For over a year, the US has been threatening Russia with the sanctions bill "from hell”, but as the West’s bungled response to Russian president Vladimir Putin’s aggression towards Ukraine has shown, the capital markets, like any weapon, cannot be wielded without repercussions.
The catch 22 situation in which the West — and Europe in particular — finds itself is this: it cannot allow Putin to ride roughshod over Ukraine’s sovereignty, but is fearful of poking the bear that guards Europe’s fuel supplies.
Russia must be stopped and punished, but not too much, for fear of retaliation.
Cutting Russia off from SWIFT, the international payments system, was the centrepiece of the original set of sanctions that were proposed and widely discussed. But this month, Germany seemed to rule that out, for fear of gas shortages.
Capital markets sanctions are a useful weapon. They entail no direct bloodshed. But like any other act of aggression, they come with consequences.
They also lose their effectiveness the more they are used.
When the first round of this kind of sanctions was levelled at Russia for the annexation of Crimea in 2014 and 2015, there was shock in the bond markets and in Russia. But since then, Russia has used the intervening time to come up with a plan B for its financial systems. It has pivoted towards China for trade and financing, cut its dollar debt, built its reserves. It is no longer as reliant on the international capital markets. It is, as one analyst calls it, a “fortress”.
This financial resilience in the face of further sanctions is clearly reflected in the trading of Russian bonds, wider over the last few weeks, but mostly bid well above par. There was even a small dead cat bounce on Tuesday, even as newspapers ran headlines suggesting that Putin was contemplating a full invasion, including an attempt to put boots on the ground in Kiev, not just the regions bordering Russia.
In the meantime, what has the West done to lessen its dependence on Russian gas supplies?
A war played out in the financial markets is preferable to one on the ground, if one must be fought at all.
But, as with a military conflict, for it to be effective the countries involved must have the appetite for it and be willing and prepared to withstand the consequences. Russia seems to have understood this better than the West.