Everyone agreed that the first round of Russia sanctions were laughably ineffective, aimed at a motley assortment of Kremlin B-teamers, whom Putin demoted to limit the damage they can cause and about whom Putin couldn’t care less. The second round of sanctions hit closer to the mark, including squarely at members of Putin’s ‘inner circle,’ including his long-time friends – Gennady Timchenko and Brothers Rotenberg. This Monday, the US built on and deepened this strategy with another round of sanctions. In short, the sanctions add the listed individuals/entities to the ‘Specially Designated Nationals’ (SDN) List, which prohibits US persons and companies from doing business with them (e.g., no contracts, no bank deposits, nothing), and with any entities owned or controlled by them.
Targeting the Cancer
Although the major ‘shock’ factor from Monday’s sanctions was the inclusion of Igor Sechin and Sergey Chemezov – but not Rosneft and Rostec, respectively – this seems more like optics. What is more interesting is the addition of entities owned/controlled by Timchenko/Rotenberg. Of course, such entities would already be covered by the sanctions via the individual, but the ownership schemes they prefer are not always models of transparency. Supposedly, the targeting of all business holdings linked to Timchenko and Rotenberg is a strategy of making them ‘radioactive‘ – to essentially freeze them out of the US-led economic system.
This poses some interesting issues, particularly for US/Western companies still trying to go about their day in the hopes that the tensions blow over:
- Unlisted Entities – what about unlisted entities wholly-owned/controlled by Timchenko or Rotenberg? The rule is they are covered by the individual’s inclusion. Thus, OOO “Gazprom Burenie” (Burgaz) would be covered by the sanctions, as it is 100 percent owned by Rotenberg (who bought it from Gazprom for far below-market value, of course). But Burgaz is the primary drilling contractor for Gazprom. Foreign companies do millions of dollars in business with Burgaz every year.
- Unclear Ownership – it is not uncommon for rumors about Timchenko’s ownership of a company to swirl for years, he denies it, and then one day it is an established fact. Thus, it’s difficult to know how to treat companies such as Novatek, in which Timchenko holds 23.4 percent, but the rest of the shares are held by close associates (Leonid Mikhelson) or Gazprom. This is the whole system in Russia now – a harmonious marriage between the state and Putin-selected oligarchs with the goal of extracting as much wealth from the country as possible.
To accomplish this goal, they need schemes where money can be transferred from public to private hands – sometimes it’s the government selling a public company at below-market prices; sometimes its the state-owned joint venture partner overpaying for shares held privately; and other times it involves the use of a sham company during a procurement to artificially mark up the price (something both Timchenko and Rotenberg have caught doing, btw).
But they also need access to international capital markets, foreign bank accounts in secrecy jurisdictions, and Western companies trying to sell products to state-owned companies. By targeting Timchenko/Rotenberg, who really do frequently surface in Russia transactions, the US may very well deny them access to these essential tools, and probably will not do much damage to the Russian economy in the process.
In a way, we unplugged Russia from the Matrix, but there’s no alternate reality waiting for Russia where it is a self-sufficient great power. They’re just outside.
Some observers have argued that the sanctions are intentionally ineffective – more of a face-saving measure vis a vis Ukraine. I do agree that there is not necessarily a logic of effectiveness driving the development of these sanctions. What I have heard – second-hand – from sources directly involved in the process is that the whole thing is a circus, with a lack of imagination for how to tailor them to Russia, lack of familiarity with the players in Russia, etc. (that’s the sort of policy acumen you develop after ignoring a country for 20 years). But it seems unlikely that the strategy is brilliantly intended to look tough but fail. I think it’s just random flailing like the US government does in response to every crisis.
What makes the sanctions even more significant, however, is the reaction they are getting out of Russia.
If You Build It, [T]he[y] Will Come
Russia is no North Korea – Putin no Kim. Wild animal photo ops notwithstanding, the systematic extraction of wealth from Russia cannot be built on a Putin personality cult. There has to be an idea, and the current leadership’s indelible Cold War experience provides a convenient fall-back position. The general population’s nationalism, combined with the long-running Russian tendency to turn inwards, provides fertile ground to cultivate this idea. In fact, some reporting indicates that the Cold War mindset shaped the thinking of Putin’s conservative advisers on Crimea before the purported crisis that necessitated Russian intervention.
As for Sechin, we do know that he frequently reviews the minutes of Communist Party congresses from the Soviet era; as one colleague put it: “He was drinking from this fountain of sacred knowledge so that Russia could restore its superpower status and take its rightful place in the world.” Thus, the fall-out with the West over Ukraine presented not only a challenge, but an opportunity to build that alternate reality.
PM Medvedev trotted out the most comprehensive version of this ideology last week, in a report to the Duma on the government’s work. Really, the speech is a reheated version of Medvedev’s standard State of the Union from when he was president – i.e., non-diversification of economy, low investment, poor institutions – minus the laser focus on pervasive corruption and with an added dash of nationalism. Medvedev explained, “Furthermore, the current situation should be viewed not only as a challenge, but also as a great opportunity for improving government efficiency and creating a new foundation for the national economy based on domestic production.”
