Putin in the Micex | FT Alphaville #EuroMaidan

Putin in the Micex | FT Alphaville:

Russian stocks having a bad morning following the sanction filled night before:

That’s the Micex off 3 per cent and the RTS off 3.7 per cent at pixel…

While we wait to see if Gunvor gets squeezed to death and if this escalates, some relevance from Citi’s Stephen Englander a few days back:

One advantage using finance as a weapon is that it can be scaled up or down as needed, and is much more reversible than military actions. It is also quicker than traditional trade sanctions to have an impact, and arguably is more likely to hit decision-makers and those who have access to them than trade sanctions, which often hit the poor and almost always create profit-making opportunities for the well-connected in sanctions-running.

How far can this go and what are the implications?

So far the steps taken are baby steps – sanctions applied to a handful of Russians and Crimeans by the US and EU, but no real screws being applied (Russian President Putin not named, for example). Probably there are huge holes through which transactions can continue to occur and the sanctions can be evaded. However, if the crisis intensifies, the US/EU may be tempted to apply broader sanctions on Russian assets on the view that this is the quickest way to apply pressure and that Russians will be unable or unwilling to move their assets into friendly jurisdictions quickly enough.

For the Russians, the temptation may be to try and sell USD assets in order to disrupt US asset markets, but the leverage may be temporary. Their reserves are almost USD470bn but they have been actively diversifying away from USD for years. Relative to the size of any market they might be tempted to disrupt, the USD holdings are small. Moreover the sense that the price was being driven down by politically-motivated selling would likely attract buyers on the view that the effects would be limited. Were they do convince other countries to join them, the impact would be more longer lasting and more disruptive, but it is a little bit like letting your own home run down because it will lower the property value of a neighbor you dislike. The damage you do to yourself is more than you can expect to do to your neighbor.

The Russian holdings of USD are probably enough to give the USD a big whack, were they to go into the market selling, especially as since there may be selling pressures already from other reserve managers, and given the trend-loving nature of currency investors. Once you get past hurt feelings, it is not clear that USD weakness would be a US economic or financial market negative. A strong dollar is hardly a US policy priority, to the extent that USD weakness would crowd in both exports and imported inflation, it would probably be viewed as going in the direction preferred by Fed policymakers. Were it not for the unfriendly motivation, it is unlikely that US policymakers would object.

Long-term implications

If the use of financial market warfare intensifies, the risks are:

1) More home bias in investing,

2) Official investors gravitating to jurisdictions and custody arrangements that insulate their assets from seizure

3) Premium on gold, physical commodities and other unattachable assets

This would unwind many years of international capital market liberalization. Moreover, it would have the greatest impact in discouraging long-term, illiquid investments, as these would be most vulnerable to seizure. It is much easier to cut positions in short term liquid assets if there is trouble brewing.

External deficit EM economies would probably suffer the most since creditors would see an extra force majeure risk premium added. Apolitical safe havens would probably benefit the most. Where there is an interaction with the traditional currency war discussion is that the damage to EM borrowers would probably be greater than to G10 borrowers. When EM countries depreciate, they often get hit by higher bond yields as well. G10 countries, even when they depreciate sharply, often do not face big pressures on their bond markets. Moreover, higher food prices from depreciation are not nearly the same social issue in G10 that they are in EM.

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