Long before Russia started the current war with Ukraine, it was planning for the isolation it is currently facing. By building up over $630 billion in reserves, the Russian central bank was ready to prop up the ruble and provide liquidity in case it was cut off from the rest of the world.
Or so it thought.
In reality, Russia and its investors have learned a harsh lesson—and one that many on Wall Street are well aware of. You don’t just care about the value of your investments going up. You also care about who your counterparty is, how liquid the market is, how much access you have to markets, what you can do if one of your touchpoints is lost, and how hedging all of these risks is crucial to surviving over the long term.
Russia, for all of the mistakes it has made in this war, has blundered massively on the financial front. Its $630 billion in reserves is not all in Russia—in fact, roughly half of it is elsewhere, stored at other banks and central banks globally. Since Russia has been hit with a wave of sanctions, that money is essentially impossible to access: central banks holding accounts for the Russian central bank have effectively told the Russians that they cannot access those accounts.
This is arguably the biggest hit to Russia (at least financially speaking), and an unprecedented one. Central bank access to assets has been politically neutral and untethered to national relationships for pretty much the entire history of central banking, and the move the west has made to block Russian access to its foreign-held assets is entirely unexpected. As such, it has meant Russia suddenly cannot control the value of its currency (down over 30% in a week and over 50% in a year), and Russia has had to result to many market interventions to try to stop the disaster it is facing: the Russian stock market has been closed for days, foreigners are barred from selling Russian assets, and capital controls have been placed on the country.
To make matters even worse, there is an odd Heisenberg uncertainty now when it comes to Russia’s assets. Many funds and institutional investors now either legally or financially have to offload their Russian investments, but they need to do so at a time when no one wants to buy those assets. For instance, British firm BP wants to sell its shares in Rosneft and has announced its plans—but it can’t sell those assets to pretty much any domestic buyer, so it will need to sell them to the few buyers who can legally buy them and who want to. BP may be forced to sell those assets to Russian investors, but there is significant legal and logistic uncertainty involved in doing even that.
The resulting action that a growing number of Wall Street analysts are predicting is a bit weird: simply ignoring those investments exist. More technically speaking, this would mean writing down the value of those investments to zero, creating what will look like a very bad quarter in terms of capital losses but one that the market will immediately recognized as being Russia related. Given the rise in oil prices and the benefits to oil prices that this war may have (at least going by market responses), analysts could argue that the value of BP shares shouldn’t reflect the writedown as much as the potential in higher profits from higher oil prices.
Also, the writedown is largely an accounting fiction. If BP keeps its Rosneft holdings, writes them down to zero, and then looks to sell them ten years from now, at that point the holdings will definitely not be worth zero. In short, BP’s writedown really has nothing but symbolic value, and as long as it keeps its connections to markets and ability to sell assets in the future, there’s no reason why the Russian war against Ukraine should impact their ability to sell the Rosneft assets over the long term.
This is largely because BP has no financial need to sell anytime soon. The same cannot be said for Russia. War is expensive, and with the massive drop in Russia’s stock markets and currency, it needs to sell at a discount to maintain the cash needed to keep its war going. That problem is compounded by Russia being locked out of the west’s banking system, meaning that it needs to turn to China as a large scale buyer to keep funding its war. China can leverage that position, because it has become a monopsony; no other buyers are willing to buy Russian stuff, so it can demand a lower price.
To call this a miscalculation would be an understatement. Russia, or perhaps better to say Vladimir Putin himself, did not realize that a lack of liquidity and a lack of market access could essentially destroy his access to the cash flow needed to keep this campaign going, especially since his nation’s central bank has lost access to half of its foreign currency reserves. While Putin clearly made steps to shield Russia from foreign sanctions—the strategy, called Fortress Russia, has been guiding Russian financial decisions for years now—he did not do enough or, more accurately, he did not understand how interconnected and interpersonal finance is.
You can’t just depend on higher values—what the cryptocurrency world calls “line goes up”—and assume you can sell whenever you want as values climb. If you have the most valuable thing in the world and no one wants to buy it from you because they don’t like you, the most valuable thing in the world suddenly isn’t so valuable. To maintain the value of your portfolio you need to maintain the relationships and infrastructure necessary to sell your portfolio to others—Putin failed to do that, and the Russian economy is collapsing as a result. And it just might spell disaster for his aggression in Ukraine, too.