April 28, 2014
I am the former Co-CEO of KP Media, a leading Publisher in Ukraine. In addition to being the leading news organization in Ukraine (Korrespondent, Kyiv Post), we also owned the largest online business, Bigmir.net. I’m now back in the US, consulting and speaking in the areas of Digital Marketing and Digital innovation. You can find my website at DigitalToronto.com and follow me on Twitter @DigitalTonto.
The author is a Forbes contributor. The opinions expressed are those of the writer.
The US Treasury Department announced further sanctions today on seven Russian officials and 17 Russian companies, including Igor Sechin, the head of Rosneft, Russia’s largest oil company, several financial institutions and a number of firms connected to the energy sector. These will include visa bans, asset freezes and further restrictions on trade.
When the first round of sanctions were imposed, the Russians largely laughed them off and critics of the administration pounced. How could visa bans and asset freezes affect the calculus of Putin’s most ardent supporters? What effect will it have on the ones don’t travel extensively the West or keep assets in foreign banks?
Yet this line of reasoning betrays a deep misunderstanding about the purpose and effects of the sanctions. They are, in fact, a new breed of financial warfare that the Treasury department has been honing since 9/11, which rely on new legislation such as Section 311 of the Patriot Act and “know your customer” banking rules.
Originally, these rules were designed to lock terrorists out of the global financial system. As Juan Zarate, one of architects of the new techniques, explains in his book Treasury’s War:
The point was not necessarily to freeze assets in US banks–though that was a benefit–but instead to use the designations to make it harder for individuals who were financing terrorists to access the formal financial system. Our analyses therefore focused on the networks of actors and institutions providing the financial backbone to the terrorist enterprises.
Before long, the new techniques were expanded beyond counterterrorism and deployed against nation states, such as North Korea and Iran, to great effect. When coordinated with allies these are even more effective, but are powerful even if pursued unilaterally.
That doesn’t mean that the sanctions will deter Putin–like any lunatic out on a ledge, the decision to jump is his alone–but his actions will incur ever increasing costs that will undermine his already weak regime.
To understand how the sanctions work, let’s look at the case of Vladimir Yakunin, Putin’s close friend and the head of Russian Railways. He told the Financial Times, “I did not intend to travel to the US. I have no assets. So it does not bother me at all.” Even if we assume he’s telling the truth about his assets (which is doubtful), the sanctions still hit hard.
While asset freezes and visa bans are somewhat of a nuisance–Yakunin’s children live abroad–the real strength of the sanctions lie in the fact that they are designations. In effect, they are the financial equivalent of leprosy, discouraging financial institutions from touching the targeted entity in any way.
What many people don’t realize is just how pervasive the US financial system is. If, for example, Mr. Yakunin wanted to buy a nice vacation house in Dubai. He’d have to pay for it somehow. Yet to transfer the money, he would need to use a bank and that’s where things get difficult. Every financial institution needs a correspondent banking relationship with a US entity in order to do business.
The penalties for defying US Treasury designations can be quite severe–HSBC was fined $1.9 billion–and if the offending bank wants to continue to do business in the US, it complies. In effect, once you are designated, you are cut off from the international financial system.
Further, the sanctions apply not only people like Yakunin, but also entities they control. In his case, Bank Rossiya was also designated. So it can no longer do business with any bank that deals in dollars either. In fact, they can’t deal with any entity that does business in the US, which is why Visa and MasterCard cut off service.
The new sanctions tighten the noose even further because companies in the financial and energy sectors are now being targeted aggressively. That means that their ability to do business internationally will be greatly curtailed. The EU will be announcing their own sanctions later today, magnifying the impact.
And it doesn’t stop there. Because the sanctions are designed to be incremental, nobody knows for sure who will show up on the list next. So the entire Russian economy is effectively being isolated in a much more effective way than it would be under a traditional sanctions regime. It is not specific activity that is being proscribed, but financial relationships themselves.
The effects are already being felt. Russian corporations can’t roll over their loans and have had to cancel IPO’s. The Russian government has had to call off all but two bond auctions since the beginning of the crisis. This adds to capital flight, puts pressure on the Ruble and creates inflation. At the same time, it limits investment in the country and lowers income.
Recognizing the serious peril the Russian economy finds itself in, Standard & Poor’s recently downgraded Russia to one level above junk status, which will lead to further capital outflows as bond funds reallocate their portfolio’s to manage risk. And the crises is still young, things will only go downhill from here for Putin’s regime.
While it’s true that the nationalist fervor in the wake of the Ukraine crisis have increased Vladimir Putin’s approval ratings, it is doubtful that will last. The May holidays–a big deal in Russia–are coming up and many Russians will have to alter their travel plans. Others will find that their credit cards don’t work. Foreign adventures become decidedly less attractive when they inhibit the ability to enjoy your life.
When Russians arrive back home, they will find things only getting worse. The Russian economy is expected to fall into recession this quarter and Putin’s continued adventures will only get more expensive. Before long, imported goods will become scarce and social payments will need to be cut. Russians will begin to remember what the Soviet Union was really like.
In the years to come, decreased gas exports to Europe and a softening market for oil could cost the Russian economy as much as $100 billion annually–roughly 5% of GDP. Putin promised a new stronger Russia, respected throughout the world. Now he is delivering an impoverished pariah state.
Perhaps most importantly, it’s hard to see how Putin will prevail. Ukraine is a big place and occupying it would take hundreds of thousands of troops–something Russia can’t afford financially or militarily.
There is, in fact, very little he can do besides make threatening noises while Obama’s sanctions erode the Russian economy.
And that means trouble. Running an aggressive, authoritarian state takes money. You need a hefty military budget, a large internal security service, lots of money sloshing around to buy the loyalty of officials and extensive social benefits to keep the populace docile. Even a brutal, corrupt ruler needs internal support.
The truth is that Putin is a KGB operative to the core and, as David Paul recently pointed out in an excellent article in the Huffington Post, the KGB has been losing since the 1970’s. He has rather sloppily blundered into the same mistakes his predecessors made in Afghanistan decades ago.
As strange as it may seem, Vladimir Putin, the bare-chested, horse riding tiger hunter, is about to be taken down by a bunch of accountants.
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