Macro and Markets

The rules for implementing new EU sanctions against Russia have been released (see also here and here).  On quick glance, they are, as advertised, an important step that will have systemic effects in financial, energy and defense markets. In this respect, they are "sectoral" or "level three" sanctions in the language of policymakers.  While narrow in scope-- the financial ban (Article V) is on new transferable securities of majority state-owned Russian banks with maturities greater than 90 days--one is left with the impression that Europe, like the United States, stands ready to extend the sanctions if there is evasion or further Russian efforts to destabilize Ukraine.    

The Europeans look set to surprise us with significant economic sanctions against Russia (see here and here) that exceed in some respects U.S. measures. The United States likely would expand their sanctions in parallel. I yesterday published an op-ed on what we should make of the moves, and assuming reports of an agreement are true, I think it is worth highlighting four takeaways from that piece and recent developments: 1. These are meaningful measures, with long-term adverse consequences for the Russian economy, but not full sectoral sanctions. Europe, having earlier extended sanctions to 33 individuals and entities, is considering prohibiting European institutions from participating in new debt or equity of majority Russian state banks (similar to U.S. measures earlier this month, but in principle including more and larger banks such as Sberbank); sale of critical energy equipment and technology; and an arms embargo including dual use technology. These restrictions apply to transactions going forward, so existing contracts, such as the French warship sale, would be exempted. (Why can’t Australia, Japan or some other power buy the French ships so they don’t go to Russia?) It is not a comprehensive ban on financial transactions, including the payments system, and so not the “Lehman moment” I have suggested could be the most powerful use of sanctions. But it is sufficiently broad to have systemic effects—thus effectively “level three” sanctions in policy-speak. 2. All of this suggests a substantial, longer-term cost to the Russian economy (and to its trade and financial partners in the west), a threat I don’t think is recognized in recent official or most private forecasts. Wolfgang Munchau has also made this point (and thanks for the shout out). 3. There would appear to be inexorable momentum for further sanctions: (1) Europe now is less of a constraint on further U.S. action; (2) Ukraine is achieving success on the battlefield, and without intensified Russian involvement would likely see further gains. If recent evidence of Russian shelling across the border is any indication, Russia has intensified its support in response to developments on the ground, which is justification for further sanctions; and (3) sanctions are likely to be extended over time in response to evasion. This last point is often unappreciated. As with capital controls, prohibitions on financial transactions create incentives to innovate to evade the control. In some cases, that can be a helpful escape value, but in this case, where the West desires to impose a credible cost on Russia for its continued destabilization of Ukraine, controls need to be extended. If the restrictions on new debt, for example, are evaded in size by using non-sanctioned companies or alternative markets (such as foreign exchange swap markets), I’d expect the types of transactions and/or sanctioned institutions to be extended to close off those flows. This may be only the early innings of the sanctions game. 4. There remains a tension between economic and political timelines. I heard commenters this morning say that it could take a month to see if sanctions would work. I suspect that it could take longer still. The current approach—emphasizing incremental moves and the threat of more to come, works primarily not through an abrupt break in financial market channels but rather through a slow squeeze on trade and finance. Firms hold back on investment, unwind trade and financial relationships, for concern about the future legal and economic risks as much as current bans. As debt comes due, the financial pressure on Russian companies intensifies. Thus the cost of sanctions for the Russian economy is best measured through capital flight, reduced investment, and recession. Yet political pressures point toward the need for more immediate evidence of success. From this perspective, the debate over the pace and intensity of sanctions is far from over.  

America’s woeful lack of infrastructure spending is well appreciated.  What is missing is action to address it.  My colleague Heidi Crebo-Rediker writes that the Administration has now launched a new Transportation Investment Center to share best practice, provide technical assistance, and give support for accessing credit programs for new infrastructure projects. This one-stop shop within the Department of Transportation has much in common with (and looks to draw heavily on) Heidi’s earlier proposal for an "Infrastructure USA" initiative.  While no silver bullet, it’s a valuable first step.