[Financial War] Sanctions on Russia: An Experiment on Fiat Money

On February 24, 2022, Russia invaded Ukraine, European and American countries put forward a number of sanctions, including suspension of trade, removal of Russia from the SWIFT system and freezing of Russia’s foreign exchange reserves, etc. They plummeted the Russian stock market on the first day, a sharp drop of the ruble exchange rate, and a rise in interest rates. If the sanctions continue, it will likely lead to a recession and a surge of inflation in Russia. Among them, the sharp depreciation of the ruble has already triggered a bank run and made the financial system unstable. The central bank of Russia has tried every means to rescue the market, it works like an experiment of the fiat money system.

Stock Market Plummet

Figure 1 shows the MOEX index of the Russian stock market. The war caused the stock price to fall vertically from 3622 on February 16 to 2060 on February 24, a drop of more than 40%! However, totalitarian countries have plenty of ways to prevent the stock market from falling, including suspending the market, restricting the sale of stocks, and injecting state funds to buy stocks in the market. Therefore, the current stock price has recovered by more than 400 points.

Moreover, the stock market has risen a lot in the past few years. Even after a 40% drop, the stock price is still higher than the level of 2018. The decline of stock prices usually indicate a sense of panic which may not have a long term impact on the economy.

Figure 1 Russia MOEX stock market index, 2018–2022 February. Source: Trading Economics

Ruble Plunges

As most of Russia’s foreign exchange reserves have been frozen, the Ruble currency loses its value derived from its foreign exchange support, a crisis of currency confidence is occurring in the country, which has resulted in a plummet of the currency exchange rate.

Figure 2 shows the exchange rate of the US dollar against the Russian currency ruble, which rose sharply from 75 to 104 (on February 28), and the latest rate today is 110, an increase of more than 50%! It broke the record of 25 years (earliest data available on the Internet).

Figure 2 USD/RUB exchange rate, March 2021 to February 2022. Source: Trading Economics

It is more difficult to stop currency from depreciating, because the value of fiat money is basically derived from trust and confidence. Once the confidence in the future economy of the country of the currency is lost, and the currency itself does not have valuable commodity support, the currency can become no value. That is why it is called fiat money. Fiat money is defined as money (more correctly currency) that are made legal tender by a government decree or fiat, (Britannica Encyclopedia, https://www.britannica.com/topic/fiat-money) instead of commodity-based.

Interest Rate Hike

The most common way to solve currency devaluation is to raise interest rates through the central bank to attract inflows of funds. Therefore, the Russian central bank has increased the interest rate from 9.5% to 20%, breaking 20-year record, but Ruble is still falling against the dollar, it appears that the 20% annual interest rate is still not enough to hedge against the devaluation risk.

In addition, in order to provide enough foreign exchange, “the Central Bank of Russia has also teamed up with the Ministry of Finance of the country to impose mandatory foreign exchange sales on companies, requiring Russian export companies to sell 80% of their foreign exchange earnings” (Translated from Freedom Finance, 2022), indicating that Russia has a foreign exchange shortage.

Figure 3 Russian Central Bank Interest Rates, 2017–2022. Source: Trading Economics

Fiat Money Experiment

Last October was the 50th anniversary of the replacement of the Quasi-Gold-Standard (Bretten Woods Agreement) by the fiat money system. I have written an article reviewing some monetary historical events in the past 50 years (Yiu, 2021). The article put forward the weaknesses and the market’s concerns about the fiat money system. Russia has now been experiencing the problems of the system.

For example, in order to save the banks from bank runs, Russia Central Bank has increased the supply of Rubles, but since most of the foreign exchange reserves have been frozen, increasing money supply is equivalent to devaluing the Ruble and doing harm to the exchange rate. This is a textbook-type experiment of monetary theory, providing an empirical test for the fiat money system.

Since 1971, the world has entered a fiat money system, countries have been looking for ways to consolidate investors’ confidence in their currencies. The most commonly used method is to increase their foreign exchange reserves. For example, the linked exchange rate system adopted by the de-facto central bank of Hong Kong, which pegs the currency to USD at a fixed exchange rate. It relies on a sufficiently large amount of foreign exchange reserves to support the currency value.

