Previously published on March 7, 2022 in
By Milton Ezrati, Chief Economist at Vested
Russian aggression has called forth a powerful reaction from the United States and its allies. Many on both sides of the Atlantic and the Pacific have described that response as inadequate, but make no mistake, the sanctions put in place so far will have a powerful effect on Russia and on Russia’s leadership, one that will become more intense the longer they last. In this, time is not on Russia’s side.
Today’s phalanx of measures builds on a weaker set of sanctions put in place when Russia seized the Crimea in 2014. The more recent set are primarily financial but include direct economic measures as well
Most prominent is a freeze the assets of Russia’s largest commercial banks as well as the reserves of Russia’s central bank. The commercial banks in question account for some 80% of Russian banking assets. The action against the central bank will deprive Russia of some $630 billion worth of central bank reserves held in dollars, yen, and otherwise outside the ruble. This huge reserve, ironically built up to make Russia “sanctions proof” after the 2014 measures were put in place, is no longer at Putin’s disposal. Though Russia holds some 15% of its central bank reserves in China and furthermore has a gold reserve of some 2,300 tons worth about $142 billion, the general freeze renders even these assets all but unusable to the Kremlin. As one Wall Street trader put it, with Russian banking all but shut out of world markets “just try monetizing that gold hoard.”
Sanctions will also seize or freeze the assets of major members of the Russian elite, including Putin and his relatives, at least those assets outside Russia. As was hoped, several of these so-called oligarchs, according to rumors, already have leaned on Putin to stop the war. The Europeans and the Americans have also agreed to deny selective Russian agents access to SWIFT. China offers an alternative to SWIFT with its Cips system, but it is miniscule by comparison. Because SWIFT is essential to the settlement of most every financial transaction, this move, in addition to a ban on any Russian government financing on world markets, will make it all but impossible for the Kremlin or Russian business to raise money outside the relatively tiny Russian market.
The allies have imposed a few direct economic measures, chief among them a ban on technology sales to Russia, including semiconductors. In time, and not a very long time, this cutoff will limit Russian efforts to upgrade its industry and critically, its military. Even before that, it will hamstring efforts just to maintain what already exists. To extend the ban beyond the allies who have agreed to it, the United States has made clear that nothing with an American-made component can go to Russia, wherever it is eventually assembled. There is very little in the world of technology, especially semiconductors, that does not have an American component.
Several countries, including the United States, have forbidden any commercial Russian aircraft to pass through their air space. Meanwhile, many western commercial ventures have withdrawn from Russian ventures. Most recently, Visa and Mastercard have suspended operations in Russia. Previously, Norway’s huge sovereign wealth fund began its divestiture of Russian holdings, while Norway’s premier energy producer, Equinor, has stepped away from its joint projects in Russia. American firms, Federal Express and UPS, have halted all shipments to and from Russia, and British Petroleum (BP) is divesting itself from its 20% stake in the Russian oil giant, Rosneft.
Notable for its absence are direct efforts to stop the flow of Russian oil to world markets. Blocking these sales would certainly hurt the Russian economy. Oil and gas are more than half the country’s exports. The object here is less to spare Russia as to spare people in the West, who are already suffering inflation, especially in fuel prices. A sudden stop of Russian supplies would compound that problem. After all, Russia produces some 10% of the world’s supply of fossil fuels. Europe gets some 70% of its energy imports from Russia.
Even without a formal ban, the price of energy has soared. In the United States, the price of a barrel of crude oil, already up in 2021, has jumped more than 35% in just the last few weeks, and the price of natural gas has risen more than 28%. The issue is not a sudden shortfall in supplies. That simply has not happened. Rather the recent price jumps reflect uncertainties about what will happen. Traders worry that the West will soon impose a ban on Russian oil and gas or that the Kremlin, in extremis, will try to punish its tormenters by blocking sales, an economically suicidal act, to be sure, but still a plausible, if desperate possibility should the Russian economy already be approaching ruin.
There is ample global production capability to replace Russian energy supplies. With these, the West retains a potential threat, especially once it has had time to work up marginal sources and bring them to market. That needed interval would be a lot shorter had not Biden killed the Keystone XL Pipeline on taking office and discouraged both conventional drilling and fracking since. Had the United States continued the path it was on, it would have had excess capacity in both crude oil and natural gas to replace Russian supplies to Europe. That reality would have tempered the immediate price impact of recent events. But as it is, the United States has already slipped back from an energy surplus to the status or a net energy importer.
Even without these resources available to global consumers, Russia will quickly feel the cumulative effect of the measures already put in place. It already has. The International Monetary Fund (IMF) has estimated that the sanctions imposed on Russia after the 2014 seizure of the Crimea cost Russia’s real gross domestic product (GDP) 1-1.5%. Stronger sanctions placed on Iran erased one third of that country’s foreign trade. On this basis, preliminary estimates suggest that the still stronger sanctions placed on Russia could in time cost its economy as much as 9% in real terms. That loss would be twice as bad as America suffered during its great recession of 2008-09. Whether the pain is enough to stop Russian military ambitions remains an open question, but there can be little doubt that Putin’s adventure will impose costs in an economy that can little afford them.