Odd Lots - This Is What Sanctions Can Do to the Russian Economy

Episode Date: March 3, 2022

U.S. and E.U. countries have unveiled extraordinarily tough sanctions against Russia over its invasion of Ukraine. But what effect will they have? Are they tough enough? And will Russia feel a significant amount of pain as long as the sanctions don't include energy? On this episode, we speak with sanctions researcher Edoardo Saravalle about the existing sanctions, their power, what more can be done, and what history says about how they will work.See omnystudio.com/listener for privacy information.

Thanks for listening to Oddlots. Follow the show on Amazon Music for more future episodes or just ask Alexa, play the podcast, Odd Lots on Amazon Music. Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthal. And I'm Tracy Allaway. So Tracy, our last episode was, of course, with Zoltan POSAR and we talked quite a bit about the sanctions, the sort of the economic pressure that, uh, the U.S. and Europe are putting on Russia over the war. However, it really seems like there's a lot more to dive into with respect to the mechanics and power of the sanctions themselves. Oh my gosh. I'm getting flashbacks to doing international relations stuff at university. But yes, there is a lot to do and say when it comes to sanctions. And of course, the overarching question has always been, do they actually make much of a difference? And on the one hand,

hand, what we've seen in the past, I guess, week or so is that they can be very dramatic. And clearly, you know, in the space of a few days, the U.S. and its allies has basically created a financial crisis in Russia. But on the other hand, Russia is still invading Ukraine. And there's the question of what happens next now that you've ratcheted up this kind of financial pressure. Right. And there's the fact that even with the sanctions, Russia is getting tons of cash every single day, largely from Germany and other Central European players who are deeply reliant on Russian energy, in particular natural gas, but also coal, which of course raises the question of can European countries, can the U.S. impose effective sanctions that

accomplish something against Russia when at the same time, particularly Europe, is so dependent on Russian exports? Absolutely. I think having a big commodities exporter involved here obviously complicates everything, especially at a time when people are worried about inflation. But the other thing I will say, and I think I mentioned this on the episode with Zoltan, but the other interesting thing here is people have been reacting preemptively to the threat of sanctions. So sort of voluntarily self-sanctioning themselves. And in fact, on the day after the invasion officially began, we saw a lot of people in the market just step away from Russian assets altogether simply because they didn't

know what was and wasn't going to be impacted. And to some extent, that's continued today. So yes, we still have Europe, in particular, Germany importing a lot of energy, but we've seen some other players, you know, some commodities traders in Singapore, for instance, voluntarily step away from the market. Yeah, absolutely. And then there's another element, which is also sort of voluntary, which is just not necessarily fear of sanctions, but companies just deciding, you know what, we're going to wash our hands of anything to do with Russia. Too much paperwork. And yeah, it's pretty striking this sort of like domino or cascading effect of companies saying,

we just don't want to have any involvement. We want to completely walk away. You know, I don't think the Russian economy has boomed in recent years. So it's not as though, you know, perhaps this is not a huge source of revenue and profits for a lot of these companies. But it is really striking to see so many corporate interests abandoning the Russian economy right now, even apart from like formal sanctions-related activity. Absolutely. So many different threads to pull here. That's key. And as long as the U.S. and the rest of NATO does not want to get involved directly, militarily, for obvious reasons,

then, of course, sanctions and other related things become the primary means of putting pressure on Russia. So we have to dive into the sanctions and how they work and what they accomplish further. We're going to be speaking with a sanctions researcher. There's a lot of background in this area. We're going to be speaking to Eduardo Sarajevali. Eduardo, thank you so much for joining us. Thank you so much for having. So why don't we start off big picture? You know, what in your view are the key elements? There have been tons of announcements really over the last week. What are the key, most important things in your view that have been announced so far? I'd say there are a few of them. I think the big one to start is the action against the Russian

Central Bank. That was initially discussed as kind of a final escalatory move and the fact that it came so early in the escalation is a sign of how serious governments on both sides of the Atlantic were about sanctioning Russia. But I think the other big ones, the other biggest one I'd say are the banking sanctions, those are the ones that have the most immediate effect, and they have been quite aggressive. And there's still room for escalation there, but the Spurbank and VTB were the two biggest targets there. And they were the kind of most extreme type of, especially in the VTP side, the most extreme

type of sanction that the United States can impose. I'd say there are other ones that are very notable, but their effect is in kind of the overnight panic that we're seeing. So they're not the kind of EM-causing ones, but I think there's other notable steps which are remarkable in terms of how the United States thinks about sanctions. So, for example, things like

the United States is currently leading this global export control initiative, basically meant to cripple the arrival of inputs for Russian industry. Each country is doing them slightly differently, but it's kind of a remarkable thing because we tend to think of U.S. sanctions as primarily focused on financial

mechanisms, but here from the start, they've targeted kind of physical inputs and supply chains as well. So this actually brings me to the question that I wanted to ask you. And I think it's kind of a basic question, but one of those basic questions that probably has an extremely long answer. But how does sanctions policymaking actually happen? So, you know, someone sits in a room, presumably, there's a committee or something. And they look at the available suite of previous sanctions actions that they've done on regimes like Iran or Hong Kong or whatever and try to decide about what would be most effective or most applicable to the Russian situation.

