Russia’s invasion of Ukraine represents the gravest challenge to peace in Europe since World War II, and, according to some, the onset of a new era in world history.
The West’s response has been nearly as monumental. While forswearing military confrontation with Russia, NATO and its allies have waged something akin to financial war on Vladimir Putin’s regime. In addition to sanctioning Russia’s oligarchs and seizing their Western assets, the U.S. and E.U. have effectively evicted Russia’s entire banking system from the global financial order. Russian banks can no longer use the international payments known as SWIFT to complete transactions, forcing the firms to conduct business at a snail’s pace, one telephone call at a time. Not that Russia’s banks have all that much business to conduct, given that engaging in virtually all forms of commerce with Russia will now expose foreign firms to secondary sanctions.
Even more significant than these measures, however, was the freeze that central banks throughout the West put on Russia’s sovereign assets. Since his invasion of Crimea in 2014, Putin has carefully built up one of the world’s largest reserves of foreign currency. This $640 billion stockpile was intended to give the Russian leader greater freedom of geopolitical maneuver by insulating his economy against the threat of crippling sanctions. One of the worst consequences of sanctions for the penalized nation is that they debase its domestic currency: When most of the world is boycotting Russian exports, demand for rubles dries up. That increases the Kremlin’s borrowing costs and the prices that Russian consumers must pay for imported goods. With its giant stockpile of foreign currency, however, the Russian central bank could engineer demand for rubles by buying them up with its own dollars and euros.
But there was a flaw in this plan. Although Russia owns hundreds of billions in foreign currency, those funds are legally stored in central and commercial banks in New York, Paris, Berlin, and other global cities. The West exploited this fact to cut off Russia’s access to its own sovereign wealth.
Never in modern history has an economy of Russia’s scale been subjected to such extraordinary ostracism. The ruble’s value swiftly plummeted. According to analysts at JPMorgan Chase, the Russian economy is now poised to shrink by 7 percent this year. Other forecasters paint an even darker picture, with The Institute of International Finance projecting a 15 percent contraction in Russia’s GDP. Putin’s regime owes much of its popular legitimacy to the fact that it managed to steer Russia back to economic stability and modest growth after its 1998 debt crisis. That year, the Russian economy shrank by 5.3 percent.
And economists may actually be underestimating the economic difficulties that lie ahead — for both Russia and its adversaries.
For all their technocratic brutality, the West’s sanctions did include a loophole large enough to run oil tankers through: Transactions involving Russian energy exports, which account for about a quarter of its economy, were exempted from sanctions, so as to spare Western consumers from paying for Putin’s sins.
On paper, this provided the Kremlin with a precious lifeline. So long as Russia could carry on selling oil and gas to the U.S. and Europe, it would continue to accrue dollars and euros, which it could then use to prop up the ruble’s value. And this has indeed helped to cushion the Russian currency’s fall over the past week.
If the West’s governments threw Putin a lifeline, however, its private sector is steadily cutting through it.
Over the past few days, Western traders and refineries have slashed their purchases of Russian oil, with some ceasing to transact with the Russians altogether. Meanwhile, oil giants Shell and BP both announced that they are abandoning partnerships with Russian state-owned oil companies and halting extraction projects in the country.
“The enablers of oil exports — the banks, insurance companies, tanker companies and even multinational oil companies — have enacted what amounts to a de facto ban,” Tom Kloza, the global head of energy analysis at the Oil Price Information Service, told the New York Times last week.
The motivations behind this emergent boycott vary from firm to firm. For one thing, while Western sanctions include exemptions for the energy trade, executing such transactions without running afoul of some other restriction in the process is a tricky, time-consuming business. Many buyers would simply prefer to do business with less vexsome suppliers. At the same time, some shipping companies do not want to expose their vessels to the risk of attack; shortly after the onset of Putin’s invasion, a missile struck a Moldovan oil tanker.
