The question for the U.S. and Europe is what measures should they be willing to take against Russia for violating Ukraine’s sovereign territory. The West’s objective should be to deter further Russian aggression if possible or to diminish its ability to continue to misbehave in the future if it persists in violating or threatening to violate the sovereignty of its neighbors.

Putin’s justification for its invasion of the Crimea and potentially more of Ukraine, the need to protect ethnically Russian citizens of Ukraine, is reminiscent of Hitler’s take over of the Sudetenland (the largely German-speaking western areas of Czechoslovakia). “Putin-the mask comes off but will anybody care” American Interest 2014/03/15/3.  Particularly egregious is Russia’s disregard of its commitments made on December 5, 1994 in Budapest, Hungary Budapest Memorandum on Security Assurances (also signed by the U.K. and the U.S.). In exchange for Ukraine’s giving up its nuclear weapons stockpile (then the third largest in the world) Russia and the U.S. provided assurances against the use of force against the territorial integrity or political independence of Ukraine.

Henry Kissinger has set out reasonable terms of an agreement with Russia (on the assumption that Putin is pursuing genuine Russian interests in the area) but offered no suggestions for how to encourage Russia to accept them. “To settle the Ukraine crisis start at the end” Washington Post /2014/03/05/.  The West’s strategy should be explicit and transparent and should escalate with continued Russian aggression. It should begin with measures that will command the most attention in Russia at the least cost and risk to the West. We should not make threats that we are not willing to carry out. No Obama red lines that are later ignored.

President Obama has already ordered the freezing of U.S. assets and a ban on travel into the United States of those involved in threatening the sovereignty and territorial integrity of Ukraine. No individuals have been named yet. It is a tool that can easily be expanded to a larger number of people if and when Russian intrusion expands. These measures are aimed at those in Russia with the greatest influence with Putin and would diminish the joys of their ill-gotten wealth (extravagant vacations in London, etc.). But unless the EU joins the U.S. in applying such sanctions, they will obviously be far less effective.

If Putin is unwilling to reverse course or at least stop advancing even in the face of targeted sanctions, the West’s strategy should be to reduce or limit Russia’s financial capacity to reestablish its former empire. Putin’s hold on power rests on the wealth he has directed to his friends, and wage and pension promises to the general public. About one half of Russia’s federal budget financing comes from its exports of oil and gas. The price of oil needed for Russian fiscal balance is in the neighborhood of $120 per barrel. This so-called breakeven price increases with expenditures by the Russian government and with the cost of producing its oil and gas. Brent crude is currently trading for around $108 per barrel. Russian exports and government revenue have become overly dependent on oil and gas and its supply of cheap oil is running out. It has not kept up with the investment in newer technologies and while its output can be sustained for some time its cost of production is rising.  Acquiring the Crimea or eastern Ukraine would add to Russia’s budgetary costs.  “Crimea as consolation prize-Russia faces some big costs over Ukrainian region” Washington Post /2014/03/15/

Europe is more cautious than the U.S. about trade sections in part because of its heavy reliance on Russian gas delivered though pipelines running through Ukraine and large investments by some of its companies in Russia. One of the interesting and beneficial things about increasing trade interdependence is that it cuts both ways and thus tempers the behavior of all sides. Russia is reluctant to shut off its gas sales to Europe as it did in 2006 and 2009 because it needs the money. Europe is less dependent on Russian gas than it was then and could replace it all together if it got over its aversion to the use of fracking technology. The U.S. should be doing everything possible to bring oil prices down in any event. Obama’s long delay in approving the Keystone Pipeline project to deliver Canadian oil to and through the U.S. is more than embarrassing. And all U.S. restrictions on shipping natural gas to Europe or elsewhere should be removed. In addition, oil supplies globally are expected to improve as the embargo on Iranian oil is lifted and production in Iraq, Libya, and South Sudan increases. Liberalization in Mexico promise increases in its oil production. Russia can’t afford to expand its empire of inefficient industries.

If we went all out, Russians and Russian companies could be locked out of the use of the U.S. dollar, a tool that has brought increasing pain to Iran. It is an effective tool because of the dominance of the dollar and dollar financial instruments in international commerce.  But like Russia’s shutting its gas pipelines to Europe, every use of such tools reduces its future effectiveness as those affected take measures to reduce their dependence on the products involved (Russian oil, or the U.S. dollar and financial system).

If in the hopes of preventing a Russian attack, the United States threatens to respond militarily in any way, it had better be prepared to do so. But should it? Clearly the American defense umbrella over our NATO allies should not be questioned and deploying additional aircraft and military capacity to Europe (especially the Baltic members) makes sense. Ukraine is not a member of NATO and I agree with Henry Kissinger that they should not be. If Russia grows up and behaves like a responsible adult we should not unnecessarily provoke insecurity on its part.

But if Russia, despite all, invades mainland Ukraine, should we militarily assist Ukraine and if so in what ways? Or should we prepare for a new cold war of containment, isolation and the eventual economic collapse of the new Russian empire? This, as they say, is above my pay grade. However, an invasion of Ukraine would be quite different from the invasions of Iraq and Afghanistan because we wouldn’t be the invaders. It would be different from the situations in Syria, or Libya because we would not be joining one group or another in a civil war.

The new interim government in Ukraine is promising but unproven. The distraction from the reforms needed that would result from a Russian invasion of Ukraine would be a tragedy for Ukraine as well as Russia. Excessive external aid (financial and/or military) from the West would likely prolong Ukraine’s history of corruption and deepen ethnic tensions. The external financial assistance now planned would largely address external debt service and would allow a more gradual reduction in government spending than would be required by a debt default. This would allow Ukraine itself to strengthen its governance and economy, but would not guarantee such a result. The West can encourage the adoptions of helpful reforms but cannot impose them on an unwilling or unready Ukraine. Russia is in a position to destroy or undermine these efforts, if that is Russia’s role in history that Putin wants.