How exactly does it work? Yeah, I think that's accurate description. The United States sanctions the kind of two offices that had the two agencies that handle sanctions are primarily the Treasury Department than the State Department. The Treasury Department, I'd say, is the more in the weeds, technical department. So you've probably heard in these days about OFAC, the Office of Foreign Asset Control, that is within the Treasury Department, whereas the State Department handles, A, it has sanctions it specifically handles. So, for example, the decision to sanction Nord Stream

the other day was actually taken by the State Department rather than Treasury Department, but that's kind of a quirk of U.S. sanctions, though. But I'd say it's a kind of trial and error and discovery process. So people are describing the sanctions these days as unprecedented. I I wouldn't say they're unprecedented in the sense that they have never done before. What's unprecedented is kind of the speed and impact and kind of how it goes together they've been and how much they've shaken the Russian economy. There are precedents for what the United States has done. So, for example, the central bank of Iran has previously been sanctioned.

So this isn't the first time a central bank is sanctioned. So there are, in that sense, there are, I would say there is kind of a sense of escalatory measures you can take. If you think of sanctions, the most traditional, kind of basic form of sanction is the individual, especially the so-called SDN sanctions, so it's against an individual. And so that basically means they don't have access to their assets. Their assets are frozen. So in a basic sense, your bank accounts are frozen and you probably can't come to the United States. And that's, for example, what they did against Putin the other day. That's kind of the most basic building block. And usually that's what you see. When you hear,

in the news, sanctions are being posed in response to a crisis, that's more likely than not what people are talking about, because they're pretty easy to impose, and they don't have massive macroeconomic effects. And then from there, you can kind of move up. You can put these so-called blocking sanctions where you block the assets on corporations, and that can have a significant effect. So, for example, that kind of depends on the target. So if you're sanctioning VTB, which is a major Russian bank, it'll clearly have a massive effect. If you're a lot of sanctioning. In the Iran case, they would often sanction small kind of satellite entities that were doing something in the nuclear program that doesn't necessarily have a macroeconomics

location. And then from there, you can kind of move on. And people, there is a lot of innovation in sanctions from program to programs. So, for example, the Russian sanctions that had been imposed in 2014 were an attempt to break out of the normal escalation ladder. So the sense there was these blocking sanctions were, would be too blunt and would have too much of a backlash. And the idea there, for example, is they impose sectoral sanctions. So rather than targeting an entire company, they just imposed limitations on what those companies could do. Americans couldn't buy certain forms of debt and equity from those companies or couldn't provide certain services. And so that's just a way you can refine it. But I would say more generally, there is a sense of

depending on the seriousness of the situation, you can kind of move up the ladder. And I'd say central bank and then the swift measure that has been in the news would be toward the upper end, at least in the financial sanctions side. So, you know, obviously there would perhaps there was some hope that sanctions or the threat of sanctions at least would have some sort of deterrent effect against this war. It hasn't happened. The war has happened. In general, it feels as though sanctions all.

often get placed and stay for a long time and often don't seem to, it's not obvious what the effect is. But what is the theory of what the sanctions are supposed to accomplish and how? So the basic theory, especially now that kind of the deterrent theory is off the table, is that sanctions are a bargaining tool. You impose certain costs and say, if you exceed to our demand, we will stop imposing these costs. The basic theory is pretty simple, but it gets very complicated, very fast. A, because the ask is not always clear, and I think, or the off-ramp is not always clear, so people will kind of make up new goals and new asks as they go.

So it's very hard, especially in kind of a live conflict, to know what you're asking for. So in the Russia case, now, one of the big challenges will be, what would we consider enough for us to impose the sanctions? And as of now, I truly don't know. I feel as if there isn't a unified transatlantic view on what would be enough for lifting the sanctions. And the other thing which is sometimes ignored is that you have to hold up your own end of the bargain. So say we said in order to lift sanctions, all you would need, Russia would need to return to the situation we had on January 1, 2020. Then the United States in Europe would need to actually deliver the relief from sanctions effectively and basically try to restore Russia's economy to 112.

And that is very challenging because sanctions, the United States issues these regulations, but then it's the businesses that decide how to react with them. So, for example, BP has decided to exit Russia. the United States can't necessarily make BP return to Russia if Russia complies. So it often can be very challenging. The private sector is hyper-challenging to do the carrot side of the sanctions, whereas the stick is very quick. Companies are much more responsive to the threat of U.S. punishment than they are to kind of requests by the United States to rekindle relations. during the Iran deal, when the Iran deal was passed, then Secretary of State Kerry would actually go around Europe and speak to banks and say, we've lifted the sanctions.

Please rekindle your business in Iran. And the banks kind of bulked at it for all sorts of reasons because it's very difficult to convince the other side that you're doing your best. And then they feel like they kind of got a raw deal because they complied and they didn't necessarily get all the benefits they were promised. So this is exactly what I wanted to ask you, because again, even before a lot of these sanctions were formally announced, we did see various companies, financial institutions, start to step away from the market. And, you know, suddenly you have Russian companies, you know, whether they're logistics

networks or commodities exporters, things like that, unable to get credit from their banks, even though technically nothing has happened yet. How much of that friction is, I guess, beneficial to sanctions actually being implemented and enforced versus how much of it is unhelpful in the sense that it sort of accidentally escalates the situation and may, as you just pointed out, be difficult to reverse if a deal was actually reached? I think it's very much a double-edged sword. It's definitely helpful because it's difficult to fully calibrate once actions. And in that sense, you can kind of maximize the shock and all in that sense. And in that sense,

it's a positive, I guess. I mean, it's nice to know that the United States doesn't necessarily, if everyone imposed the sanctions followed the exact letter of the law of sanctions, sanctions would be kind of an unwieldy measure because you would actually have to think through every single thing you're trying to block. So in that sense, it would be impossible to administer a program where you did that. There have been cases where companies are extremely forward-leaning in terms of interpreting things exactly, and that can be counterproductive. On the other hand, I think it's a big concern, the over-compliance concern, as you said, first of all, because things can very quickly spin out of control. I mean, in a sense, if there was all this kind of excitement about

how much was happening in Russia, and Russia kind of, I would say in this situation, made it warranted because it continued with its advance. But in a situation where Russia had paused and the bank runs had continued, you would have had a difficult situation. And I think it's very hard on the back end to credibly deliver the relief. So I think it's very difficult. I think the current situation is kind of a unique one, because at least for now, everyone is hoping that this confrontation will be fairly short.

