The Economic War on Russia

Over the past few weeks, there is one story that trumps all in the world, and that’s the Russian war against Ukraine. Like all of you, I have been bombarded with stories from mainstream sources on TV and print, as well as the legion of armchair geopolitical experts on social media. Despite the firehose of everchanging information, it seems there is no shortage of opinions on what we (the US, NATO, etc) should do next. Ban Russian oil? No fly-zone over Ukraine? Join the war against Russia? Additional sanctions?

I’m not going to tell you what I think we should do about those issues. They are more complicated than they seem on the surface (shocker, I know) and there’s generally little room for personal feelings in investing anyway. What I CAN talk about is what has already happened in Russia, and how this may affect you and your portfolio going forward.

The Sanctions

Of course, we can’t talk about this without talking about the economic sanctions. There are many and they are devasting to Russia.

The most drastic may be the US, UK and EU bans on any transactions with the Central Bank of Russia (CBR). You’ve likely heard that Putin has been preparing for this invasion for several years now, building up a $630 billion war chest to allow it to get through whatever sanctions would inevitably be thrown its way. However, most (estimates of up to 2/3rds) of that money is held all over the world at various central banks or invested in securities. Halting transactions with the CBR essentially freezes those funds and makes them unusable to Russia. Another 20% of CBRs reserves are in gold. It’s likely they’d be able to use a portion of this, however there’s still the question of who would be willing to buy their gold and at what price.

Other popular sanctions include various Russian banks being disconnected from SWIFT, the global communication network that facilitates payments between banks in 200 countries. Germany cancelled the Nord Stream 2 gas pipeline which would’ve brought a huge amount of natural gas from Russia into Europe. Switzerland has frozen the assets of various Russian leaders. Japan is limiting transactions with the CBR and imposing sanctions on Belarus, as well as freezing various Russian leaders’ assets. The US, in addition to the CBR, barred transactions for all assets held in dollars for the Russian Direct Investment Fund, calling it a “slush fund” for Putin. They blocked exports of various technology blocks such as semiconductors, sensors, maritime tech, etc. The US cut off several state-owned corporations from being able to raise money in the US, and like several other countries put direct sanctions on Putin, and various other Russian leaders and oligarchs.

Private Company Response

This is a small sample of some government-imposed sanctions but includes none of the measures taken by various private companies.

The following companies have cut off some form, if not total operations in Russia:

KPMG, PWC, AMEX, VISA, Mastercard, Netflix, Disney, Tik Tok, Facebook, Google, Apple, Microsoft, Ford, GM, Mercedes-Benz, Toyota, Ikea, Nike, Airbnb, Boeing, Airbus, Shell, Exxon, BP, and the list truly goes on and on and is being added to daily.

In addition, insurers refuse cover to businesses exporting to Russia and shippers have backed away from Russian ports whether to export or import.

It’s unclear what effect these “private sanctions” will have in the immediate term. I’m sure being restricted from Snapchat won’t quite have the same effect as not being able to use your credit cards. In combination however, it seems it would make daily life much more difficult for the average Russian citizen. This should (maybe? hopefully?) create additional pressure on their government to stop the war.

Russian Financial Crisis

Russians are facing spiraling inflation, economic hardship, and a sharp squeeze on imported goods. Just last week, after some of the sanctions above were placed on Russia, the ruble (Russian currency) lost a 3^rd of its value in just one day. The Russian stock market also fell 33% in a day, and is now closed.

“The watch I wanted to buy now costs around 100,000 rubles, compared to 40,000 around a week ago,” he said, declining to give his surname.” (Reuters)

This quote is a small example of the immediate impact of these sanctions to regular Russian citizens. In addition, interest rates have more than doubled which squeezes all borrowers, including mortgage holders. There has been a run on local banks and atms in Russia, and a rush to spend those declining rubles immediately, with the anticipation that they will continue to lose value going forward.

JP Morgan predicts a 35% GDP contraction in the 2^nd quarter, and a 7% decline for all of 2022 (meaning there should be a bounce back in 3^rd or 4^th quarter). However, as these sanctions continue to mount, that bounce gets weaker and much of the damage will be permanent.

How this Affects You

The economic effects of the conflict are already being felt here of course. The stock market has seen a sharp increase in volatility. The same is true for markets around the world. But perhaps the most popular consequence are commodities prices. Russia and Ukraine are major exporters of several commodities including energy, but also soft commodities like wheat and corn.

As we’ve talked about in past WJ Blogs/Notes, inflation is an issue globally, and there is a lot of uncertainty around how long it will last and at what level. We’ve said before that we believe much of inflation is due to COVID related reasons and should regulate on its own. But there’s no doubt this conflict makes that worse. The most obvious place you’ll see this is at the pump. Gas prices nationally are over $4 a gallon, the highest since July of 2008.

Going back to the question of whether to stop buying Russian oil, it should certainly influence gas prices here, however it will be several times worse for European countries such as Germany (who get 34% of its oil and 53% of its coal from Russia).

Last point, despite the rising inflationary pressures, US interest rates have actually gone down the last several weeks, from around 2.05% to 1.76%. All of these factors should make for some interesting Federal Reserve decisions this year. The Fed would like to raise rates to help slow inflation, however they don’t want to be so aggressive as to slow the economy into recession. The Fed will have to factor in geopolitical risks, inflation, yield curve inversion, and stock market turmoil into its already difficult monetary decisions.