Russians Know U.S. Sanction Threats Are a Joke

As Russia President VladimirPutin consolidates his military hold on the Crimean Peninsula, President Obama signedan executiveorder suspending certain Russian visas and allowing the TreasuryDepartment to impose financial sanctions on individuals and entities for “misappropriating state assets of Ukraine.” 

Both Houses of Congress are also drafting financial, trade, and other sanctions against Russia. This follows thespeech by U.S. Secretary of State John Kerry March 2 that the Group of Eight (G8) and a number of countries are “preparedto go to the hilt to isolate Russia.”  But given that retaliationfrom the Russians would cause more pain to American businesses and might freezeEuropeans to death, the Russians know U.S. sanction threats are a joke.    

Only 2% of Russianexports went to the U.S. in 2013, including $19.3 billion in petroleum and $1billion in nuclear power plant fuel. DespiteRussia’s protectionist policies against imports that would compete with localindustries, the U.S. enjoys a substantial trade surplus with Russia. About 4.9% of Russian imports come from theU.S., including civilian aircraft, autos, chemicals, and meat and otheragricultural products. Russia is lessthan 1% of U.S. export volume and the U.S. is less than 4% of Russian export volume. Everything in the bilateral traderelationship can be sourced from other nations. 

Russia does notleave much of its wealth in American hands, because Russian banks and financialinstitutions have relatively little exposure to the U.S. banks. At the end of 2013, Russia had $750 billion indeposits in Russian banks and only $20.2 billion deposited in in U.S. banks. U.S. investors do hold $56 billion of Russianstocks (6% of $870 billion total market capitalization), but there already was substantialselling of these shares since February 28th, when the Russianmarket fell by 11% in a single day.  

TheU.S. government could force American mutual fund and individual investors toimmediately divest of Russian stocks, but this would cause big losses for Americansforced into distress selling. Any marketdrop would be temporary since most private and state-owned Russian companies listingon foreign stock exchanges tended to register on the London Exchange or the FrankfurtExchange. 

The Russian rublecurrency has slumped during the Ukrainian crisis, but the U.S. Federal Reserve doesnot keep rubles as reserves they could dump. The CIA could solicit private Wall Street firms to drive the currencydown, but coordinated action would violate the U.S. SecuritiesExchange Act of 1934 and set a horrible precedent for insider trading. The Russian Central Bank has been spending $11billion a day to support the ruble, but they have very deep pockets with $658billion in foreign currency reserves.   

After 85 years ofprotectionist policies, Russia had begun signing joint-venture deals with foreignfirms. According to Stratfor Intelligencereport, the UK’s BP now holds a 20%stake in Russian state-owned Rosneft and the French company Total has a 14%interest in Novatek, the largest independent gas producer in Russia. 

U.S. based ExxonMobilesignedbillions of dollars of deals in the last two years, including a $2 billion joint venturewith Rosneft in Black Sea and a $15 billion liquefied natural gas facility at theSiberian port of Vladivostok. Rosneftalso owns with ExxonMobile 30% of a field in West Texas, 20 explorationconcessions in the Gulf of Mexico, and a 30% stake in the West Canada Basin. The projects are designed to demonstrate to Russiathe advantages of using American technology to explore and develop unconventionalshale and tar sands resources.  

Banning U.S.firms from joint ventures would cause contractual defaults and tie up the Americanproperties in litigation for many years. Russia would probably nationalize foreign assets, and U.S. exporters ofdrilling equipment and oil services would scream at Congress for destroying jobsin America. Furthermore, Europeans who relyon Russian energy for 30% of their needs run the risk of Russia cutting offsupply.   

Sanctions againstRussia would also sting Boeing, which invested $7 billion in Russia over thelast decade and has plans to invest another $18 billion over the next 7 yearsto gain a steady supply of titanium as a key to Boeing’s future competitiveness. Russia’s state-owned commercial airlinescurrently have 100 planes from Boeing, and the company was expecting significantfollow-on orders.    

The Duma, Russialegislature, is already drafting laws that would give President Putin the powerto retaliate against enactment of economic sanction by confiscating property,assets and accounts of U.S. companies. Russia could also shut-off natural gas flow toEurope, but this action would have to be short lived since their economy reliesalmost exclusively on foreign currency from energy sales. 

The ultimate revenge by Russia would be to withdraw from the Intermediate-Range Nuclear Forces Treaty, which limits the maximum rangeof U.S. and Russian missiles, or the Strategic Arms Reduction Treaty, which reducedthe total number of nuclear weapons in each nation’s arsenal. But such action would spark a wildly expensivearms race with America. 

Vladimir Putin and the Russians have managed to humiliate President Obamaand demonstrate to their former members of the Soviet Union that the U.S. and Europelack the military capability and the stamina to challenge the new Russia. Ibelieve that the Putin will seek a settlement to the crisis from the positionof strength he now holds. The Russians know U.S. economic sanction threatsare a joke.    

The author welcomes feedback @ chriss@chrissstreetandcompany.com.

Chriss Street is teaching microeconomic at University of California, Irvinethis spring from March 31 – June 8, 2014. Call Student Services at (949) 824-5414 or visit http://unex.uci.edu/courses toenroll!