VOLUME XIII, No. 2 - Current

THE EFFECTS OF SANCTIONS
ON THE GLOBAL ECONOMY HAVE NOT
BEEN THOUGHT THROUGH

October 6, 2022

Ray Kinsella

The humanitarian catastrophe unfolding across Ukraine has triggered a tsunami of EU sanctions on Russia, unleashing seismic disruptions across the global economy, currency arrangements, and the infrastructure of global financial payments systems.¹ It is orders of magnitude more damaging and intractable than the banking and the sovereign debt crisis of a decade and a half ago, and more disruptive of geopolitical stability than wars of intervention in the Middle East. Here is how the IMF sees it:

The economic consequences are already very serious. Energy and commodity prices […] have surged, adding to inflationary pressures from supply chain disruptions and the rebound from the COVID-19 pandemic. Price shocks will have an impact worldwide, especially on poor households for whom food and fuel are a higher proportion of expenses. Should the conflict escalate, the economic damage would be all the more devastating.²

The IMF continues, ‘The sanctions on Russia will also have a substantial impact on the global economy and financial markets, with significant spillovers to other countries’.³

There is little indication that the ‘spillover’ effects of escalating sanctions have been thought through by the EU and, even less so, by the US. In the rush to ‘punish Putin’, there has not been time. So the question remains unanswered, what will be the cost to the rest of the world, particularly trade-dependent, lowincome countries?

IMPLOSION OF POST-WAR ORDER

What is at issue here is not alone the humanitarian and political trauma triggered by Russia’s invasion of Ukraine after a six-year hiatus since Minsk I and II. Nor the impact of an increasingly embedded war on an already vulnerable global economy that is challenged by rising inflation and supply-side shocks. It is the fact that settled post-war assumptions regarding trade, the security of global payments, and trust in the dollar as a reserve currency suddenly look vulnerable. It is a (deeply) negative sum game. Everybody loses. Everybody.

When the global banking crisis rolled over Western economies from 2008–2010, governments and international organizations responded in an ad hoc, chaotic, and sometimes repressive manner in their efforts to dampen the spreading fires and re-establish a measure of stability. It did not work out well, especially for some countries, as supranational authorities scrambled to ‘fix’ problems they had not been anticipated with policy responses they had not thought through. Sound familiar?

The dangers are far more significant this time around, and the lack of preparedness is even more apparent. From the outset, there was no Plan B to address the unanticipated consequences of sanctions.

NO REBOOTING OF THE STATUS QUO

When peace comes—as it will—the most urgent economic priority will be international reforms in the governance of global currency arrangements, international trade, and the security of payments systems. Reforms are imperative to begin rebuilding trust in the economic values that shaped international economic governance at the Bretton Woods Conference at the end of the Second World War—the same values that underpinned European economic cooperation. They are now fractured under the unanticipated consequences of the tsunami of sanctions, together with existing embedded structural weaknesses.

War, once started, does that. The negotiating table is displaced by the battlefield, and the battlefield becomes mired in hidden, and not so hidden, agendas. Escalating military interventions and a fixation on sanctions are harbingers of chaos. They are the product of an unreflective mindset detached from an authentic understanding of Europe’s Christian and democratic origins.

Nowhere is this dichotomy more evident than in the widening division between the US which provides tens of billions of dollars in weaponry and military assistance for an open-ended continuation of the conflict, and more reflective and nuanced views in parts of Europe. The Italian Prime Minister Dr Mario Draghi has recently pointed out, ‘People think that—at least they want to think about—the possibility of bringing a ceasefire and starting again some credible negotiations … I think we have to think deeply about how to address this.’⁴

The EU centre does not think deeply. In her inaugural address, the new Hungarian President Katalin Novák synthesized what thinking deeply means, and demands, of Europe. That is, to unequivocally denounce war and to reach out and embrace the orphaned and the displaced. And to do so as an expression of a European solidarity that is informed by a distinctive national culture shaped by resistance to external oppression and which is at ease in celebrating the aesthetic of this culture affirmed in its Christian Democratic politics. President Novák reflected, in terms that bear citing:

