Russia and the long shadow of Versailles

NEW DELHI — The debate over using frozen Russian assets to fund Ukraine’s reconstruction is coming to a head. The arguments in favor are compelling. The objections are weak. But there could also be unintended consequences.

Canada has passed legislation allowing Russian assets to be redeployed on behalf of Ukraine. In the United States, four members of Congress have introduced legislation to repurpose sovereign Russian assets for Ukraine. And European Union leaders considered the issue at their recent summit, though German Chancellor Olaf Scholz and others expressed concern that any such action might violate international law.

The arguments in favour of seizing frozen Russian assets have been conveniently assembled in one place by Lawrence Summers, Philip Zelikow and Robert Zoellick. Russia possesses the means to finance reconstruction. A vigorous economy will be postwar Ukraine’s best defence. Truth and justice are on Ukraine’s side. Other strongmen tempted to emulate Russian President Vladimir Putin’s imperialism will be deterred.

Then there is the pragmatic case. G-7 governments are heavily indebted and are confronted with the need to devote additional resources to national defence, to the green transition, and to aging populations. Already, there are signs of Ukrainian aid fatigue, and critics ask why Western countries should bear the costs of a war they did not start.

These complaints are heard despite the fact that financial transfers from the US and the EU, amounting to some $3 billion a month, pale in comparison with the costs of reconstructing Ukraine. In March, the World Bank put those costs at $411 billion. The bill continues to mount with each additional day of fighting.

G-7 governments will not provide funding on this scale. To be sure, other countries and the multilateral financial institutions will contribute, and foreign direct investment will flow in, though it is unlikely to be sufficient even if provided with war insurance. In these circumstances, $230 billion of frozen Russian central bank assets, plus interest, would go a long way toward filling the gap.

Some objections are easily dismissed. One worry is that if central-bank currency reserves are garnished, central banks will stop holding reserves, and the international monetary system will become illiquid and unstable. But only central banks whose governments commit the most egregious violations of international norms would be subject to such measures; the risk will not be general.

Others worry that the dollar’s international role will be diminished if the US and its allies garnish Russia’s reserves. But this argument neglects the fact that there is no practical alternative to the greenback. China’s renminbi, though much vaunted, remains leagues behind as an international currency.

Would the measure be legal? Interpretation of existing law is best left to lawyers. But if legal provisions are all that stand in the way, then the laws in question should be changed.

On the other hand, garnishing Russia’s frozen assets would give the Kremlin a powerful propaganda tool with which to paint Russia as victim rather than aggressor. This would make it harder to negotiate a durable armistice, and it would reduce the odds of a transition to a post-Putin government that respected Ukraine’s territorial integrity and reestablished peaceful ties with the West. Offering to return the frozen funds if Russia adheres to its obligations under international law could have the opposite effect.

An obvious analogy here is with German reparations after World War I. The war guilt clause of the Versailles Treaty, which assigned blame for the war to Germany, and the massive reparations bill that was subsequently attached had devastating economic and political consequences for the Weimar Republic.

The 1923 hyperinflation and ensuing output collapse resulted, in part, from that reparations burden. The hyperinflation occurred when the German government, unable to meet its domestic obligations while paying reparations, forced the central bank to provide monetary finance. As Roger Myerson of the University of Chicago has noted, Chancellor Heinrich Brüning, seeking to demonstrate the urgency of suspending reparations payments, “deliberately drove the German economy into the worst of the Depression” by pushing through spending cuts and tax increases, which greatly aggravated the 1930s slump.

These economic catastrophes undermined Germans’ confidence that their elected leaders could manage the country’s affairs and enhanced the appeal of demagogues who blamed the Allies for Germany’s woes, setting the stage for renewed militarism. While Hitler’s rise cannot be entirely blamed on the Great Depression (which involved much more than reparations), the obligations imposed by the Treaty of Versailles did not help.

Today’s situation is different. A reparations levy on Russia would be a one-time event, not an ongoing, festering sore. Russian leaders would not have the same incentive to mismanage their economy in order to wrest concessions from their creditors.

For the moment, there is no Russian democracy to preserve. But it is important to contemplate the development of Russia’s domestic and foreign policies once the war is over. At that point, mitigating “Versailles risk” will be a central concern for all.

Barry Eichengreen, professor of Economics and Political Science at the University of California, Berkeley, is the author, most recently, of In “Defence of Public Debt” (Oxford University Press, 2021). Copyright: Project Syndicate, 2023. www.project-syndicate.org