The Money That Was Not There

A central bank's foreign exchange reserves sound like a vault. They are not. They are entries in other people's systems: deposits at foreign central banks, holdings of foreign government bonds, balances with commercial banks abroad. The asset is a claim, and a claim is enforceable only through the institutions of the country that issued it.

Every reserve manager knew this. Almost none of them had priced it.

In late February and early March 2022, following the invasion of Ukraine, the United States, the European Union and allied states prohibited transactions with the Russian central bank. Roughly three hundred billion dollars of reserves, out of a total the Russian finance ministry put at around six hundred and forty billion, became unusable. About half the reserves of a major economy, immobilised in days.

Note the word. Immobilised, not seized. The securities still existed. The balances were still recorded with Russia as the owner. They simply could not be moved, sold, pledged or used to defend the rouble, and for a central bank in a currency crisis that is indistinguishable from not having them.

The immediate effect was dramatic and is not the interesting part. Capital controls, an emergency rate rise, a rouble that fell and then recovered under those controls.

The durable effect is on everybody else.

Before 2022, the risk that reserves could be frozen was a seminar question. Afterwards it was a demonstrated fact with a date attached, and reserve managers in a great many countries with no involvement in the conflict re-read their own holdings in that light. The visible consequence is gold. Gold held in your own vaults cannot be immobilised by a foreign decision, pays nothing, costs money to store, and central bank gold purchases rose sharply and stayed high.

That is an expensive choice being made deliberately, which is what it looks like when somebody is buying insurance against a risk they have just learned to see.

And here is the tension that has no solution.

The dollar's position rests on being the dullest asset in the world. Not the highest yielding, not the most exciting: the safest, most liquid, most boring place to put money you cannot afford to lose. That property is what makes everybody hold dollars, which is what makes the clearing system universal, which is what makes sanctions through that system effective.

Every use of the instrument is a demonstration that the boring asset has a political condition attached. One demonstration changes little. A standing policy of demonstrations is an argument, made repeatedly to every finance ministry on earth, for holding something else.

So the instrument works, and using it erodes the foundation that makes it work. There is no resolution to that, only a rate of depletion, and the rate is set by how often it is used and against whom. A freeze aimed at a state most of the world regards as an aggressor costs little. A freeze that looks like an ordinary tool of commercial disagreement would cost a great deal, and the difference is a judgement nobody can make in advance.