As President, I have the responsibility to showcase what my homeland, Hungary and my compatriots, the Hungarians mean to me, and how I see the life we share and the place we occupy in the world. […] We attend to the wounded, send food to those who have stayed behind, offer the opportunity of education to children arriving in our country, provide families with a roof over their head, food, and work, and give encouragement and spiritual support to the discouraged. In addition, we also need to know what our response is to this war, what is in the best interest of our nation seen from the perspective of our past, present and the future we hope for.⁵

That is what the EU cannot comprehend from the centre in its pursuit of energy embargos that are unworkable, discard the national interests and welfare of member countries, and turn International Trade Theory 101 on its head.⁶ President Novák’s address exemplifies what thinking deeply entails for a Europe beset by a war that was foreseeable and, likely, preventable—and whose economic and political effects have been exacerbated by the dissonance in its response to unfolding events. Part of a return to peace building will require breaking free of the weaponization of trade and finance that are neither thought through nor rigorously modelled, notwithstanding that the EU Commission is knee-deep in the necessary data for doing precisely this.

Continued and escalating military destruction and a fixation on sanctions that are bringing chaos and crisis across the globe cannot be the answer. It is deeply concerning that there is no strategy of how to rebuild a stronger, less skewed system. Rebooting the status quo is delusional.

WEAPONIZING TRADE, CURRENCY, AND PAYMENTS

The dilemma is this. The ethical case for penalizing President Putin’s Russia for its invasion of Ukraine and its devastation is a given. The question is how far it is ethical to weaponize global trade, payments, and currency arrangements for this purpose, without considering the impact, not just on Russia and the EU, but on poorer, often emerging countries, and also on the principles underpinning global economic governance. Ad hoc and conditional assistance to such countries may help, but it is no substitute for a better system.

Financial Times journalist Martin Wolf recently warned that ‘a new world of currency disorder looms’.⁷ This will resonate with those who lived through the 1970s, when the stability of the Bretton Woods fixed exchange system, based on the convertibility of the US dollar into gold, collapsed. The consequences were massive instability and disruption for Western as well as emerging economies. What the West’s sanction regime has done, in an astonishingly short time, is to reverse the post-war reserve currency payments and trading systems.

Russia’s invasion of Ukraine has triggered round after round of unprecedented trade, transportation, and financial sanctions. This continues apace in Brussels and in Washington. These sanctions have impacted the Russian economy at every level, notwithstanding that the data point to a recovery in the rouble and to a restoration of the effective domestic monetary policy in stabilizing the economy, albeit with a significant loss of output. At the same time, sanctions are also affecting the EU economy and threaten significantly greater costs to households and serious, even permanent damage to businesses in the coming years. After three months, it is time to question the rationale for the EU sanctions regime.

The capital costs of re-building EU energy systems to eliminate dependence on Russian oil and LPG are, quite simply, enormous. The EU’s Green Energy policies are shredded. Quiet reflection and even common sense point to the uncomfortable reality that in punishing Russia, Western sanctions are doing great damage to the West itself and turning international trade theory on its head.

Many people believe that ‘it is a price worth paying’. Others wonder whether they can afford the price, and what it will all lead to—the stuff of nightmares. But at least as important is the fact that escalating sanctions have also ricocheted upwards and outwards. They have corroded trust in the reserve currency system, in the welfare gains from international trade, and in the security of global payments systems. The West is turning its back on seventy years of institution building aimed at putting in place resilient and trustworthy systems of economic engagement among nations. As the IMF points out, low-income countries are at the sharp end of this implosion.⁸

THE COSTS OF SUFFOCATING RUSSIA

Western sanctions aim to suffocate the Russian economy, to stymie its global trade relationships while cutting off access to Western financial institutions and capital markets. Over and above these sanctions, half of Russia’s external reserve assets—over $350 billion—have been seized by the West.⁹

This has never happened before. All countries hold such assets, largely in the form of ‘reserve currencies’. The stated intention is to reinforce further existing pressures on Russia from NATO’s long-standing military assistance to Ukraine and from its most recent response in the form of escalating military assistance into what is no longer a proxy war between NATO and Russia but a military confrontation that has no obvious firewall, even nuclear.

