SWIFT – The Nuclear Option

The last sanction to be mentioned is one that has not been implemented but threatened widely in the UK and EU: Disconnecting Russia from the SWIFT system.

From humble beginnings in 1973, SWIFT has grown to become the dominant network for the secure exchange of payments and securities orders, reaching 5.6 billion messages among 10,805 users in 215 countries last year. Russia is a major user, with 360,000 messages daily from over 400 institutions and 90 percent of all foreign transfers. (This has led to a Russian recently joining the SWIFT board of directors for the first time.) Thus, disconnecting SWIFT would be catastrophic for the Russian financial system and economy.

Proponents of this measure point to success in Iran. To be sure, Russia would encounter difficulties in receiving payment for its exports of 7 mbpd and 190 bcm of gas annually. But this is yet another illustration of the pipeline fallacy, namely that the EU is at the mercy of gas imports from Russia when it is logically equivalent to say the Russia is at the mercy of EU gas exports. In other words, without SWIFT customers would have difficulty in paying for imports, possibly leading Russia to curtail exports. Thus, in the short term both the EU and Russia would suffer pain (although the United States would be relatively immune).  

Furthermore, exclusion from SWIFT was easier in Iran as it is less integrated in the global economy. As mentioned above, Russia has become very integrated in the global economy. Also, at $500 billion annually, exports are an order of magnitude greater than those of Iran, and are largely directed to Europe, not China, India and Turkey. It is also worth noting that by using physical gold and Turkish Lira, Iran was nevertheless able to continue exporting, albeit at added cost due to such cumbersome settlement.

(The effect on domestic financial transfers is likely to be very limited. The RCB has already tested old, low-tech systems involving telexes and faxes. While less efficient, they are certainly functional and robust. This author remembers the start of stock trading in Russia, when all quotes were indicative and deals were consummated by phone on a recorded line, followed by fax confirmation.)

In the longer term, the desire to create an alternative to SWIFT will only increase. Currently, many countries, particularly Russia and China, would like to end the ability of the West (United States) to inflict such financial damage to achieve policy goals. Progress on this front has been glacial, since the economy is truly global and a wide variety of participants would have to accept the new system for it to work. Also, the costs of building it are enormous.

Still, as time goes by and this sanction is more often used, or at least threatened, causing consternation in foreign countries, the desire to develop an alternative and bear the associated costs will no doubt increase. Already, modifying or creating an alternative to SWIFT has become a frequent topic for discussion at BRICS meetings. This would be a major blow to the current Western-dominated system for several reasons. First, in the interim, as the current system degrades and the new system is not in place, global trade will suffer. This will affect all, but the largest trading economy is likely to suffer the most.

(SWIFT itself, “a neutral global cooperative,” recognizes this risk, and has stated that it “will not make unilateral decisions to disconnect institutions from its network as a result of political pressure” since this would “risk undermining the systemic character of the services that SWIFT provides.”)

Second, although the West may be threatening to use financial isolation too much, and/or to achieve policy goals that are not primary, and/or destroying its own institutions to do so, such sanctions do have a place. Specifically, control over SWIFT has helped greatly in the fight against terrorism, trafficking in drugs and humans, and tax evasion. If an alternative system were to arise, the West would lose this ability, to the detriment of all.

Third, SWIFT and nearly all major global economic systems require at least the submission of a great number of countries and other economic actors. Many give grudging consent because there are no viable alternatives. The appearance of an alternative might lead many to jump ship, thus reducing the reach and effectiveness of existing systems. Plainly, undertaking actions that lead to the destructions of systems that you created, that benefit you and your goals (and hopefully the world’s too) is not acting in rational self interest.

Lastly, it seems unlikely that shutting off SWIFT would lead to Russia pursuing different policies. As we have seen with credit cards and other sanctions, the people come to the conclusion that the pain is being inflicted by Brussels and Washington, not Moscow. Even in the cast of Iran, where the expulsion from SWIFT may be a factor leading to resolution of the standoff, it was by no means the only one and the situation persisted for many years. (It also generated considerable ill will among ordinary Iranians toward the West, something that is happening in Russia today.)  Additionally, as discussed above, basic game theory indicates that capitulation in the face of such sanctions will only lead to them being used (or at least threatened) again. As Joshua said, “the only winning move is not to play.”

Conclusion

Policy goals, however well-intentioned, reasoned and moral they may be, or seem to be, should not trump cost-benefit analysis. Policy levers, such as sanctions, that hurt the country or economic actors imposing them should be avoided, and rejected outright if the damage inflicted on the initiator of such actions is greater than that inflicted on the target. The same is true for actions which lead third parties to engage in behavior that is not conducive to our well-being.

To achieve political ends, many actions undertaken by the West over the past few years, particularly against Russia, have impaired the value of societal and economic institutions that have helped the West achieve a higher degree of prosperity. This trend may intensify if policies and the means to achieve them are not scrutinized more carefully.

This is not to say that our policy goals vis-à-vis Russia or any other part of the world are wrong per se, but simply that they are not worth pursuing at any cost, particularly at any cost to ourselves and our systems, which necessarily affect the happiness and well-being of ourselves and our children. If we believe policy goals are necessary and just, then appropriate means to achieve them must be found. Swinging a bigger stick in a crowd is not always the answer.

Scott Semet has been working on global and Russian financial markets since the latter’s inception over 20 years ago, in many different capacities, including establishing and running the research department of major financial institutions. He has an MBA from Columbia Business School, an MA from Yale University and is a CFA charter holder.

Image: Wikimedia/Petar Milošević