The chilling effect of sanctions against Russia

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Sanctions are tearing holes in the Russian economy. Global powers led by the United States have imposed restrictions ranging from a freeze on the Russian central bank’s overseas assets to a ban on buying sparkling wine from a bottler in Crimea. On Sunday, US Secretary of State Anthony Blinken said the allies were now discussing a ban on Russian crude oil exports.

The ruble crashed, bond default risk soared, the Moscow stock exchange closed, and Russian oil is trading at ever-deepening discounts to Brent.

The barbaric invasion of Ukraine fully justifies the economic war against Russia. Financial sanctions are sometimes seen as symbolic gestures. If so, they cause real damage and could trigger a recession.

In the process, some errors regarding these brakes became clear. This should help Western banks and corporations stay out of trouble, and developed democracies more effectively deploy new sanctions – which should include the Russian energy export embargo.

The main mistake is that sanctions can target Vladimir Putin and his inner circle of cronies and related businesses. This inner circle becomes too vast to deserve description. In the past fortnight, the US, EU and UK-led group has added the names of around 400 Russians to sanctions lists, according to World-Check, an intelligence database on the risks.

The number of newly sanctioned organizations – most of which are businesses – is over 600. Many Russian oligarchs and their businesses have been left out, including a particularly egregious example in the UK. But all companies controlled by sanctioned groups are, by definition, also sanctioned. You need to figure out who they are before you can stop dealing with them. This is difficult, given the lack of transparency around Russian companies. The actual total would be several thousand.

Business in the corrupt former Soviet regimes is partly organized according to the “krysha” principle. The big man in your district usually pays a regional boss to shelter under his metaphorical roof, or “krysha”. The regional boss then hands over to a national oligarch who pays protection money to a powerful politician. The dictator sits atop the overlapping rooftops.

This is a usefully flexible system for regimes that avoid sanctions. When sanctions prevent an oligarch or organization from dealing with the West for the godfather, an unauthorized lackey can be delegated to do so instead. This is how the Russian central bank could dispose of part of its $160 billion in sanctioned gold.

Banks in the City of London and New York cannot be sure who they are dealing with. The result, says the head of a major city institution, is that “a lot of organizations just put all Russians in the crosshairs.” This is the famous “chilling effect”, whereby most companies and businessmen in a country are cold alongside their appointed peers.

The chilling effect is particularly chilling in the area of ​​payments as international banks are rightly terrified of US authorities. Thanks to their extraterritorial reach and the dominance of the dollar as an international currency, US prosecutors and regulators can make things very hot for banks that participate in sanctions dodging.

Due to the chilling effect, I am told that some major international banks are quietly avoiding their Russian peers who remain on the Swift international payments messaging system after the eviction of seven major lenders, including VTB, VEB and Otkritie. This would make it harder for Gazprombank, the banking arm of gas giant Gazprom and Russia’s third-largest lender, to receive payments.

The fallacy this illustrates is that sanctions can be fine-tuned to spare Russia’s energy sector harm. The United States and the EU have sought to provide energy companies and their subsidiaries with an exception to sanctions. The reason is that Germany and Italy are heavily dependent on Russian gas due to multiple energy policy mistakes of their politicians. Despite the exclusion, oil from the Urals is trading at increasingly higher prices relative to Brent, reflecting the reluctance of foreign buyers.

Russia’s massacre of Ukrainian civilians forces the West to step up sanctions. The United States is right to threaten Russia with an embargo on oil exports. It’s better than simply imposing a halt to all energy exports without warning.

The case is different from freezing the assets of the Russian central bank. The allies needed to act immediately to reduce Russia’s ability to make precautionary sales of its assets. Gold and bonds represent a store of value. Oil exports, on the other hand, are a continuous stream of income. The West can impose sanctions if Russia refuses to defuse and negotiate.

Game theory suggests offering exit ramps for Putin, as Sven Behrendt of German policy consultancy GeoEconomica points out. Sanctions hawks disagree. But it’s still the sensible way to deal with an enemy you hope to force a retreat rather than destroy. Tactics are needed to win financial wars as well as military wars.

This article has been edited to reflect Russian oil embargo talks and the impact on markets.

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