The immediate and narrower problem is that the burden—the economic costs— of ‘punishing Putin’ have not, and cannot be, contained in Russia. The spillover effects are already washing through every interface of a vastly complex and interconnected set of economic relationships that bind countries, and where realtime efficiency and, above all, trust is everything.

This requires reflecting upon. The dollar is by far the main global reserve currency. It plays a pivotal role in facilitating international trade and payments, operating through a network of Western banks and the global SWIFT payment system controlled by Western governments and banks, and from which Russia has been excluded.

In principle, all countries benefit from using a widely accepted reserve currency such as the dollar as ‘international money’ to price, invoice, and settle transactions. However, the US benefits most, since its national currency is used widely in financial and trade-related transactions. It means that the US Treasury can finesse the dollar exchange rate and thereby its international competitiveness. For an extended period, it can also fund its Balance of Payments deficit by issuing, in effect, national IOUs that are convertible into dollars and can be held by governments for payments and investment purposes.

Reserve currency status confers enormous benefits on national currencies. It gives countries economic as well as political leverage. It is efficient, but it is also an asymmetrical system, skewed towards the hegemons—the US, the EU, and China (and its renminbi)—whose currencies are used. Reforms might, as a first step, include an authentic international currency to be issued and managed as a global ‘public good’ rather than on national IOUs, as well as payment systems that cannot be weaponized for political purposes.

It pivots on trust. Sanctions by the US Treasury that effectively weaponize the dollar are not new. What is new and unprecedented is the scale, scope, and swiftness of the sanctions imposed by the US Treasury, supported by the EU, on Russia and any political, financial, and commercial entity with whom it engages in what was, just months ago, an ostensibly open global economy.

VULNERABILITY SUDDENLY APPARENT

Countries holding dollars as the core part of their external reserves have suddenly been made aware that their assets can be sequestered. They can find themselves cut off from access to these reserves held in what they formerly regarded as trusted global financial institutions and intended to manage external debt, as it falls due. Solvent and well-managed economies can even be forced into default. They observe that sanctions have now blocked two thirds of the Russian banking sector.

This has always meant that countries using reserve currencies and third party financial institutions have been vulnerable but have not thought about the risks. Suddenly, US sanctions have laid bare their vulnerability. The US Treasury has more power and global ‘reach’ than national central banks or even the IMF.

This now creates a powerful incentive for large countries to diversify out o f the dollar as a key strategic objective, bypassing the post-war multilateral arrangements and adopting bilateral, country-to-country trade settlements. Russia and India, for example, have recently adopted a rupee/rouble currency arrangement to facilitate mutually beneficial trade—circumventing Western sanctions in the process.

Large countries are now acutely sensitized to their vulnerability to external control and seizure, something they previously had no reason to anticipate. Smaller and emerging countries do not have options, and can be strong armed. Large, advanced countries with significant natural resources—notably the BRICS—can and do face down threats.

DESCENT INTO AUTARKY?

All of this represents an unprecedented burden on the post-war economic order—a pushback against trade liberalism and multilateral engagement built on trust. What we are looking at is a descent into autarky—and that is a very big deal.

The welfare costs of financial and trade ‘disintermediation’—the fragmentation of what has been so laboriously built up over decades—are enormous. Moreover, these welfare costs fall on all countries, especially smaller, often emerging countries and those far removed from the tragedy unfolding in Ukraine and a fully-fledged war between Russia and NATO.

The evils that have attended Russia’s invasion of Ukraine are unequivocal. The response in the form of unprecedented sanctions by Western powers has to date been driven, at least in part, by understandable, emotionally driven political considerations. They have proved the catalyst for enormous and unanticipated collateral damage that has perhaps been too little considered from the outset.

‘WAR IS NOT ALWAYS INEVITABLE. IT IS ALWAYS A DEFEAT FOR HUMANITY.’

The Russian invasion of Ukraine has demonstrated, once again, the human suffering and economic devastation triggered by war. St John Paul II best articulated the immorality of a resort to violence.

