Fighting On The Financial Front

The Russia-Ukraine war may be the most sprawling, multi-front conflict in history. There’s brutal fighting on the ground, of course, and also in social media and in cyberspace. And a another new front has been opened in the financial sector, where an allied group of countries are throwing haymakers at Russia’s economy, with the goal of crippling Russia’s ability to sustain the conflict.

The current set of financial sanctions that have been brought to bear against Russia may be the most sophisticated and extensive in history. A group of countries that include the United States, the European Union, the United Kingdom and Canada have cut off Russian banks from SWIFT, a global financial messaging service. Even the historically ever-neutral Swiss have joined in the sanctions and frozen Russian assets. The U.S. also banned U.S. dollar transactions with the Russian central bank. The overall goal is to prevent the Russian central bank from accessing the reserves Vladimir Putin was expecting it would be able to tap to finance the conflict.

We’ve come to expect economic sanctions to take a while to work, but that hasn’t been the case here. The assembled sanctions caused an immediate drop in the value of the Russian ruble, as shown in the chart above that shows its value against the dollar. You don’t need to be a financial whiz kid to recognize that any data that shows the value of a nation’s currency tumbling off a cliff isn’t good news for that country. A ruble is now worth less than a penny. The sanctions also caused a run on the banks by everyday Russians who are afraid the purchasing power of their savings will vanish as the ruble crashes and inflation takes hold. And the sanctions also caused Russia’s central bank to raise interest rates and halt any trading on the Moscow stock exchange, which also aren’t positive signs for the Russian economy.

Financial sanctions can be effective against some countries, but not so much against others. Countries without advanced economies, or that are willing to become pariah states like North Korea, or that have secret benefactors that might help them skirt sanctions are better equipped to withstand the impact. Russia doesn’t really fit into any of those categories. In fact, the prompt and devastating impact of the sanctions is causing some people to wonder whether they might be too effective, and back Putin into a corner that might cause him to entertain doing the unthinkable and escalating the conflict to a nuclear stage. We’ll have to hope that other, rational forces in Russia prevent that.

Unfortunately, the sanctions will cause the most pain for the ordinary Russians, who had nothing to do with the decision to invade Ukraine–but one of the ultimate political goals in any war is to crush the resolve of the enemy population so it will sue for peace. That’s what the allied fighters on the financial front are hoping to achieve.

Better Late Than Never

Every once in a while you read a news story that really surprises you, because it addresses something that you would have bet had been resolved long ago. I had that reaction when I read about the Federal Reserve Board’s recent decision to ban ownership of individual stocks and restrict trading activity by senior Fed officials.

The Federal Reserve, as the nation’s central bank, often takes action that can affect the securities markets–whether it includes decisions about interest rates, tightening or loosening the money supply, or buying or selling bonds to try to ensure market liquidity or shore up the balance sheets of large financial institutions. Anyone who follows the financial markets knows that daily market movements, up and down, are often attributed to reactions to what the Federal Reserve has done, or said. You would be hard pressed to find any federal agency that has a more direct effect on the financial markets.

The Fed found itself caught in a controversy recently when the news media reported that certain Fed officials were buying and selling stocks while the Fed was taking aggressive action to respond to the financial fallout from the COVID-19 pandemic. Two Fed regional presidents resigned after their trading practices during the pandemic were disclosed.

Under the new rules, senior Fed officials will not be able to own individual stocks, bonds, agency securities, or derivative contracts and will be restricted to holding interests in mutual funds, which they will have to sold for a year. (Mutual funds are viewed as more diversified assets and therefore are less likely to be directly responsive to potential actions taken by the Fed.) And no trading of any kind will be permitted during times of “heightened financial market stress.”

Given all of the regulations that are imposed on every facet of American life, it’s surprising that the restrictions announced by the Fed didn’t exist already. The new rules should remove any temptation or concern about self-interested decisions, but it is also interesting that the rules are self-imposed. It might not be a bad idea for Congress to take a deeper look at the issue, and consider whether there is a need for laws to regulate the securities ownership and trading activities of Federal Reserve officials.

Greece Is The Word

If you’re somebody who has been saving for retirement and investing your savings in the financial markets, here’s a bit of friendly advice:  don’t check the markets today, or for that matter all of this week.  You’ll just be depressed.

The problem is Greece.  It defaulted on its repayment of loans from the International Monetary Fund last week, and yesterday its voters overwhelmingly rejected a referendum that would have imposed strict austerity measures.  Greece’s finance minister Yanis Varoufakis, who had opposed the austerity measures — he once said that “austerity is like trying to extract milk from a sick cow by whipping it” — then resigned with a flourish, saying that the referendum result would “stay in history as a unique moment when a small European nation rose up against debt-bondage.”

“Debt bondage”?  That’s a good one!  Try it on your bank the next time your mortgage or car payment comes due.

The problem for Greece is that there is no alternative to repaying its debts.  Greece is paying the piper for electing bad leaders who didn’t recognize the inevitable crash that was coming from constant borrowing to pay for a broken economic and pension system.  After defaulting on its IMF loan, Greece really has nowhere to turn for cash.  Who is going to loan money to an impoverished country where the citizens apparently don’t recognize their obligation to repay their debts?

All of this would be a valuable economic lesson in unsustainable borrowing if Greece were just going down the tubes by itself.  The problem is that Greece is part of the European Union, and its problems therefore are Eurozone problems.  Now European leaders need to figure out whether they have Greece exit the EU — not exactly a ringing endorsement of EU political and financial stability — or extend still more credit to the Greeks, which probably isn’t going to sit well with voters in Germany and other prudently managed EU countries who wonder why they are picking up the tab for Greece’s problems.

All of which loops back to affect those of us who have saved and invested.  Financial markets hate uncertainty, and the Greek crisis has now become uncertain to the nth degree.  Today we’ll be seeing news coverage of closed Greek banks, crowds in the streets trying to find cash, and frowning finance ministers going to meetings in ornate European buildings — not exactly scenes that speak of financial stability.  So even though the Greek problem has nothing to do with the U.S., in our global economic system our financial markets will be affected just the same.

It will be a wild ride until the Greek problem is finally resolved, and there really is only one solution:  Greece will need to leave the EU, issue its own currency, and witness the worst hyperinflation seen in Europe in decades.  After its economic system crashes and its elderly citizens see their savings eaten up by inflation, maybe the Greeks will recognize that some austerity and continuing “debt bondage” really wasn’t so bad.