The war in Ukraine began on 24 February 2022, when Russian forces — aided by Ukrainian separatists and militias — commenced a full-scale assault on Ukraine from the south (Crimea), the north (Belarus), and the east (Russia and Donbass).
The apparent goals were to encircle and subdue major Ukrainian cities (Kyiv, Kharkiv, Odessa, Mariupol), create a land bridge from Donbass to Crimea, replace the existing government with a kind of puppet government, and announce a ceasefire and treaty that would cement a new status quo that serves Russia’s interests.
That status quo is likely to include de facto Russian sovereignty over all Ukrainian territory east of the Dnieper River (either through annexation or the creation of subordinate regional authorities), and commitments from the newly reduced Ukraine not to join NATO or the EU and to maintain strict neutrality between Russia and Western Europe (on the model of Finland or Austria during the Cold War).
There’s no assurance that these goals will be accomplished. The outcome of the war is highly uncertain. Russia has advanced massive forces, surrounded major cities, and created supply chains to support those forces. Still, they haven’t yet shown the ability to actually capture and control these cities. It may take massive destruction and loss of life, including high civilian casualties, to do so. Russia has used these blunt force tactics before in Aleppo, Syria, and Grozny in the Caucasus.
Those cities were peripheral to US and EU interests and were not places the West was inclined to intervene in. Ukraine is different in that it is geographically the heart of Eastern Europe, and it forms a critical link in East-West natural gas supply chains that keep the lights on in Western Europe.
Kyiv has devoted considerable efforts to building financial and political links to Western elites. In particular, Ukraine has been a huge source of cash for democratic politicians and foundations, as illustrated by the millions of dollars paid to Hunter Biden as a way to cultivate influence with Joe Biden. These, and other factors, make Ukraine far from a walkover.
Biden raises the ante on sanctions
Western financial sanctions against Russia were swift and relatively strong. After announcing a weak set of sanctions on 24 February, Biden raised the ante by announcing much stronger sanctions on 27 February and in the following days. These sanctions ejected 10 major Russian banks (with about 80% of all Russian bank assets) from the SWIFT messaging system.
It’s important to understand that SWIFT (the Society for Worldwide Interbank Financial Telecommunications) is not a financial institution or a payments system. It’s a message system where major member banks can confirm financial transfers. The confirmations are irrevocable and legally binding, but the actual transfers don’t occur via SWIFT. Instead, they occur through other payment channels, such as the international CHIPS system and Fedwire.
So it’s still possible for Russian banks to complete transactions without SWIFT, although the process is slower and more cumbersome, and it may involve old-school message traffic using telex and telephone. The Biden administration also left payment channels open for dollar payments for oil and natural gas in order to not deprive Western Europe of badly needed energy supplies. In short, the SWIFT ban is meaningful, but there’s much less there than meets the eye.
A separate sanction, which is both impactful and unprecedented (at least, since the end of the Cold War), is a freeze on the assets of the Central Bank of Russia (CBR). The CBR had seen the confrontation coming and gradually divested itself of US treasury securities over the past year. Still, it has huge holdings of government bonds denominated in euros and Swiss francs, and it has about US$150 billion in physical gold (about 2,300 metric tonnes) that can’t be frozen.
The sanctions effectively freeze the bonds and cash equivalents in place. They aren’t confiscated, but they can’t be sold or transferred. Russian gold is safe in its physical form inside Russia, but if it needs to be converted to dollars or euros, those currency transactions will be blocked. In effect, the CBR is offline, except for internal transactions and some transactions with nations outside the Western sanctions, such as China. Other Western sanctions include prohibitions on the sale of certain high-tech equipment to Russia.
The Russian response
It didn’t take Russia long to respond. The CBR imposed capital controls that prevented foreign owners of Russian companies from selling those shares. The amounts covered by this ban are enormous, including minority interests of BP, ExxonMobil, and Shell in major energy development projects in Russia, especially in Siberia and Sakhalin Island.
The CBR also banned payments by Russian borrowers to Western creditors in both ruble (RUB) and hard currency denominated bonds. This is a default that may trigger cross-default clauses in other agreements and lead to a cascade of financial failure and a broader global liquidity crisis.
Something like this happened in 1998, in the Russian Long-Term Capital Management (LTCM) financial crisis. Russia defaulted on its bonds and currency on 17 August 1998. By 28 September 1998, markets were just hours away from a shutdown of every major stock and bond exchange in the world. Only the US$4 billion rescue of LTCM orchestrated by the Fed that day saved the world from collapse. We’re not there yet, but we may be headed down the same path.
Assessing the economic consequences of the war
The war news changes daily, and our purpose is not to give a dense chronology of causes, events, and prospects in this war. Readers have plenty of sources on the progress of the war and will form their own views on how it’s going. In Strategic Intelligence Australia, our purpose is to consider the economic consequences of the war, regardless of military success or failure by one side or the other.
These consequences will be with us long after the war is over, independent of whether Russia subdues Ukraine or not. In some ways, the damage has already been done. What remains is to understand the positions of Ukraine and Russia as commodity suppliers and key links in global supply chains, and to assess the impact on the global economy now that these links in the chain have been broken.
We’ll look at this topic through the specific areas of energy, agriculture, semiconductors, and strategic metals. Based on that analysis, we’ll have a strong foundation for determining which companies will benefit and which may suffer from the ongoing disruption. That will then inform our specific investment recommendations for the foreseeable future.
Unprecedented times bring unprecedented opportunities to profit and preserve wealth, despite the geopolitical turmoil. Highlighting those opportunities is our goal at Strategic Intelligence Australia.
All the best,
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Jim Rickards,
For The Daily Reckoning Australia Weekend