There is also a widespread belief among traders that, as Russia ramps up its attacks on Ukrainian civilians, Western governments will eventually feel compelled to use their remaining economic weapon. So buyers are looking to get ahead of that development by securing new suppliers now. Finally, a lot of participants in the energy trade simply do not want to be bankrolling war crimes (or, at least, to be seen to be doing so). This moral objection to facilitating the Russian energy trade is not confined to executive suites. In Britain on Friday, dockworkers refused to unload a tanker full of Russian gas, thereby forcing the ship to be diverted.
As a result, Russia is struggling to find buyers for its top export, even as it offers the nation’s highest quality oil at a discount of $20 a barrel.
Should this de facto embargo continue, the implications will be devastating for Russia’s economy and burdensome for virtually everyone else’s.
“We’re in unknown territory if you pull 13 percent to 15 percent of global oil out of the pool,” Brenda Shaffer, a senior adviser for energy at the Foundation for Defense of Democracies, told CNBC Thursday. “Sanctions on Iran and Venezuela, it’s not even comparable to what that could do to the global oil market if you actually pulled away most of Russian production.” Shaffer went on to note that while many are cheering the exit of Shell and BP from Russia as a “feel-good moment,” those moves are “going to be a huge, huge shock to the state of these companies and to the stock market in general.”
As of late Friday morning, a barrel of Brent Crude Oil was trading at $114.50, its highest level in nearly a decade. Meanwhile, the Dow Jones Industrial Average was down 500 points on the day.
Given Putin’s expansive war aims — which include the dissolution of the Ukrainian government, and the establishment of a Kremlin-aligned puppet regime in Kyiv — sanctions are unlikely to be lifted anytime soon. And should they remain in place for much longer, they are likely to permanently reshape the global economy.
Already, European leaders are discussing efforts to durably reduce their reliance on Russian energy through both an acceleration of decarbonization efforts and, in the immediate term, the aggressive pursuit of spare liquefied natural gas from other suppliers. For its part, Russia is likely to pivot its own export strategy away from Europe and toward China.
If Putin’s rogue geopolitical strategy is to be remotely sustainable, he will need the partnership of Xi Jinping’s regime. It is not a coincidence that, shortly before Putin’s invasion, Russia and China announced a “no limits” partnership meant to counterbalance the coercive influence of Western powers. But here, too, Putin’s fortifications against economic bombardment have been splintering. China’s political leaders have found Putin’s offenses against the international order easier to defend in theory than in practice. Following Russia’s haphazard and bloody first days of fighting, Beijing distanced itself from Moscow, declined to support the ruble from Western attack, and called for the protection of civilians in Ukraine.
And China’s political leadership is more sympathetic to Russia than its large businesses. Chinese banks have mostly steered clear of Russia since the war began, wary of jeopardizing their access to more profitable Western markets. If China eventually agrees to serve as Russia’s financial savior, Xi will have the leverage to extract lopsided terms of trade from Moscow.
Even if Putin pulls out of Ukraine in a few weeks, and Western nations lift the current sanctions, American and European firms and investors are likely to remain wary of Russia, given the risks inherent to doing business with a rogue state.
Thus, Putin’s war of conquest is poised to inaugurate not only a new geopolitical era — one in which the European Union spends much more on defense and NATO enjoys a new sense of purpose — but also a new economic one, in which global commerce is increasingly divided between adversarial blocs. These two developments could interact in dangerous ways. As Russia and the West become less economically interconnected, relations between the world’s two largest nuclear powers could become even more tense and tenuous than they were before the present crisis.
In the immediate future, the costs of adjusting to a less globalized economy could be steep. Already stricken with high inflation before Putin’s invasion, the West will now see its energy costs explode. In Russia, the scale of devastation and disruption that awaits is difficult to comprehend. For some of the world’s poorest people, meanwhile, a sudden drop in wheat exports from Russia and Ukraine could very well mean starvation.
In drafting its sanctions, the West set out to wreck the Russian economy. At the moment, it appears to be succeeding beyond it’s wildest hopes (and/or fears).
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