People don't see this as necessarily an attrition, like multi-year Iran-type situation. So I think people are, there is a concern over compliance can be a good way to very quickly dial up and then dial down. But if you're trying to be more calibrated than negotiate, I think you would be concerned. So I think it's a huge problem. And it's always easy to welcome over compliance at the front and then forget that you'll have to deal it on the back. The news doesn't stop on the weekends. Context changes constantly. And now Bloomberg is the place to stay on top of it all.

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I'm Jessica Chen, and in season two of Leading By Example, we'll sit down with executives like Grace Chen of Bertie Gray to find out. It's important to understand where you spike, but also really acknowledge where you don't and find people who can fill those gaps. Listen to Leading By Example, executives making an impact on the eye-heartening, Radio app, Apple Podcast, or wherever you get your podcast. So at this point, because we've discussed, obviously, the deterrent element didn't work. And so in theory, you know, you continue to apply stress and continue to offer out the

chance of, okay, hopefully in theory, this gets reversed. If Russia reverses its actions, what about just the persistent damage? I mean, yes, Russia is going to continue to have, at least for now, cash coming in through the energy market. Could it be that the sanctions just impose such weakness that it has to backtrack in some way? Because the damage compounds to its economy, compounds to its banking system, and so forth. Could it be that the penalty, the sanctions weapon is so harsh that it essentially forces Russia is forced into some sort of reversal? It definitely could. I mean, I think that's the hope that it forces some sort of reversal.

And as far as everything that's happened up to now, I'd say, if you're trying to impose pain to force a reversal, you're getting what you wanted. And I mean, there's still more one could do, but it has been very successful. Sanctions, I feel it's kind of like people talk about kind of the economy in general. Bad things happen to economies all the time, but they don't just stop existing. They kind of adjust and muddle along. like Russia defaulted in 1998, but it kind of picked up the pieces. It was bad, and they keep going. So sometimes I think during sanctions, conversations, but in general, there's the sense that there's like a final blow you're going to deal or some moment, some point

of no return. I read recently some really interesting comparisons of the Russia sanctions to the Iran and the Venezuela sanctions. And in that sense, those are concerning precedents, Because in those cases, the countries kind of muddled along. So, for example, Iran lost access to 90% of its reserves, and it still kind of had to consolidate. There was the economy shrank. But it kind of muddled along. Energy became a smaller part of its economy. Manufacturing, mostly domestic focus, became a bigger one.

And it was able to kind of build some semblance of an economy that could work. In the Venezuela case, there were aggressive oil sanctions and really harmed the Venezuelan oil sector, but eventually the oil sector kind of came back. So in that sense, it's hard to imagine a situation where you kind of deal some final blow, in which case the country has no chance or no option but to negotiate. But at the same time, you can inflict a lot of pain. And at least in the Iran case, the country has been willing to negotiate together outside of sanctions. So in that sense, you can definitely use sanctions to get to a deal. I would just say that

the economic pain itself is not the only factor. It ultimately comes down to politics. So what are the kind of internal constituencies that are willing to bargain? And what can you, are you willing to accept what they have to offer? And can you give them what they want? So just on this note, you mentioned the idea of the U.S. actually targeting specific sectors while trying to, to leave others, you know, relatively untouched, such as energy or commodities. How does that change, I guess, the efficacy of sanctions and what kind of impact would you expect that to have on the Russian economy? Would that be something like what we saw in Iran, where energy starts to become, well, I guess in this case, energy would become an even more important factor in the economy,

or would you start to see Russia try to, I don't know, offset some of the impacts of the sanctions? First of all, it's true that the U.S. and Europe have stayed away from directly targeting energy, and they've tried to be pretty explicit about it. So, for example, in the United States case, they've added licenses, which are basically exceptions to sanctions saying certain transactions are allowed. And for example, within the Russian central bank sanctions within VTB and Spurbank, they've allowed energy transactions. But I think in terms of kind of the overcompliance and all that, I think it's very hard to say that the current sanctions aren't hitting energy. I think I was just seeing right before the show that Russian oil is trading at a discount, financial institutions, dealing with commodities, aren't as forthcoming with letters of credit.