War is not always inevitable. It is always a defeat for humanity. International law, honest dialogue, solidarity between states, the noble exercise of diplomacy: these are methods worthy of individuals and nations in resolving their differences. I say this as I think of those who still place their trust in nuclear weapons.¹⁰

We are back to conversations that should have taken place. Had the West responded with more foresight to the political hiatus in post-Soviet Russia, our world would not be in this parlous position. Had Russia not invaded Ukraine … Had the EU and G7 invested a fraction of the political effort that is now going into suborning the global economic infrastructure by engaging with Russia’s concerns at being encircled by NATO … The root cause of this war lies in conversations that could, and should, have taken place. Sanctions are no substitute. Now the consequences resonate globally across a world that is bearing the burden.

CONCLUSIONS

The resort to weaponizing the multilateral trade and payment system has not been thought through. It is impelling larger countries towards autarky and our world towards the impoverishment of tens of millions of people globally. There is no Plan B in place. It is a hard message and an unpopular one, but history is insistent that re-building peace requires a willingness to reflect, to reach out beyond short-term aggression and punitive political pressures, to engage with the effects of our actions on the welfare and stability of the wider global community. Peace requires gritted teeth as well as grace.

1
1 European Commission, ‘Sanctions Adopted Following Russia’s Military Aggression against Ukraine’,
2022, https://ec.europa.eu/info/business-economy-euro/banking-and-finance/international-relations/
restrictive-measures-sanctions/sanctions-adopted-following-russias-military-aggression-against-ukraine_en. See also European Commission, ‘European Commission Calls for New Sanctions on
Russia’, (updated 4 May, 2022), www.dw.com/en/european-commission-calls-for-new-sanctions-on-russia/a-61680477.
2
2 International Monetary Fund, ‘IMF Staff Statement on the Economic Impact of War in Ukraine’,
Series Release 22/61, (5 March 2022), www.imf.org/en/News/Articles/2022/03/05/pr2261-imf-staff-statement-on-the-economic-impact-of-war-in-ukraine, accessed 10 March 2022.
3
3 International Monetary Fund, ‘IMF Staff Statement on the Economic Impact of War in Ukraine’.
4
4 Felicia Schwartz, ‘What Is America’s End-Game for the War in Ukraine?’, Financial Times (29
May 2022).
5
5 Katalin Novák, ‘Presidential Inauguration Speech’, 14 May 2022, www.sandorpalota.hu/en/
presidential-inaugural-speech?fbclid=IwAR3qwzIiVaiRbEfoR2PDGRfEmhkDfEtcAxdpMBZoT7
yQnpmGNSKjBtofIMI.
6
6 Sam Fleming, Andy Bounds, and Marton Dunai, ‘Viktor Orbán Refuses to Discuss Russia Oil
Embargo at EU Summit’, Financial Times (24 May 2022), www.ft.com/content/0c90617c-e3a7-
41be-94f4-0c5515ea7bb0.
7
7 Martin Wolf, ‘A New World of Currency Disorder Looms’, Financial Times (30 March 2022),
8
8 IMF, ‘IMF Staff Statement on the Economic Impact of War in Ukraine’.
9
9 Alan Rappeport, ‘U.S. Escalates Sanctions with a Freeze on Russian Central Bank Assets’, The New
York Times, (28 February 2022); Wolf, ‘A New World of Currency Disorder Looms’.
10
10 Pope John Paul II, ‘Address of His Holiness Pope John Paul II to the Diplomatic Corps’ (Libreria
Editrice Vaticana, 2003).

THE EFFECTS OF SANCTIONS
ON THE GLOBAL ECONOMY HAVE NOT
BEEN THOUGHT THROUGH

Ray Kinsella

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THE EFFECTS OF SANCTIONSON THE GLOBAL ECONOMY HAVE NOTBEEN THOUGHT THROUGH

Ray Kinsella

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THE EFFECTS OF SANCTIONS
ON THE GLOBAL ECONOMY HAVE NOT
BEEN THOUGHT THROUGH

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articles