Feb 28, 2022

War with Sanctions

The US will not engage in military action in the Ukraine but will instead wage economic war, particularly with sanctions on the Russian financial system.  To that end, the US and its allies have placed sanctions on Russian individuals and institutions.  

What does that mean? 

The sanctioned individuals will of course be unable to enter the US or access their assets in the US.  Sanctioned businesses will be unable to ship any goods into or out of the US.  Sanctioned banks will be unable to conduct any business with US financial institutions; they will be unable to borrow in the US, sell securities of any kind, or make transactions on behalf of their Russian customers.

The big question is whether these sanctions will cripple the Russian economy or just inconvenience it.  The Russian oligarch who cannot get to Miami this winter will find some other place to park his yacht.  The Russian importer is likely to find other sources for manufactured goods; if I-phones are unavailable, there will be Chinese substitutes in the Moscow electronics stores.  If the Russian development bank needs to borrow, Russia will find rogue bankers in Beirut, Lagos, Dubai or elsewhere willing to do business.  There will always be a rogue government or bank or exporter willing to channel resources to evade sanctions and take advantage of opportunities. 

Sanctions might be a major inconvenience that will make the Russian economy stumble a bit.   But that has been the case since some sanctions were introduced after the Crimean incursion in 2014.  The example of Iran is instructive: extensive sanctions are painful but have not loosened the government’s grip on its people or changed its ideology.

What comes next?  

There is an important additional step that gives sanctions a stronger bite.  That is to place a financial blockade on Russia by denying Russian financial institutions access to SWIFT.  The international community hesitated to take this step; it was noticeably absent from President Biden’s speech on Thursday afternoon.  However, over the weekend some initial moves were announced

SWIFT (the Society for Worldwide Interbank Financial Telecommunication) is the Belgian based cooperative that links thousands of financial institutions around the world and is used for millions of cross border transactions daily.  SWIFT is not a bank or an exchange; it is a platform for quickly, safely, and inexpensively making payments.  Denying Russia access to SWIFT is the financial equivalent of a blockade. It would effectively close down Russia’s access to global finance and payments. Without access to SWIFT, efforts to evade sanctions would be much more difficult.

However, not all Russian banks will be shut out of SWIFT and there will be exceptions for certain critical transactions.  Russia is a major exporter of oil and gas. There is ample capacity around the world to replace Russian petroleum exports over time.  Crude oil prices that spiked to over $100 per barrel are likely to fall back.  Nevertheless, oil prices are likely to remain elevated which will affect the American consumer at the gas pump and make it more difficult for the Fed to fight inflation.  In addition to oil, Russia also supplies natural gas to Western Europe which would be more difficult to replace.  

Thus, the willingness to isolate the Russian banking system comes with a big asterisk.  Sanctions make exceptions for energy, Russia’s major export.  Our European allies need to maintain an uninterrupted flow of energy and allow access to SWIFT to make payments.

What more can be done?  

The Russian central bank has accumulated large foreign exchange reserves, over half a trillion dollars in gold and financial assets denominated in other currencies.  Ordinarily these reserves would cushion the blow of sanctions.  Russia could use these assets to support the value of the Ruble and protect the Russian economy.   However, to do so the central bank would need to access financial markets to sell assets.  An additional extraordinary step under consideration would be to sanction the Russian Central Bank directly and limit its access to financial markets.  This move would further cripple the Russian economy.

Despite the asterisk for the energy industry, the financial sanctions already introduced by the U.S. and its allies will strike a strong blow to the Russian economy.  Putin is trading the prosperity of the Russian people for his vision of a greater Russia.  

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