And there was an announcement from shipping companies to that they might be peeing away from energy. So in that sense, I think there will be an effect directly. I mean, compared to Iran, Russia is about 30 or so percent of its government budget comes from energy, whereas in the Iran case, it was in the 60s. So the interesting thing about thinking about the reliance on energy is that I mentioned kind of the big ticket sanctions. But some of the other ones that have been imposed are meant to target long-term energy production. Some of these started actually in 2014. And the idea there in 2014 was exactly, that's not target energy right now because we wouldn't be able to withstand it. But let's make it so Russia has more trouble getting the technology it needs,

getting the funding it needs for its kind of frontier project. So in that sense, Russia might struggle with replacing its reserves. And in that sense, energy might decline as a part of its economy just because it's not able to put in the investment. In that context, the departure of its part of companies like Shell and Equino and BP might be potentially further loss of kind of human capital or expertise that could harm the energy prospects of the Russian economy over the medium to long term. So I want to talk a little bit more about that because the introduction you said, one of the things that you found. striking. It's like, okay, we all expect the financial sanctions, but this sort of export controls limiting Russia's access to factors of production, perhaps some intermediate stage goods that would really undermine Russian industry. What specifically has been announced in that respect?

What are the areas of sort of Russian economy, maybe be the energy or elsewhere, that will really be affected by some of these new limitations? There's some differences between the U.S. and the EU here. The United States said it's mostly focused on defense and aerospace. So it specifically it mentioned so far that it planned to kind of limit inputs like semiconductors and lasers and other parts to the defense and aerospace. The European band seems more focused on a broader variety of components targeting the energy sector as well. We've been coming at this very much from, I guess, the sort of external side, like from the perspective of the U.S. and Europe, but what can Russia actually do here to offset sanctions, impact? And of course, there's

been a lot of talk about what role China could play, if any, in all of this and the idea that maybe Russia can look to China for some type of credit. So what sort of response might we expect here? The short-term response is kind of what we saw the other day. with the raise of rates and kind of the capital controls. Over time, I think it will be primarily about turning inward, kind of finding domestic sources of demand, and, I mean, the energy aside of it may change, but kind of encouraging capital to stay in. I think other sanctions we've seen in these days has been the targeting of the oligarchs

and people close to Putin. One potential scenario would be kind of a full repatriation to the extent that they're able to, of their assets and kind of like new sources of capital within the Russian economy, all looking inward. In terms of relationships with China, I think something that was interesting in the context of the comparison with Iran that I saw was that Russia right now is much less exposed to China than say Iran was, just because Russia historically has been very tied to the West compared to Iran. In that sense, there is like an opportunity to kind of reorient the entire economy, east rather than west.

And so that could be one way to kind of break the connection with Europe. But at the same time, I think, two things. First of all, these things take time. And right now we're still in the adjustment phase. It seems like Russia will have ways to stabilize the ruble in the short term. It seems difficult to me from a sanctions perspective. What you don't want is the so-called Cuba scenario. were sanctions, stay in place forever.

You kind of, you don't have, right now the United States has been admirable in the fact that it's been able to be extremely multilateral. And so bring on countries like Switzerland that are historically neutral, for example. The risk is the longer this goes on, the less multilateralism there is, and more kind of countries start to break away, start to re-engage with Russia. And then you kind of have the situation where there's a complete blockade against Russia from one part of the world, but it's not enough to completely undo, kind of unmake Russia's economy or bring it to the bargaining table, and the economy kind of readjusts, like,

Europeans go to Cuba all the time. It kind of readjusts towards the east. So that's, I think, the thing everyone is really wants to avoid. So my sense of the goal right now is to try to impose so much pain that there isn't the ability to remake oneself and kind of adjust, because otherwise, the adjustment you could kind of end up in this worst of both worlds where you don't necessarily achieve your goals. You don't achieve your goals. You're cutting off a major part of the economy, and you're kind of reorienting a major part of the economy away from you. So for me, I struggle to imagine anyone wanting the current situation to be long term. And I think the hope is to reach a deal. So how, as of right now, and we're, you know,

We're barely a week into this war and the announcement of sanctions. How surprised are you by the level of unity and the completeness of the, I mean, as you mentioned, even Switzerland, neutral Switzerland is involved by the sort of the unanimity on the part of European powers in the U.S. in the sanctions. And how does that compare to other ones in terms of unanimity versus, say, when dealing with Iran and others? I think it's extremely impressive. I think it was unexpected.

I mean, both the Switzerland and then Singapore's joining, which have kind of been unique cases. But in general, if you think about the way sanctions work within the European Union is that you need unanimity of all 27 countries. It's not a majority decision. So even with getting the European on board for anything really requires getting 27 members on board. And you saw it over this weekend where there'd be kind of one-off reports. Italy OK with swift cutoff, Hungary, not opposed to swift cutoff.

So in that sense, it's a really challenging diplomatic struggle. And I think it's been amazing to see how much the United States was able to get everyone on board. In terms of kind of looking at it in precedent, first of all, I would say there are small differences between the sanctions. This isn't necessarily a bad thing. But I think everyone does minor adjustments or carve-outs. I think, in some cases, and some of this is just the way, kind of the way these work is that every country sits in a room and kind of writes out the same press release and then releases

it. Everyone does it a bit at the same time, a bit differently. The United States say released at central bank sanctions. They agreed to them over the weekend, but then the United States rules came out before the European world. So, for example, the United States have a carve-out that Europe doesn't have. And I think that's to be expected, but it's kind of a funny process in that sense that it kind of all comes together on the fly, and even more so now, where it's not multi-month or multi-year escalation process, but it's a matter of hours, everything changes. So in that sense, I think it's been pretty amazing. I think it's kind of a speed run of the Iran sanctions in that sense.

