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According to this BBC article, Russia anticipated that their invasion of Ukraine would lead to sanctions and one of their ways to sanction proof their economy was to build a large foreign currency reserve to prop it up.

However, according to this Washington Post article, it seems a lot of those reserves are held in western banks and are now being frozen.

Doesn't having the money overseas defeat the purpose of having built up the foreign reserves at all? Why didn't they store the money in their own banks?

Glorfindel
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Pollman
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    Is it just me or I can foresee a bunch of little meme videos popping up: "Gosh, why didn't I think of that before?" – Italian Philosophers 4 Monica Feb 28 '22 at 18:31
  • @ItalianPhilosophers4Monica You mean like: Why did giving away our resources for no immediate return make us not sanction proof? – NoDataDumpNoContribution Feb 28 '22 at 22:56
  • If you google for "russia foreign reserves" and "russia external debt" you get the numbers that more or less match. This might well be on purpose. You don't generally store the reserves in the local banks, for many reasons, including needing them when those banks ***k up. – Eugene Ryabtsev Mar 01 '22 at 06:26
  • background discussion https://bam.kalzumeus.com/archive/moving-money-internationally/ – ohwilleke Mar 03 '22 at 21:36

2 Answers2

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You cannot really "store" lots of money in the physical sense. Money is an entitlement to benefits in the future and mostly is just numbers in some computers and typically there is always a counterpart to every transaction. This here is a case of vanishing counterparts.

Think about money in terms of goods changing ownership. Russia sold lots of natural resources and by this converted them into overseas assets. They earned the right to buy goods from their trading partners in the future. They could have done that already and brought these assets already home by increasing imports (buy gold, apples, paper clips) or by storing huge amounts of dollar bills at home. But probably both wasn't practical and anyway, nobody can live from gold or dollar bills alone. They didn't do it, otherwise the trade surplus would have reversed. So they stayed as overseas assets. And that's where they provide liquidity. They tried to diversify their foreign currency reserves away from dollar and euro also towards yen (doesn't help them now) and yuan, but only 13% of them are in yuan, and gold. The majority of their foreign assets are still in euro, dollar, sterling and yen and they are all inaccessible now.

If there is an ordinary economical crisis, having a financial cushion is great, you can support your economy by temporary deficit spending.

If however there are economic sanctions, this will not help. Trade is disrupted and your assets are temporarily (or permanently) inaccessible. Think of it as parts of the World not wanting to honor payment agreements with Russia under the present circumstances. That makes these assets pretty useless. The gold they have is also difficult to use because nowadays it's actually hard to do large-scale business with physical money like dollar bills or gold bars.

Maybe China might help out. They could increase their exports to Russia with or without compensation. Otherwise Russia's economy is basically on its own and on its own it may be worth much less than before. It may also have an unfavorable composition, not producing the stuff that Russians actually need.

Conclusion: This question stumbles over a fundamental misconception of what money is. Large amounts of money are not stored physically. They are represented by contracts with two sides to the contract, therefore they are not localized at a single position in the world but have at least two end points (one in Russia and one overseas). Now Russia was unable to move all the overseas endpoints to China where it would have been still usable. Instead a large chunk of their foreign assets had counter-parties in Europe, the US or Japan. These counter-parties have refused to honor the agreements now and this means that a huge part of the assets of Russia effectively vanished into thin air for the moment. Russia may have underestimated the unity of almost all their trading partners in this matter and the sanctions are indeed exceptional, but in the end it just means that foreign currency reserves are never completely safe. The argument about the large amount of foreign reserves of Russia and the protection it would give them was always seriously flawed.

Epilogue: The same but even one order of magnitude larger could happen to China, should for example China attack Taiwan and the rest of the world decides to conveniently ignore the $3 trillion foreign exchange reserves of China. It could make such a potential attack the most expensive attack ever.

NoDataDumpNoContribution
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    Storing money in China (in contrast with investing in China) is rather not popular for a reason. Western administrations are quite reluctant to impose direct political actions over their money systems and this makes them predictable. China is known for exactly the opposite. – fraxinus Feb 28 '22 at 21:40
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    @Fraxinus Still they tried. They moved about from dollar and euro to partly also yen and yuan but only to a small extent. – NoDataDumpNoContribution Feb 28 '22 at 22:53
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    Does this address OP's question, why was this strategy of storing money in foreign banks performed in anticipation of sanctions? – Hasse1987 Mar 02 '22 at 02:52
  • @Hasse1987 The OP's question originates from a fundamental misunderstanding about money. Tried to make it more clear in a new conclusion. – NoDataDumpNoContribution Mar 02 '22 at 09:39
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    It may be worth adding that Russia, while expecting there would be sanctions, evidently did not expect that the sanctions would be so severe and quick as to entrap their foreign reserves. This didn't happen with Crimea or Georgia, for example. The EU and NATO and much of the world have moved with unusual speed and ferocity this time. Russia seems to have poked the bear one too many times – zibadawa timmy Mar 02 '22 at 13:22
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    @Hasse1987 I think this does answer the question. No economy can have all their reserves home (certainly not as physical, illiquid assets), so they put them abroad as contracts (with electronic representation and thus highly liquid.)