Figure 4 shows the top six countries with the highest foreign exchange reserves in the world in the third quarter of 2021. Russia ranks the sixth, with a total reserve amount of US$614.25 billion. However, since foreign exchange reserves are generally invested overseas, “Russia’s $630 billion foreign exchange reserves are mostly frozen by the joint sanctions of the United States, Canada and their European allies on February 26.” (Translated from Key Commentary, 2022).

Figure 4 Total reserves of the top six countries, Q3 2021. Source: Gold Hub (2022)

From this event, it shows that fiat money supported by foreign exchange reserves may not be safe. But in fact Russia has already diversified its foreign exchange reserve in the past decade or so. “Russia’s foreign exchange reserves currently are composed of 16% US dollar, 32% euro, 22% gold and 13% renminbi. ” (Translated from Key Commentary, 2022) In other words, the sanctions by Europe and the United States can only freeze at most 48% of Russia’s foreign exchange reserves (assuming all the reserves in US dollar and euro can be frozen), there are still 52% of the reserves that can be used.

There are reports that Russia’s foreign exchange reserves also include cryptocurrencies, which are currencies that are decentralized, that is, currencies that are not controlled by central banks. Therefore, there are reports that many issuers of cryptocurrencies have rejected Ukraine’s request to freeze Russian accounts (Chen Xiaoli, 2022). This could make cryptocurrencies attractive to dictators, as it can be immuned from sanctions. Yet, as many countries are regulating or even prohibiting the mining and using of cryptocurrencies, it can be risky.

Gold Reserve

So far, gold reserves are completely immuned from any sanctions, which also explains why Russia has increased its gold reserves over the past decade, increasing the proportion of gold to 22%. Figure 5 shows the top seven countries with the largest gold reserves in the world. Russia has risen to the fifth place, with gold reserves as high as 2,298 tons.

Figure 5 Quantity of gold reserves in the top seven countries, Q3 2021. Source: Gold Hub (2022)

In the past few years, the price of gold has risen a lot. With the outbreak of the war recently, the price of gold further gains upward momentum. Countries with a lot of gold reserves can be benefited financially by launching a war. It may further attract war-aggressive countries to buy more gold, and even urge the switch from the fiat money system back to the gold standard monetary system.

Money is valuable, currency is only a tool of exchange. The commodity standard money system establishes the value of the currency by a valuable commodity, such as gold, which is decentralized, and not easy to sanction. On the contrary, the fiat money system derives the value of the currency from the confidence in the government and the future economy. It works like a non-interest-bearing government bond. The confidence can be strengthened by saving sufficient foreign exchange reserves, but it can be sanctioned if it is invested overseas.

Finally, it has to be noted that Russia has a large amount of natural resources, such as natural gas, which can provide confidence and value to the currency. Whether the financial sanctions can effectively stop the Russia’s invasion of Ukraine remains to be seen. May Gold bless Ukrainians!

Caveat: this article is not for any investment advice, and I currently do not have any investment in gold or cryptocurrencies.


Free Finance (2022) 自由財經 (2022) 救盧布俄央行利率緊急升至20% (Save the ruble, the Russian central bank’s interest rate rose to 20%), February 28. https://ec.ltn.com.tw/article/breakingnews/3843730

Key Comments (2022) 關鍵評論 (2022) 歐美凍結俄羅斯「外匯存底」大幅提高央行穩定匯率難度,專家:西方金融武器庫中最具威力的殺手鐧 (Europe and the United States freeze Russia’s “foreign exchange reserve”, which greatly increases the difficulty of the central bank to stabilize the exchange rate), March 1. https://www.thenewslens.com/article/163404

Chen Xiaoli (2022) 陳曉莉 (2022) 烏克蘭要求加密貨幣交易中心凍結所有俄羅斯帳戶,幣安與Coinbase皆拒絕 (Ukraine asks cryptocurrency exchange to freeze all Russian accounts, Binance and Coinbase both refuse), iThome, March 1. https://www.ithome.com.tw/news/149597

Gold Hub (2022) Monthly central bank statistics, 3 February. https://www.gold.org/goldhub/data/monthly-central-bank-statistics

Yiu, C.Y. (2021) 無本位貨幣制度五十年 (Fifty Years of No Standard Monetary System) 方格子, November 13. https://vocus.cc/eyanalysispoliecon/618ece91fd897800011507ad




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