So the classic dynamic during the Iran sanctions tended to be that someone wanted to escalate, some party within the United States wanted to escalate Iran sanctions that they would push it. And usually it was something at that point unprecedented. And so the administration, which tended to be more concerned about things like dollar dominance or getting along with allies would push back. But eventually there'd be enough momentum for the kind of hawkish next step. So targeting the Iran central bank or trying to target Iranian oil exports. And so eventually the United States would kind of get on board with it. And then there'd be kind of friction with the EU, the EU would complain about overreach by the United States or lack of engagement with EU equities, et cetera. And then

eventually the EU would kind of either fully join or kind of make itself comfortable with it. And so that's kind of how it would go. And then the kind of final step was the working with China. So China would not necessarily fully agree with the sanctions. It definitely wouldn't say it was complying. But China would maybe make some adjustments and kind of conform or not to overtly go against U.S. goals. Now you're kind of seeing this extremely fast. So someone floats an idea with the Russia thing last week. So before the invasion fully started, you had all these ideas, central bank, and the correspondent banking, targeting oligarchs.

and they were kind of floating in the either. And then the United States does something. Europe bulks, but then it moves faster. Then in the central bank sanctions, actually, initially it seemed like the United States was going to take a softer approach. And in that case, it was actually von der Leyen speech that seemed to be a bit more forward-leaning.

So in that sense, you're seeing everything move very quickly. And I think the final decision on Swift is kind of an example of this gradual campaign all building up to kind of a big decision. So I think it's been admirable. It's kind of interesting. You see how much diplomacy matters, but you also see how much the technical questions matter because so much of it is kind of getting, it's making the details compatible, but also ensuring the domestic politics are feasible by carving out what you need to carve out.

You used a phrase just then for the sake of dollar dominance. And this is something that has come up in our episode with Sultan Pozar. and I've also seen some comments from other commentators about it. But on the one hand, you have the U.S. using its position in the global financial system to heap enormous amounts of pressure on Russia to try to get it to do something that it wants. On the other hand, it seems to have given rise, I guess, to a question of whether or not people are going to want to either do business with the U.S. or maintain assets in dollars if they know that, you know, if they get into a situation of tensions

with the U.S., that they could actually lose control or access to those various assets. So I guess my question is, what does all of this mean for the long-term position of the United States and the dollar in the financial system? This is kind of the million-dollar question that has been kind of one of the ongoing questions in sanctions among sanctions practitioners. Two of the current people in government working on the sanctions actually wrote a report on will sanctions threaten the result of the dollar. So everyone in the government is very much thinking about this issue.

I tend to be very skeptical about the sanctions threat to dollar dominance. I mean, first of all, I will say like the way dollar dominance usually comes up in these conversations isn't because of some like empirical threat to the dollar, but it's more of a way of arguing against the sanctions without arguing against the sanctions. So you're not saying, I think this measure is bad because it won't achieve its goal. You kind of have this bank shot argument where you say, actually, we shouldn't do this measure because of dollar dominance. So that's kind of, I tend to kind of be skeptical of the argument just because that's, it's not often very informed. I think by, it's mostly informed by kind of policy differences within the

sanctions community. I mean, it's been something people have. been worrying about for a long time. Like, Jack Liu, when he was secretary, gave a speech saying, if we keep using this, it'll be a threat. And it's, I mean, the United States keeps on, it does keep escalating in its use of it. I mean, there have been kind of all these things. There was one point in the kind of 2010s, there were all these massive fines against foreign banks.

And people would complain. In one point, President Hollande asked President Obama not to fine B&P Perry bought too much. So, like, in a sense, like, it is like a big liability in a sense that, like, the United States has this control. And it almost does it know what to do with it day to day. So, for example, in the Afghan, you recently saw the United States made that decision about the Afghanis assets held at the New York Fed. In a sense, like, dollar dominance itself is kind of a huge imposition in the United States because it needs to make these decisions that it's not necessarily, it might not want to make. So, for example, the Biden administration having to choose between sending money aid to Afghanistan and keeping it in the United States because technically the money's in the United States.

And so 9-11 victims' families could sue and take the money from the New York Fed. I guess more generally, I would say that dollar dominance has been, people have been worrying about it for a long time. I'd say the last biggest worry was during the U.S. unilateral exit from the Iran deal. And that, to me, at the time, there was all sorts of fears because the Iran deal sanctions, the Iran sanctions really leverage it. Like, the biggest thing they do is they don't allow Iran to export oil. And so you really have to lean on dollar dominance to pressure like third party countries

not to import Iranian oil. And so there was a sense that that might be the breaking point. And it really wasn't. In that case, Swift is like the bullsons. Belgian Payment Messaging Service, they even complied with U.S. sanctions during this whole escalation. People keep saying it's up to the EU to decide on SWIFT, not to the United States. In that case, the EU very much did not want the SWIFT to cut off the Iranian banks, but they did it anyway. So in the short term, the sanctions do not pose a threat to dollar dominance.

I would say mostly because while sanctions are a huge deal and they can really remake economies, as we're seeing right now. That's not what dollar dominance means day to day. It feels to me like the most important aspect of dollar dominance isn't the fact that the United States can turn off the spigots of certain capital flows when it sanctions countries. The biggest thing is that the Fed can provide liquidity in a crisis. And in that sense, if you think of that, there's this historian kind of caused sanctions the

geopolitical side of the dollar system. And like the normal day-to-day side is coronavirus. crisis in the United States doing swap lines or things like that. And so a country that might not be interested in or might want alternatives to sanctions also would need to create a parallel world where there is one entity that in a crisis can step up and keep the entire financial system afloat. And so from that angle, it just seems like the kind of benefits or at least the kind of security provided by a world of dollar dominance.

and kind of the United States being able to singularly prop up the global financial system outweigh for most countries, the negatives. Yeah, I mean, I think like we've definitely seen in the wake of the financial crisis and then more acutely starting in March 2020, the sort of benefits to being in the club or being under the umbrella that can get the benefit of Fed liquidity is pretty powerful. I want to go back to Swift for a second. And I feel like on Twitter, Swift gets talked about in hushed tones. Like, oh, this would be like, this is the thing that they can't touch.