    I think Russia was counting on a quick win and the West's traditional hesitance to freeze assets at such scale. They bet wrong on both accounts.

     – luis.espinal Mar 02 '22 at 17:39
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    2/ I forgot to add, the key is to keep reserves as liquid as possible to demonstrate solvency (to pay debt or to quickly allocate resources to whatever a country needs to buy.)

    Having all reserves at home as contracts or instruments doesn't make sense (they might be liquid only internally and are not diversified.) They certainly can't be stored home as cash (which will make them very much not liquid at all.)

     – luis.espinal Mar 02 '22 at 17:41
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In fact, foreign currency reserves almost have to be held elsewhere, usually as government securities or deposits at foreign central banks or at the Bank for International Settlements. You could conceivably keep a small part of it as physical cash but that's not possible at scale and would defeat the point of a foreign currency reserve, which is demonstrating solvency and providing liquidity by being able to buy and sell it quickly.

Relaxed
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    In a way the idea of building up foreign reserves to make yourself sanction proof seems deeply flawed if the majority of foreign nations joins the sanctions. Why has this argument been brought again and again. – NoDataDumpNoContribution Feb 28 '22 at 15:29
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    BIS, like many other banks, is located in Switzerland. Russia probably assumed there would be US sanctions, wondered whether there would be EU sanctions, and probably assumed there would not be Swiss sanctions. As it turns out, the world is more unanimous than that. – MSalters Mar 01 '22 at 09:42
  • @MSalters Does it matter? The BIS is not at all like any other (Swiss) bank, I don't think it's under Swiss jurisdiction. – Relaxed Mar 01 '22 at 10:16
  • @Relaxed: There's a "Brussels protocol" (1936) about its independence, and a Headquarters Agreement specifically with Switzerland that enumerates specific exemptions to Swiss jurisdiction. But you're right that the BIS is exempt from Swiss sanctions on Russia (Art 9 HQ agreement). – MSalters Mar 01 '22 at 10:55
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    @Trilarion - "Why has this argument been brought again and again." Sanctions are typically unilateral, never done at such a global scale, as the Russians are finding out. Even the uber-neutral Swiss are slapping their own sanctions. I don't recall when was the last time that I would see sactions covering US and Australian dollars, Sterlings, Euros, Yen, all simultaneously and coupled with export/import sanctions.

    Russians overplayed their hand, and thus nuked their own foreign reserve diversification/"fortress economy."

     – luis.espinal Mar 02 '22 at 17:45
  • @Trilarion The international economy is tightly interwoven, and simply trying to cut a major country like Russia out of it is both difficult and costly. EU and SWIFT sanctions both carved out a notable exception for gas imports because the EU, Germany in particular, are heavily dependent upon Russian gas. Before this invasion the international community seemed pretty settled on the idea that substantially removing Russia's access and participation in global commerce was far more damaging to themselves, and innocent Russians, than could be tolerated. – zibadawa timmy Mar 03 '22 at 01:34
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    @zibadawatimmy Russia may have underestimated the unity of almost all their trading partners in this matter and the sanctions are indeed exceptional, but in the end it just means that foreign currency reserves are always vulnerable and never safe. The argument about the large amount of foreign reserves of Russia and the protection it would give them was always flawed. – NoDataDumpNoContribution Mar 03 '22 at 09:44
  • @Trilarion It was a calculated risk, as literally everything and every alternative you seem to assume exists as superior to this one is, and the calculation was basically "putting our hand in the lion's mouth is bad; but this lion is toothless and feeble, so no biggie". – zibadawa timmy Mar 03 '22 at 12:22
  • @zibadawatimmy I'm mostly referring to the argument that was circulated (outside of Russia) that with 600 billion dollars of reserves Russia is protected against any sanctions that may come. I think one should have always said that even that amount of reserves doesn't give large protection. But of course one can also say that it was a misunderstanding and one meant only protection against small scale sanctions. That is more or less the same. In my answer I also mention that Russia has underestimated the scale of the sanctions, as you say here. – NoDataDumpNoContribution Mar 03 '22 at 12:27