The First Financial War

One of the early, memorable experiences I had of how international economic policy is made came in the late 1990’s when Stanley Fischer, then the second in command at the IMF, came to the Economics Dept. (Princeton) to give a seminar on the manner with which the IMF disbursed money to Russia in the aftermath of the 1998 emerging markets crisis. I, doubtless like colleagues, was surprised that much of the funding to Russia was granted without collateral or what later (i.e. euro crisis) became known as conditionality.

Being the most junior and easily least clever person in that room, I dared not pitch a question to Stanley Fischer, but I still wonder how Russia may have developed differently had the IMF financing been structured differently (at the time it was widely suspected that some of the money found its way to oligarchs and politically active former KGB agents!).

Over twenty years on, some things have not changed. The IMF is still a discredited institution (Joe Stiglitz’ attack on the IMF ‘Globalization and its Discontents’ was published in 2002), and the Russian economy is still fragile, under-developed and riven by corruption. Russia still has the same president it had in 1999, and still has many, many nuclear weapons.

What is new is that from next week, the financial penalties and sanctions enacted on Russia and key Russians will begin to take effect, shrinking the Russian economy by close to 40%, financially freezing Russia and potentially setting in motion socio-political unrest and sadly, an escalation in Russia’s military tactics. As an experiment in financial combat this is unprecedented and will effectively ‘anti-globalise’ Russia (cut off the flow of people, goods, finance).

Here, the lesson of the conflict so far is that whilst many of us expected Russia to focus on unconventional/hybrid warfare, they have concentrated on ‘old fashioned combat’ where as the West has excelled in information warfare (in calling out the detail of Russian moves before they happened) and now in prosecuting a campaign to cut Russia off economically.

In that respect Russia may be glad that it is not a highly globalized country (that might be the fault of the IMF in 199!) but it is a good example that the currency of a country, in the long run, is a decent barometer of its institutional strength. Around 1870, the dollar and rouble traded close to parity, and from then to the Russian Revolution the Russian stock market outperformed the American market by a factor of two. Today, Russia is uninvestable.

The short-term effects of Russia’s financial freeze will manifest themselves next week. There are several elements to keep a focus on – how Russia will stabilize its currency (it may peg it to gold, or to a group of Asian currencies), the decimation of pensions, the political effects of a likely bank run, the operational effect on the economy of so many businesses either closing or being deprived of large chunks of their revenue base, not to mention the cost of the invasion of Ukraine.

Add to that a global financial system that is increasingly strained (funding stress is mounting), and undercut by high energy prices, my sense is that next week the focus may be more on markets than military. The key for that stress to lift a little, will be public proclamation by a number of Fed and ECB officials that the war risks a recession, and that therefore market liquidity needs to remain ample.

The longer-term effects will be more interesting. The response of the corporate world to the Russian invasion has in general been commendable in the sense that so many companies have cut ties with Russia.

In the near future, it is very difficult to see many governments and corporates trusting Russia again and this will entail a permanent hit to its economy, of something in the region of 20%. China and select other countries may try to make some of this up eventually and Chinese investors may try to buy cheap Russian assets, but strategically this will not sit well with the Kremlin.

There is also a growing debate that the West’s cutting of ties to Russia will usher in a race for the ‘next reserve currency’. I recall being in Moscow some years ago and overhearing a story where someone asked Vladimir Putin if ‘Russia is leaving the dollar’ and he allegedly answered ‘no, the dollar is leaving us’. He was right, but is on the wrong side of the trade.

In that context, the assumption is that the Chinese renminbi, currently 2-3% of international transactions, will pick up ‘fx market’ share. I am not so sure – the lesson for China from the Ukraine invasion is that it may want to be less financially connected to the developed world, a strategy that might heavily restrict the international usage of the renminbi.

The other assumption is that crypto currencies enjoy greater usage, and to an extent there has been a pick-up in trading in crypto currencies (though not much of it in Russia). A number of crypto exchanges, underlining their independence from the centralized financial world, have refused to cut ties to Russians. In my view, this will invite regulators to police crypto exchanges and investors will discount the value of companies such as Coinbase.

To stand back a little, the invasion of Ukraine remains brutally underway this weekend. It has (correctly in my view) led to an economic war, from which it is very hard to see Russia escaping financial catastrophe. And, this time, they won’t even have the IMF on hand to help.

Have a great week ahead,


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