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What I Care About This Week | 2022 Feb 28

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by Franklin J. Parker, CFA | for ongoing updates, follow me on Twitter.

The Summary

The Details

Over the weekend western-allied monetary authorities took the unprecedented step of sanctioning the Russian central bank. It is easy to gloss over these words (“sanctions” don’t seem to mean much these days), but this is an action with serious teeth. Let’s break down why.

First, the Russian central bank holds some $630 billion in assets, mainly the currencies of other countries. In normal times, this would allow it to stabilize major currency moves. If the ruble began to show considerable weakness, for example, the central bank could sell dollars and buy the ruble and offer some support. By preventing the central bank from trading in international markets, this tool is removed.

Second, the central bank can tap these reserves to offer some liquidity in currencies other their own. Many Russian companies, to access international capital markets, have borrowed in euros, dollars, and yen. With no ability to get euros or dollars or yen, these companies could, at worst, default on their obligations and, at best, see their borrowing costs skyrocket. The same goes for the government of Russia—without an ability to get foreign currencies, they are unable to repay their foreign-currency debts (which is one reason why Standard & Poor’s downgraded Russian debt to junk status, further pushing up their borrowing cost).

Third, any actions the central bank takes to stabilize their financial system must now be done by printing money rather than from existing assets—which can compound the inflation problem.

Fourth, and this is related to the sanctions more broadly, the inability of Russian companies and banks to interact with the global financial system creates massive frictions for manufacturing and services. Since almost everything manufactured today contains components manufactured in a foreign country, and since payments cannot be made internationally, this significantly curtails the ability of Russian companies to produce anything other than the most basic goods.

Of course, many of these problems can be overcome. China offers a window to the international financial system, for example. But fund flows and supply chains cannot be simply rewritten overnight. In the short term, the effects of these actions are likely to create massive price inflation, depression of asset prices, and a significant slowdown of economic activity.

Chart of the Week

The economic damage done to the Russian economy can be seen in the movement of their currency, the ruble. It hit it’s lowest-ever value relative to the US dollar, moving some 30% in a day. Currencies rarely move like this. To put this in perspective, when the results of the Brexit election posted, the British pound moved 12% over the course of a couple of days, and that was major news at the time.

Unfortunately, this adds to inflation pressures in Russia, which is a very high cost the average Russian will have to pay.

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