And then, of course, they sort of did it, not entirely. But it has been employed. How powerful is that? What are the sort of misconceptions? What do people get wrong about what it means to lose access to Swift? Yeah, I definitely agree about the hush tones. I feel like on Thursday or Friday, after President Biden gave a conference call, he was asked something like, are you really unwilling to do the two most destructive things for the Russian economy?

Sanctioned Putin and disconnect Swift. And kind of both of them were kind of beside the point, as has been proven by the fact that all the damage hasn't been caused by those two. Swift, the base is this like payment messaging service, has 11,000 banks. It's based in Belgium. So technically, it's not responsive to U.S. requests, although in practice it tends to very much be. responsive. In part, it's responsive because its board member banks are, they have extreme exposure to U.S. jurisdiction. So its board member banks will tend to kind of align themselves with U.S. goals. I mean, ultimately, the thing is Swift is a messaging service. I mean, it's very well networked.

It's secure. So in that, and it's standardized. So in that sense, it has the perks of really good messaging service, but if someone shut down WhatsApp, you could use something else if you really wanted to communicate with people. And it's kind of the same with Swift. There's nothing that Swift does that itself couldn't be replicated. But I think the reason Swift is such an appealing kind of example is that it's kind of the embodiment. So much of sanctions depend on kind of the concept of interdependence. So like there's these few choke points or places in the global economy. that if you can exert your pressure on them, you'll be able to control all sorts of other things. So, and in that sense, Swift really is like a good symbol of that because it's like this,

what if there were one messaging service and every bank depends on them. And with one stroke, you could cut off these banks and they would lose their connection to the global economy. In practice, that's not what would happen. But I think in that sense, it's very symbolic. I think that's why it became such a symbol. And there was this talk about Europe can only be a global player if it's willing to cut off Russia from Swift. I think more generally, though, it's the kind of infrastructures that make Swift possible, that use Swift that are more important. So Swift, you're sending the messages.

But what matters is kind of, if there's been a bunch of analogies, people have used. The one I think of is like, what matters are the train tracks between, towns. You don't necessarily need like a telegraph system communicating that the train arrives. But without the telecommunication system, your trains will probably have to go a bit slower because you don't know who else is on the track. So ultimately, what the United States did with the spur bank when it basically denied the correspondent bank accounts, it just uprooted the train tracks. So no messaging service can make up for that. You can get the news whenever you want it with Bloomberg News Now.

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Listen to Leading by Example, executives making an impact on the IHeart Radio app, Apple Podcast, or wherever you get your podcasts. Just when it comes to the oligarch, so we do have sanctions. in place now, you know, possibly belatedly when it comes to the UK. And you pointed out earlier that to some extent, extensions on individuals are, you know, almost the original like plain vanilla sanction. So you say these people can't go to the U.S. They can't access their U.S. bank accounts and things like that. But what exactly is it supposed to accomplish here? Because there does seem to be a thought process that, well, we're going to sanction the oligarchs, and then they're going to call up Putin and complain about everything that's happening. But like, how realistic is that? Like, what is the

thought process behind this? I think that is the thought process in a sense. Like, the basic one, which is these are, Russia's not kind of a fully traditional, like, responsive electoral democracy. And so what matters is convincing the elites who might have, have access to Putin. And that might change things. I feel that that is the basic theory of the case. I don't think necessarily it would work that way just because these oligarchs depend more on Putin than Putin depends on them. These are some of the ones that have recently been hit in the EU are people who were Putin KGB mates in Germany. So they're not successful businessmen who placed Putin in office. So in that sense, it might just drive them closer to the government. In one sense, I read an

interesting comparison to the Venezuela sanctions, and in the Venezuela sanctions, going after Venezuelan corruption, especially given they have all these kind of state-owned businesses and Pedevesa, one of the things the United States did was really target these high-profile corrupt individuals, and for example, or say take over their assets in the United States, and that tended to push them closer to Maduro. So in that sense, it could cut the other way. I mean, at the same time, I think there is sanctions. We think of them. Before the invasion, there was the whole thinking of sanctions as deterrence.

And then now we're talking about sanctions as bargaining. But there's another theory which is sanctions as kind of a signaling message. And so you do sanctions to say, we disapprove of this. In some cases, for example, the United States will sanction people who have no assets in the United States, never plan to come to the United States. But the United States still does it as a way of saying this won't. fly for us. And I mean, I think there is some value in kind of signaling this approval. So I will say that. One thing I would note, though, is that these oligarchs do control often very large businesses and different sanctions do things differently. But sometimes, depending on how you do it,

sometimes sanctioning the head of an individual can lead to the sanctioning of a firm he owns or controls. And in that sense, it can have very large ripples. I just recently. recently, the EU just released its own sanctions, its own oligarch sanctions, and those could lead to dislocations because it has a, I mean, we'll see how it plays out, but it seems to have a capacious definition of control, which could mean major Russian companies get sanctioned as well, companies that haven't been sanctioned so far. So that could be a thing. And sometimes they can have kind of crazy knock-on effects. In 2018, the United States sanctioned Oleg Deripaska, big metals magnet.

