Building foreign reserves could have been a way for the Kremlin to guard Russia’s economy against sanctions, by giving the central bank more ammunition to protect the value of the ruble. The ruble lost half its value against the U.S. dollar after Russia annexed Crimea, forcing Russia’s central bank to spend $130 billion to stabilize the currency.

Except it turns out that Russia’s foreign reserves strategy had a major flaw: About half of the money was held overseas in foreign banks—and now Russia can’t get to it. 

Freezing Russia

On Monday, the U.S., Japan, and the European Union barred Russia’s central bank from tapping into the billions of foreign reserves Moscow had been saving up in their banks.

“As Russian forces unleash their assault on Kyiv and other Ukrainian cities, we are resolved to continue imposing costs on Russia that will further isolate Russia from the international financial system and our economies,” the leaders of the allied economies said in a joint statement announcing the accounts freeze on Feb. 26.

The foreign reserves freeze hasn’t cut Russia off from its foreign currency entirely. The embargo still allows Russia to use its reserves for energy payments, which keeps open a lifeline for the central bank. Russia’s central bank can also still access the 13% of its reserves held in Chinese yuan.

China remains the only major issuer of foreign reserve currencies that hasn’t cut Putin off. On Wednesday, China’s banking regulator said it would “not participate” in sanctions against Russia, adding that sanctions “do not work well and have no legal grounds.”

What are foreign reserves?

Foreign reserves are a government’s holdings of gold, foreign debt, and foreign currency, which is usually denominated in the world’s most popular coins—dollars, euros, pounds, yen, and yuan. Although a country can hold foreign reserves in its own banks, governments often choose to keep their reserves overseas to avoid costly cross-border transactions and gain direct access to foreign currency and debt markets.

“Large stockpiles of foreign reserves just are very useful for helping to insulate yourself from global economic shocks,” Emma Ashford, a nonresident fellow at the Modern War Institute at West Point, told Marketplace. 

Foreign reserve holdings are especially useful for managing domestic inflation, as central banks can buy and sell foreign reserves to control the value of their currency. If a central bank sells its foreign reserves to purchase more of its own currency, the value of the local currency goes up. If a central bank sells its local currency to increase its reserves, the value of the local currency goes down.

In the wake of invading Ukraine last week, Russia’s central bank tried to tap into its reserves to support the ruble, as Russians rushed to convert their currency into dollars and euros in anticipation of Western sanctions. On Feb. 24, the bank started selling its foreign reserves to buy the Russian ruble, which, at the time, was trading at 87 rubles to the dollar. As of Thursday, the Russian currency has devalued to 102 rubles per dollar.

A currency in free fall can cripple an economy. A weak ruble will make imports more expensive, harming both consumers and manufacturers, and production may grind to a halt as companies can’t afford raw materials and components. No wonder why Western officials are now pointing to crushing the ruble as another way to put economic pressure on Russia.

Are foreign reserves normally safe?

The new sanctions on Russia are not the first time the U.S. has impounded a country’s foreign reserves.

Last year, the U.S. froze foreign reserves held by Afghanistan’s central bank in order to prevent the Taliban from accessing the funds after it seized power in the country last August. In a move that outraged Afghans, the Biden administration is now using the frozen assets to compensate families of 9/11 victims and to fund humanitarian assistance in Afghanistan. 

The U.S. has also frozen the foreign exchange reserves of Iran, Syria, and Venezuela before, yet none of the previous targets of sanctions were as powerful as Russia.

“This is the nuclear option,” economist Adam Tooze told the New York Times. According to Tooze, it previously “made perfect sense” for Russia to think of its foreign reserves “as a source of stability,” because they had been when Russia attacked Ukraine in the past.

But the current Ukraine conflict “is really ripping up the playbook,” Tooze says.