As the Ukraine war grinds on, the West continues to prevail on the economic battlefield. Its sanctions are punishing Russia’s economy. Russian attempts to counterattack appear likely to backfire. And the result is a psychological blow to China, whose state-capitalist system was already looking vulnerable.
Start with the sanctions. By freezing the bulk of Russia’s foreign-exchange reserves, the West disabled Moscow’s main tool for defending its currency. In the first two weeks of the war, the ruble lost nearly half its value against the dollar. Soaring import prices, panic-buying by Russians and shortages induced by other sanctions combined to drive inflation up to 2 percent per week. If this rate were to be sustained, Russia’s annual inflation would come to a catastrophic 175 percent.
Russia’s leaders have scrambled to prop up the ruble, but this has caused new difficulties. The central bank has doubled its key interest rate, punishing businesses and households and causing forecasters to predict a deep recession. Authorities have slammed on capital controls, banning ordinary Russians from exchanging rubles for dollars and limiting their ability to get dollars out of their own bank accounts. Russians with marketable skills are fleeing the country. As many as 70,000 tech workers have reportedly left already.
The confrontation has also hit foreign investors. Russia has banned nonresidents from selling stocks traded in Moscow. Sanctions have obstructed interest payments to foreign bondholders. Appalled by the obliteration of Ukraine’s cities, some 500 Western businesses with operations in Russia have pulled out, many with no clear plan as to how they might sell assets and recoup capital; the British oil firm BP is expected to take an $11 billion hit from its exit. Foreign business confidence is unlikely to recover so long as Vladimir Putin is in the Kremlin.
Russia’s latest gambit is to demand payment for its natural gas exports in rubles. The idea is to force Germany and other energy importers to buy the Russian currency, thereby boosting its value. But the German government appears ready to call Putin’s bluff: Instead of agreeing to pay in rubles, it has taken the first formal step toward gas rationing. Rather than deprive itself of revenue that it desperately needs, Russia may well back down. Either way, its threat has reinforced Germany’s determination to wean itself off Russian exports.
What does all this mean for China, Putin’s most significant ally? China’s economy is far larger and more sophisticated than Russia’s, but it looks newly vulnerable.
To begin with, Beijing’s $3 trillion-plus stockpile of foreign-currency assets looks less potent. If Russia’s reserves could be frozen, so could China’s. Likewise, if Russia can’t generate leverage from its highly concentrated exports — until its invasion of Ukraine, it supplied more than half of Germany’s imported natural gas — it appears unlikely that China will be able to fight sanctions by threatening to cut exports of consumer electronics. Yes, China supplies around 80 percent of the U.S. market for the niche industrial inputs known as “rare earths”. But the United States is protecting itself by stockpiling and recycling them.
What’s more, China’s economy appears susceptible for other reasons. Much as Putin invaded Ukraine out of a misguided sense of national pride, so China’s leaders have refused to buy effective foreign vaccines against covid-19. Instead, even as domestic vaccines fail to work, they have isolated their country from the rest of the world, imposing draconian quarantines on visitors. With the advent of the especially contagious BA.2 omicron variant, however, this is not enough. China has been forced to lock down economic hubs such as Shenzhen and Shanghai, hobbling its growth outlook.
Meanwhile, China’s financial sector is shaky. Property developers are defaulting on bonds, and their auditors are quitting with alarming frequency. Fully two-fifths of bank loans are tied to real estate, so the trouble is poised to infect the banking system. China’s broader economy is addicted to debt, so if banks have to call in their loans, the pain will be widespread.
China’s government has compounded its problems by clamping down on its impressive digital economy. It has fined tech champions, blocked stock market listings and driven founders into exile. Last summer, at the stroke of a pen, it wiped out most of the $100 billion for-profit tutoring industry. Given that China’s population is aging and its workforce is shrinking, the government needs the productivity fillip from tech firms — which is why Beijing’s top economic official recently made nice with the sector. Not everyone expects this charm offensive to last. Authoritarian governments have a hard time tolerating disruptive innovation.
The West has been through a grueling few years. Populists have risen, alliances have frayed, and everything from inflation to the chaotic Afghan withdrawal appeared to signal incompetence and fragility. But the Ukraine crisis has changed the mood. The conflict is far from over, to be sure. But for now, the West exudes an unfamiliar confidence.
Sebastian Mallaby is the Paul A. Volcker senior fellow for international economics at the Council on Foreign Relations and a contributing columnist for The Washington Post. He is the author, most recently, of "The Power Law: Venture Capital and the Making of the New Future”, published in February 2022.