He controls one of the top producers of aluminum in the world. And then that was sanctioned. And then the London Metals Exchange freaked out because that was a big player there. And so they halted trading. And overnight, the price of aluminum went up 20%. So even the individual ones can have crazy knock-on effects. But kind of the day-to-day sanctioning the son. they sanctioned the son of the Rosnev CEO, that I would say is primarily a way of signal.

A hope that he might intercede with Putin, but also more simply a signal that this won't fly. And especially in the UK, but also in the United States, there's the sense that the United States has been turning a blind eye to Russian dirty money that flows in. And so this is also a way to kind of eliminate charges of hypocrisy, I would say, which is kind of a signaling thing, but there's value to it. So this next question is actually going to be a subject of an entire. It has, you know, I'm sure multiple episodes and certainly one imminently. But, you know, we talked about, okay, the one area that's not going to really be touched, at least directly, although maybe implicitly, is the energy sector. And of course, we all know that Europe, particularly Germany, highly dependent on Russian natural gas and to some extent call.

How did, you know, what's the short version of how, in your view, Europe got into this situation where it became so dependent, you know, even after 2014 with the annexation of Crimea, which is sort of well, sort of telegraphed what Vladimir Putin was willing to do. How did it let itself get so vulnerable on this front such that at least with energy, it has very little leverage? First of all, energy imports in Europe have been kind of a long-term source of friction. Even in the 80s, there was tension between the Reagan administration and Europe because of a European pipeline to Russia. So this has been very long. I think if I'm not mistaken, Anthony Blinken wrote a book about this in 1987. So this is kind of a long-term sort of friction.

And there's differences between gas and oil, but the political economy of Europe and energy is very challenging in terms of unwillingness to invest, has made it very hard for Europe to diversify. I think that kind of was one of the big things. Then you kind of have the freak events like Fukushima and harming, getting rid of German nuclear in the German energy mix. But I think the biggest thing I would say is, and I think this kind of goes to the shortcoming of sanctions more generally. is that sanctions can only shut off certain economic activity. They can't do the opposite and foster it. So the United States, they imposed these sanctions in 2014,

and there was a sense of geopolitical risk attached to Russian gas. But it wasn't enough to create, say, an alternative to Nord Stream, you know? So I think that's kind of a big problem. You need more active measures. Sanctions are relatively cheap in terms of imposing them. They can have their cost. But they're not, whereas building interconnections in Europe, so gas from Spain can get to Germany, which seems to be one of the concerns in terms of the geography of gas interconnection in Europe,

that wasn't enough. So in that sense, I just don't think there was enough forethought, and I think unwillingness to invest and kind of think long-term was able to diversify. I mean, we'll see what happens now. I think there's a bunch of enthusiasm about potentially the changing political economy of Germany or at least the greater willingness to invest and spend. I mean, there's been talk about nuclear and LNG, but those are long-term things. I think in the short term, without kind of an impetus to invest and instead kind of, I guess,

chronic consolidation. And that's how you end up without other options. And I don't know if people in 2015, if they've been told that in 2022, the most effective measure against Russia would have been off the table because we hadn't built the infrastructure, it's hard for me to imagine that they would actually have followed through and build the infrastructure, just because there's all sorts of other domestic problems that have halted it. So I'm very aware of the time, and it feels like we could probably, we could easily go on. I know. I had the same thought. Yeah, for another hour. So I'm just going to, I'm going to try to

squeeze in two very important questions in one, which is one of the big criticisms of sanctions is obviously the impact on the general population who may not themselves have decided or supported the invasion of Ukraine. So what's the impact there? And then secondly, you mentioned escalation earlier in the conversation. How much more could the U.S. and Europe do on this front when it comes to sanctions? On the humanitarian front, I think it's a huge problem. In the late 90s, there was a complete revulsion at sanctions. And there was sense that it didn't work. They didn't work and the main damage was inflicted on the population.

Since then, there kind of was this evolution and thinking and the creation of smart sanctions. And the idea there was like more targeting. So, for example, going off after the oligarchs and other measures, that type of measure and other ways to kind of limit the humanitarian impact. Right now, I think this conversation has continued. I think, for example, there was frustration with, say, the way. Iran sanctions limited the access to health care in Iran during coronavirus. And so I think there is

a lot of willingness to think more about the humanitarian impacts. The Treasury Department at the end of last year actually issued this kind of comprehensive sanctions review. So when the Biden administration came in, they said, we're going to rethink how we do sanctions. And one of the things that they did was much more focus on limiting the humanitarian impact. And I think you've seen it in some way. with the measures so far that have carbouts, say, related to COVID. At the same time, ultimately, when you're causing these massive slides in a country's currency are targeting its biggest banks or even its central bank and resulting in massive capital controls and interest rates going up to 20 percent, there's no way to contain the humanitarian impact.

My hope is that these sanctions are short enough that the humanitarian impact doesn't kind of ripple through or set in, it undoubtedly leave long-term scars of the Russian economy, which I think is very troubling. I mean, even something like, you can't undo these things overnight. If there was some administration officials that talked about how one of the goals of the sanctions is due is causing inflation. So these things really do have long-term effects. I guess it's kind of like hysteresis or something where it's very hard to undo. So, for example, If you cut off a bank's corresponding bank accounts, the banks will cut them off, but then reestablishing them as like a one-by-one resigning the deal.

