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How will Russia sanctions impact the global economy?

 

Russia’s invasion of Ukraine has led to severe financial sanctions being imposed on the country that are likely to have lasting consequences. Problem is, they may not be the ones the sanctioners are expecting. They may even come to regret what they have done.

Western countries are banning sales of Russian oil and gas, the country’s main export. Two thirds of the foreign reserves of the Russian central bank have been confiscated. The nation’s currency, the rouble, has fallen sharply. The hope is that by attacking the nation’s economy and financial system it will create such internal instability Vladimir Putin, the Russian president, will either be deposed or forced to withdraw.

It will not work; sanctions rarely do. Russia has already experienced years of prohibitions so has become much more self-sufficient. The country has a trade surplus, which is likely to get bigger as oil and gas prices soar. It will have no problem finding customers, especially with China and India not going along with the bans (India has quadrupled its buying of Russian oil). The main Russian imports can be readily sourced from China, the country’s biggest trade partner: cars, packaged medications, vehicle parts, broadcasting equipment.

Meanwhile, inflation in the West, which in the US is at a 40 year high, is likely to worsen. The oil price is at a 13 year high and wheat prices are at a 14 year high, in part because the biggest suppliers of fertilizer are Russia and Belarus. It is hard to see Australia escaping that inflation, despite the relatively sanguine attitude of our Reserve Bank.

It is a problem because most Western economies are burdened by unsustainable debt; in Australia the household sector is especially vulnerable. The household debt-to-GDP ratio was 119 per cent in the third quarter of 2021, which is second only to Switzerland in the world. If inflation continues to spiral, resulting in a rise in interest rates, the sanctions could turn out to be a massive own goal.

The financial (as opposed to economic) sanctions on Russia are grave. There is a ban on the use of SWIFT (Society for Worldwide Interbank Financial Telecommunication), the main method for making cross border financial transactions. Russia had, however, plenty of prior warning this might happen and had started to prepare. As JP Morgan’s chief executive, Jamie Dimon has warned, SWIFT is just a messaging system, and it will be possible to do business with Russian entities in other ways. Russia has developed its own payments system, which it is looking to link to China’s more advanced Cross-border Interbank Payment System (CIPS). The country is also reportedly asking to be paid for its oil and gas in gold.

 

'The cross-border efficiencies that have kept prices and inflation low over the last three decades could start to vanish as trust between nations evaporates and interdependence recedes.' 

 

The other aggressive financial attack, an outright act of war, is the freezing of the foreign assets of Russia’s central bank. Such a move is not entirely new. In 2020 the Bank of England effectively stole Venezuela’s gold reserves. But it is not a measure that was even used against Hitler’s Germany.

How exposed is Russia? According to Statista, about 14 per cent of Russia’s reserves, held in gold and foreign currency, is located in China. The biggest share of reserves, 21.7 per cent is held inside the country in the form of gold. That means the central bank has control of just over one third of its $630 billion in foreign exchange reserves.

It will certainly cause financial pain but Russia’s vulnerability will probably be controllable. Foreign exchange reserves are mainly used to protect the national currency from falling so as to stop foreign debt becoming unpayable. Russia has relatively low national debt and can transact with China and other nations using non-currency options.

The biggest delusion with the sanctions is that national governments control the financial markets. That has not been so for decades. Governments can impose new rules but they cannot direct how the markets respond. Already, many of the big players are positioning to buy distressed Russian assets. In the global financial system money moves at lightning speed, circumventing whatever governments attempt to do.

Another delusion is that this could spell the end of the US dollar as the world’s reserve currency. It is hard to see any case for that. According to the Bank for International Settlements daily foreign exchange turnover is $6.5 trillion and 88 per cent of the transactions have the US dollar on one side. The Russian rouble ranks seventeenth in the world; its turnover is half the level of the New Zealand dollar. Just eight hours of transactions in the US dollar in the foreign exchange markets is (notionally) the equivalent of an entire year’s sale of oil ($US2 trillion).

The greenback will only be threatened if the meta-casino of the global capital markets is unwound. High tech financial transactions in the foreign exchange markets dwarf real things like food, energy and manufacturing.

The impact is more likely to be felt with commerce. The cross-border efficiencies that have kept prices and inflation low over the last three decades could start to vanish as trust between nations evaporates and interdependence recedes. As one freight analyst comments, it is ‘the most dramatic and unpredictable supply chain map since World War II,’ that can create a ‘bifurcating global economy.’

We may be witnessing the end of the modern era of globalisation, to be replaced by a resurgent economic nationalism.

 

 

 

David JamesDavid James is the managing editor of personalsuperinvestor.com.au. He has a PhD in English literature and is author of the musical comedy The Bard Bites Back, which is about Shakespeare's ghost.

Main image: A motorist fills up her car with petrol in Australia. (Ian Waldie / Getty Images)

Topic tags: David James, Russia Sanctions, Global Economy, Inflation, Globalisation

 

 

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Existing comments

In spite of this rosy picture of the Russian economy, I notice no one is rushing to buy roubles - no matter how cheap they are becoming.


Daniel O'CONNELL | 22 March 2022  

Some of us won’t be sorry to see “the end of the modern era of globalisation” which has led to Western manufacturing being exported to China, and the general stagnation of real wages for lower and middle-income earners.

What will replace it remains to be seen. Joe Biden just stated, “There’s going to be a new world order out there. We’ve got to lead it, and we’ve got to unite the rest of the free world in doing it.” God help us all in a world led by Biden and his ilk.

Equally idiotic was the European Commission President Ursula von der Leyen expressing disbelief that Russia could invade Ukraine “in this day and age”, as if having smart phones and gadgets meant all bad guys should have disappeared. It’s best not to appear a sucker in any age.

Time to re-read Huxley’s “Brave New World.”


Ross Howard | 23 March 2022  

Interesting, also there are pressing local, regional, continental, demographic and economic issues for Putin, including Caucasus, Central Asia, China, US and EU; the latter two are far more important to China economically as it's integrated.

Russia has to deal with not just choosing to be an outcast, but dealing with long standing demographic decline (hidden by headline numbers); declining 'Russian' ethnicity, becoming more (often secular) Muslim from Central Asia, decades of emigration and now a rush for the doors....

In the meantime Xi and China can watch, but also be part of any solution to this Putin induced crisis with 'western' and other partners; 'real politik' for the times.


Andrew J. Smith | 26 March 2022  

The important thing about David James' writing is that he's a very good empiricist and tells it as it is: carefully, parsimoniously and, invariably, correctly.

The difficulty with Ross Howard's view is that it is prescriptive and its predictability laced with propaganda rather than proof.

Assuming then that Ross is motivated by conviction of Russian wickedness, prominently reflected in a highly personalised construction of events for which the absence of a free Russian press is partly to blame, one has to ask if it is not just Putin but Russian culture and history that is its own worst enemy.

Locked away from contemporary cultural influences for more than a century and perhaps longer in terms of its geography and the enforced peasantry and financial poverty of its masses, the West's strategy towards it appears to have constituted a colossal mistake, isolating Russia since Glasnost in a way that contributed to toppling Gorbachev and handing the country back to its oligarchs.

Even Nixon - a politician known not to have have been able to lie straight in bed - could see that continued isolation was not in China's or the West's best interests.

Surely now is the time to rethink strategically.


Michael Furtado | 02 April 2022