Russia now seems set for a severe recession. The combination of sanctions and dramatically falling oil prices weakened the state dramatically, with questions about Putin's ability to continue leading the nascent police state.
Western commentators have adopted an arrogant tone about all this. Globalization, inter-dependence, Russia's backwardness: all these narratives have come to fruition. We can stick it to this backwards petro-state, without lifting a finger! Take that you Crimea-annexing jerkwad!
At this point, a layman might think that the tide of history has turned, and the West really has gained the power to use economics to severely punish our enemies.
Let's walk that bit and consider a few essential items:
1. Sanctions are Limited (and it's tough to do more)
Right now, we have limited the ability of senior Russian's to travel, and the ability of some Russian companies to raise money. We're not talking about crippling sanctions, a la Iraq post-1991, and we have spent a long time enacting even these rather limited sanctions.
That means willingness to incur, or inflict, actual economic pain remains low. Europeans still want to buy Russian hydrocarbons, and will pay top dollar for them. Comparatively, the "surrender-monkeys" of Munich were, by this point, raising armies to parry Hitler, and extending defense guarantees to Poland.
Quite frankly, I think Modern Europe lacks the stomach of 1930s Europe, and that's saying something.
This matters because if we cannot enact any sort of serious sanctions, we can't really rely on using sanctions as weapon. It's sort of like combating the NVA and suggesting everything will be fine because we have ICBMs: we're not going to nuke Hanoi. I know it, you know it, and the NVA knows it, so they'll just act as if the ICBMs don't even exist.
Who cares? A weapon isn't a threat unless you can use it. Right now we've shown our willingness to bring out some light-weight sanctions, but not any sort of commitment to real economic ruin.
Why does that matter?
2. Russia's Recession is a Textbook Financial Crisis/Currency Run
This, to me, looks like your standard financial crisis, not all that much different from 1998 or 2008. Most people still do not understand how much major companies depend on financial markets for even day-to-day operations: hell I'm an accountant and most of the people I work with don't understand why Finance needs daily cash flow reporting (ain't it obvious guys?)
We've restricted most major Russian companies, ESPECIALLY banks, from accessing capital markets. And a lot of commercial banks are fearful of lending money to any other Russian companies, since GOK if they will get hit by sanctions/recession/bombs, either. Better to sit it out!
This restricts the ability of most Russian companies to perform daily economic activity, and forces serious cut-backs. Worse, it produces a run on the currency: these Russian companies operate in rubles, but borrowed in dollars or Euros. Now they have to repay all their creditors, in dollars or Euros, so they have to use a lot more rubles to buy dollars.
And since oil is down so much, oil consumers aren't really partial to spending a lot of dollars to get rubles to buy gas, and etc.
Now why does that matter?
3. Crises can be ridden out
You might not be able to stop the recession, but you can certainly moderate its impact. That's the point behind foreign exchange reserves, and Russia has spent the last decade storing hundreds of billions of dollars and Euros for just this case.
In the worst case scenario, the Russian Central Bank might be able to pay off all the interest and principal owned by Russian banks for the next year or two. That would drain the reserves to zero, but collapse would be averted. Hopefully by then some of the sanctions will have been lifted, oil will have gone up, and Russian companies will have adjusted to new realities.
So, not the Great Depression, but a mild recession....
Now that's hardly a severe problem. We're probably better off ramming some of their fishing vessels, for all the good it will do. Either that, or increase the sanctions: shut off ALL financing, refuse remittance payments, and place quotas on oil exports.
Except that's a problem because....
4. Not Everyone is Boycotting Russia
Japan hasn't boycotted Russia much: they've put on hold an investment deal with Russia, but have not severely restricted trade. China just penned a gas deal. But more important than that, the Chinese and Russian central banks have agreed to a 3-year Currency Swap Deal, that just might save Russia's skin.
Additionally, Russia has sought admittance to the world body governing Securities trading: think of it as the SEC, but for the whole world. Admission would allow Russian companies to issue stock and raise funds in Hong Kong (after negotiations).
Russian companies have also explored issuing "Dim-Sum" bonds: bonds denominated in RMB rather than USD. Little harder to shut down a Russian company if you don't control the currency or the capital markets.
Basically, if they can't get financing from the West, Russia will try to finance through China. That's not a sound replacement: the West has a LOT of capital. However, as the Chinese markets mature in the coming decades, the West will find limiting financing a non-viable option.
Summary
We are at a point where our limited sanctions have proven unusually effective: this is not the dawn of a new era. This is PEAK effectiveness. We have control of all the world's major financial institutions, and its capital, while our enemy remains weak, and faces an unfavorable commodity market. These will all go away in the near future. And even at peak effectiveness, we still cannot deter a relatively weak nation from aggressively annexing another nation's territory.
Sanctions are not strong enough by themselves, and they'll never be. Western policy-makers need to explore, and commit, to other means of punishment.
-Robert
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