Russia to U.S.: Sanctions Would Crash Your Financial System

Source: http://www.flickr.com/photos/teegardin/

Source: http://www.flickr.com/photos/teegardin/

Over the past few months, the situation in Ukraine has devolved from political unrest to the brink of violent military action. Russian paramilitary military forces — men with guns in military uniform but without insignia — have entered and occupied the Ukrainian peninsula of Crimea and have forcibly, though so far nonviolently, taken over several government buildings and seized munitions from Ukrainian military stationed there.

Policymakers around the world have been quick to criticize Russia for the aggression, though they have been hesitant to offer any military support to Ukraine. Despite calls for strong-handed decisive action by America’s political right, President Barack Obama has so far only promised political action and has floated the idea of economic sanctions against Russia, a strategy that appears to have the support of policymakers in the European Union. Obama has also refused to attend preparatory meetings for the G8 summit scheduled to be held in Sochi, Russia, in June.

Between the geopolitical tension and the threat of economic sanctions against the world’s eighth-largest economy, international markets have been jittery. Oil is generally the first to react when tensions run high. Crude oil futures for April delivery spiked between the end of February and the beginning of March, climbing from about $102 per barrel to as high as $105 per barrel. The Monday following the news that Russian paramilitary forces occupied Crimea, U.S. equities experienced their largest one-day decline in a month, as risk premiums tend to rise during times of crises. Meanwhile, safer assets such as gold and Treasuries rallied.

Unsurprisingly, the Market Vectors Russia ETF (NYSE:RSX), which invests in Russian companies, has also been volatile. The ETF is down about 6.6 percent over the past month, falling dramatically over the weekend, when Russian paramilitary forces occupied Crimea.

The ETF has regained some of its value while the situation appears stable, but the threat of sanctions is clearly weighing heavily on the minds of investors. The ETF is down nearly 18 percent on the year. The Russian Micex index is of course down as well, falling as much as 11 percent in light of news that the U.S. and the EU may use economic sanctions against Russia. The rubel also sank to an all-time low against the dollar.

But Russian officials appear unfazed by the threats. In the event of sanctions, “We would find a way not just to reduce our dependency on the United States to zero but to emerge from those sanctions with great benefits for ourselves,” said Sergei Glazyev, a Kremlin aide, early on Tuesday. “An attempt to announce sanctions would end in a crash for the financial system of the United States, which would cause the end of the domination of the United States in the global financial system.”

The veracity of this position is dubious, but the uncertainty of the political situation has had an adverse affect on global markets. Russia is a major player, particularly in the energy market — as is Ukraine — and the so-called “Putin Effect” extends into all of Russia’s trading partners.

A possible conflict with Russia is the largest geopolitical crisis that U.S. financial markets have had to cope with in at least a decade, but if history is any lesson, the markets will emerge bruised but not broken. Economic sanctions against Russia are more likely to disrupt, not destroy, international markets, although the impact would likely be greater for the EU than for the U.S.

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