The problem is that Russia has long pursued efforts to encourage a more multipolar global system – e.g., establishing the Eurasian Customs Union, promotion of Moscow as financial center, economic partnerships with ‘independent’ states like Venezuela – and modernize its economy. Most of these projects have not gotten off the ground – except the customs union – and none have reduced Russia’s reliance on foreign goods, foreign technology, and foreign financial infrastructure to keep its economy alive. Based on the numbers, Russians simply despise (i) buying domestic goods and (ii) keeping their money in Russia. At a macro level, the economy desperately needs investment to fuel productive enterprises, mostly from Russian enterprises and individuals that stash their cash offshore. In other words, Russians make economic decisions based on the same criteria that guides everyone else, and they don’t like what they see in Russia. Will doubling down on its strategy of playing global gadfly help?
De-Dollarization – Glazyev’s Dream
Reducing or eliminating its reliance on US dollars is reportedly a key element of Russia’s plan to create a ‘new foundation for the national economy based on domestic production’. The de-dollarization plan is the baby of Sergey Glazyev, advisor to Pres. Putin on regional economic integration (pictured right). According to a copy obtained by Vedomosti, Glazyev’s plan includes the following steps:
- Transition all state assets in USD/EUR to ‘neutral’ currency
- Return all state-owned assets (e.g., precious metals) to Russia
- Sell bonds of NATO countries involved in sanctions
- Suspend exports of gold, precious metals, and rare earth metals
- Monetary swap with China to finance critical imports and transition to settlements in national currencies
- Creation of a SWIFT-like local system of interbank information exchange for payments in the Customs Union, the CIS, and ‘partner countries’
- Creation of card payment system in Customs Union similar to Visa/Mastercard
- Limit foreign exchange position of banks and require declarations of major non-trading transactions; future introduction of tax on capital outflows and speculation
- Transition to settlements in national currencies in the trade of the Customs Union and other countries; conclusion of new contracts for export of hydrocarbons in RUR
- Monetary swaps with countries to finance trade
- Rapid reduction of dollar-denominated instruments from reserves and debt obligations to countries involved with sanctions
- Substitution of loans by state banks and corporations in USD/EUR with loans in RUR on the same terms
- Advocacy work with the population regarding the need to convert from USD/EUR deposits to RUR; freezing of Central Bank liabilities denominated in USD/EUR
- In response to trade embargo, initiate ‘critically important operations’ through Belarusian and Kazakh enterprises
- Conversion of strategic enterprises with offshore ownership in hydrocarbons and real estate sectors to national ownership
I agree with Vedomosti’s assessment: Glazyev’s plan has mostly nutty/impossible parts, but some very sensible and likely helpful parts. My personal favorite is the last – Russia’s expressed concern that foreign ownership of ‘strategic’ enterprises may jeopardize national or economic security is belied by the reality that most of these assets are owned via offshore holding companies incorporated in secrecy jurisdictions.
The proposal to reduce reliance on the US dollar and USD-denominated instruments (namely, Treasuries) has generated excitement before. For example, right before the first round of sanctions last month, the Fed reported a record drop in US government securities held in custody at the Federal Reserve. The USD 2.86 trillion held by foreign central banks fell by USD 104 billion during the week ending March 12 (Russia holds approx. USD 123 billion of the total foreign holdings).
There is No Red Pill
Monetary issues are not an area of interest or expertise. Still, based on available research and commentaries, it seems like predicting the end of the US dollar as reserve currency is a perennial pastime of skeptics on the left and right. The interest in the subject appears to have remained constant over the past decade, and you can find roughly equal numbers of articles arguing opposite sides of the issue. Sure, it will definitely happen some day. But for now, it seems clear that the Yuan – probably the only rising challenger to the dollar – is far off from being a reserve currency. And the broader question is – who else will fill that role? Nobody but the US for the moment.
Russia’s folly in its response to the Ukraine conflict is that it assumes the existence of some national autonomy on how to engage with the rest of the world. Russia seems to believe it can reject the terms of the US-led system and go out on its own – the state equivalent of me marking up the iTunes Terms and Conditions and sending revisions to Apple for consideration. The power differential is irrelevant – Apple could not deal with me on an arms-length basis even if it wanted to; it wouldn’t work..
Russia cannot expect to be successful at ‘opting out’ of the US system and creating an alternative. The existence of foreign investment, global trade, commodities markets, and financial centers is inseparable from the US system. Russia’s leaders have already acknowledged ad infinitum that Russia needs these things to modernize. Thus, it’s disappointing to see that Russia’s grand strategy for the post-US world is hoarding gold and precious metals.
If Russia pursues these strategies in response to the sanctions, it will be accurate to say that the sanctions ruined Russia. Not because the sanctions directly damaged the Russian economy, but rather Russia’s reaction to them did.