My first book was about economic sanctions. Back when I wrote it, sanctions were seen as kind of a backwater in international relations scholarship. Now, with Ukraine and Iran and the South China Sea and East China Sea and such, things have clearly changed. But as the European Union debates what to do about Russia, it’s worth remembering that in this century, the most powerful effect of sanctions isn’t what the federal government or the European Commission actually impose in terms of sanctions. It’s how the private sector reacts to geopolitical instability — and the answer appears to be that markets don’t like it.
Let’s start with Russia. There’s this report from Reuters:
Russia”s economy is stagnating as data showed on Wednesday that capital worth $75 billion has left the country so far this year following sanctions on Moscow over its involvement in Ukraine.
“We have for now a period of stagnation, or a pause in growth,” Deputy Economy Minister Andrei Klepach was quoted as saying in an interview where he also said that GDP was flat from April to June after shrinking 0.5 percent in the first quarter.
Klepach, speaking to Interfax news agency, noted that the second-quarter figure of zero growth over the three months, previously unpublished, indicated that Russia had avoided a “technical recession” – two successive quarters of GDP decline.
But central bank data on capital flight showed investors are concerned about the state of the $2 trillion a year economy. Though the outflow slowed in the second quarter, the $75 billion that left in the six months to June already surpassed the $62.7 billion capital flight seen for the whole of last year.
And this, as Bloomberg reports:
Foreign direct investment flows to Russia will fall to half of last year’s level in 2014 as the conflict with Ukraine prompts companies to delay expansion, the Vienna Institute for International Economic Studies said.
Russian FDI will fall to 30 billion euros ($41 billion) from 59.7 billion euros last year, the steepest decline in eastern Europe, the institute, also known as WIIW, said in an e-mailed report. Inflows to the 23 east European countries WIIW tracks will decline to 72.9 billion euros from last year’s 97.3 billion euros, the institute forecast.
Russia’s wealthiest have lost billions of dollars since the beginning of the year, as Western sanctions against the country over its involvement in Ukraine continue tightening their grip over the weak economy.
Russia’s 19 billionaires have lost $14.5 billion since January, data from the Bloomberg Billionaires Index shows.
Does all of this mean that Putin will acquiesce on Ukraine and cut off material support to his proxies in the Donbas? No, but it shows the long-term flaw in Putin’s Ukraine strategy. His goal is to keep Ukraine destabilized in the hopes of a more pliant regime. All he has succeeded in doing, however, is to rally most Ukrainians around the idea of creating a a real state as opposed to the 20-year facade that previously existed. Just as important, this strategy will also destabilize Russia’s economy. As Bloomberg reports:
The price to protect Russian bonds against default, already the highest among the world’s four largest emerging markets, has surged since the July 17 tragedy in eastern Ukraine. The Micex Index resumed its decline, putting the losses since Putin began his push into Crimea in late February at 4.2 percent through yesterday and wiping out about $28 billion in market value, even as stock gauges from the U.S. to India jumped to all-time highs.
Russia’s market slump is exacerbating an economic slowdown, the opposite effect of the wealth generation from stock rallies that are helping underpin growth across the globe. Russian Deputy Economy Minister Andrey Klepach said this month the $2 trillion economy posted zero growth in the second quarter when compared with the first. That follows a 0.5 percent contraction in the January-to-March period.
“The market is sending a signal that Russia should avoid becoming an outcast and avoid shutting itself out of global markets,” Aleksei Belkin, who helps manage about $4 billion as chief investment officer at Kapital Asset Management LLC in Moscow, said by e-mail yesterday. Putin “believes that what he is doing is justified and he is very much aware that he is not facing a united opposition in Ukraine. But it’s getting costlier with every month.”
Sure, Putin is riding high in the polls now, but rally-round-the-flag effects fade over time unless there is a victory on the ground — and in the post-MH17 environment, it’s very hard to see how Russia can bolster its proxies without triggering an even more negative market and political reaction.
Japanese investment into China dropped by nearly half in the first six month of 2014, according to a new report by China’s Ministry of Commerce. As recently a 2012, Japanese investment posted growth of 16.3 percent, reaching $7.28 billion. The decline actually started last year, with a 4.3 percent drop.
Zhang Jifeng, director of the Japanese economy department in the Chinese Academy of Social Sciences, told the China Daily that Japan’s entrepreneurs are “waiting and watching.” He added: ”They’re profoundly aware of the connection between the political climate and their commercial performance [in China]. They don’t want to put their assets at risk.”
Now this dropoff is certainly not going bring China to its knees. But bear in mind that China’s economy is likely smaller and weaker than official statistics suggest. So Beijing will feel this kind of effect a bit more than officials let on.
One supreme irony of this is that as geopolitical tensions simmer in eastern Europe and the Pacific Rim, capital movements are creating a windfall… for the United States and western Europe. The Wall Street Journal reports:
In a world in turmoil, investors are hungry for super safe assets like U.S. Treasury bonds. Spanish and Italian debt were favorites earlier this year, but in the past month, as tensions mounted in the Middle East and Ukraine, investors flocked back to Treasurys, stodgy Germany bunds and British gilts, over risky rivals.
Just to be clear, I’m not saying that these market responses will induce Russia and China to moderate their foreign policy behavior. I am saying, however, that the economic costs to their foreign policy are becoming clearer by the day, and that over time, these costs will weigh more heavily in their foreign policy calculations. Going forward, it’s becoming clear that as Russia and China try to change the geopolitical facts on the ground, they will reap the geoeconomic whirlwind.