And so these things will have long-term effects, and so people will feel them. Your question of unescalate. So I hope there would be ways one could mitigate them, but unfortunately, especially I think those have with the speed of escalation so far, those haven't been as top of mind. but we'll see it. There's a lot that could be done. So far, the United States has targeted banks, but it hasn't, the banks that has targeted, it hasn't necessarily targeted to the fullest extent.

So for example, the Sber Bank, the biggest bank, it's only bad correspondent bank accounts, hasn't done the full blocking sanctions. And other banks, it just hasn't targeted. So, for example, Gazprom Bank hasn't been targeted with any measure so far. So in that sense, you can target those more banks. there's potentially space for on the central bank they actually haven't done the full blocking sanctions so potentially they could do a full blocking sanction but on the mart so that could be a way to kind of tighten the screws and there's the energy sanctions as we talked about so those like you could

just say you can't buy Russian oil in practice you probably couldn't do that in practice what they did during the Iran deal is they kind of said they required every country to gradually decrease its purchases in Iranian oil. So you would probably have to do something like that because otherwise it would be kind of, I don't think any economy or kind of the global oil market could necessarily react that easily to a complete cutoff. There's also other sectors you could target or other companies. Right now, because finance is so pervasive, you kind of, like you can hit, you're hitting other targets. So, for example, I saw the swift cutoff and some of these finance cutoffs are making it harder for Russian airlines to pay for the leases of their aircraft.

And so that's harming the Russian airlines. But I'm not necessarily advocating targeting Russian airlines. But you could also just target Russian airlines directly. There's like ways right now, because of the effect of the financial sanctions, there's a sense that the entire Russian economy is in turmoil. But you could also just target direct sectors. And there's other sectors that kind of have this ripple effect through the economy. For example, insurance is one of them.

So, for example, targeting Russian insurance companies could make it harder for companies that need insurance to carry on their business. For example, like in the Iran case, the United States made it harder for oil tankers to get insured, but you need insurance to kind of dock in places in case something happens. And so then the Iranian government had to insure its own boats. And so there are ways you can kind of escalate by targeting more and more subsectors of the economy. So I'd say those are some of the main areas that you could talk with. Well, Eduardo, as Tracy noted, I feel like that went by in the blink of an eye and we could talk for hours. But that was fantastic. I learned a lot.

I really appreciate you coming on online. Oh, no. Thank you so much for having. That was fantastic. Thanks to D'Wurton. Thanks, Eduardo. That was really good. Yeah, thank you.

That was extremely informative. And, you know, we just said it. I feel like we could have talked for like two more hours, very important. easily on this topic. Absolutely. I mean, there are a number of things to pick out there. But, I mean, one, I thought it was really interesting what Eduardo said about the idea that even if you throw all this stuff at an economy, you can't, you can't just turn it off. And of course, I mean, there's the original sanctions question when it comes to dictators, which is if they're not answering to a population, which is actually feeling the economic pain, do they even care?

and will sanctions have any policy impact, that's there as well. And then the other thing was this idea that it's difficult to turn these things off once you get them going. I thought that was really interesting. I think that is a really important dimension to all of this because, you know, obviously what we've seen over the last week, like in theory, the hope is that, okay, this imposes significant pain, that at some point Putin decides to turn around, removes forces from Ukraine. That's the hope that there's some sort of peace and end of fighting. Even if you start to turn these off, however,

we've seen such a dramatic move over the last several days of companies just saying, you know, we talked about in the beginning, washing their hands, not wanting to do business. It seems very hard to imagine what restoring the status, you know, getting back to 10 days ago, not just of the least, regime, but of the various corporate activity that was taking place in Russia, it seems essentially unfathomable almost at this point to go back. So then the question is like, well, how much of a carrot is there still to offer if it's going to be such a long haul just to get back to, you know,

what the middle of February looked like? Absolutely. And I mean, we haven't even touched on ESG considerations, but it does feel like, okay, you can't necessarily turn sanctions on and off with the switch of a button because people have compliance departments and, you know, the people who work in compliance tend to be cautious people. And then secondly, what does this actually mean for ESG? Because even if you remove sanctions, there could be plenty of investors and companies out there who still don't want to invest in Russia because of previous behavior. And we're already seeing some inklings of that in the market. Yeah, companies have compliance departments. They also have PR departments.

And I think that's going to be, now for real, that's going to be another big factor of like, well, do we want to go back in after this for PR reasons alone? Or is it better to just not have anything to do with the country? A number of companies may be having to ask themselves that question.

I also thought it was interesting, like even on like the sort of like the technical aspects of financial sanctions, the loss of correspondent banking for Spurbank. As he noted, it's like easy to turn them off, but then you need to, write new deals to bring them back on. And so to the extent that the sanctions, the removal of sanctions is hopefully a carrot to end the war in a short period of time, there's got to be something that can realistically be regained for them to have that effect. Yeah, exactly. Well, I mean,

either way, I feel like we're going to have a lot more episodes on this topic. Yeah, it definitely feels like that. Okay, shall we leave it there? Let's leave it there. All right. This has been another episode of the Allotts podcast. I'm Tracy Allaway. You can follow me on Twitter at Tracy Allaway. And I'm Jill Wisenthall.

You can follow me on Twitter at the stalwart. Follow our guest on Twitter, Eduardo Sarvali. He's at E. Saravale. Follow our producer, Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg head of podcast. Francesca Levy at Francesca today. And check out all of our podcasts at Bloomberg.

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