Unintended Consequences of US Foreign Policy in Ukraine

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Unintended Consequences of US Foreign Policy in Ukraine

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As has happened so often with ill-advised US foreign policy in the recent past, the law of unintended consequences has prevailed in the Russo-Ukrainian War – not only have the sanctions failed spectacularly but the inability of the US to orchestrate a cohesive effort to force Putin’s hand in Ukraine suggests that the global balance of power is shifting.

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2023-01-03

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Introduction

US Response to Russia's Invasion of Ukraine

In response to the Russian invasion of Ukraine in February 2022, the US has imposed across-the-board sanctions against the Russian government, many of its domestic companies, and even some of its private citizens. No doubt President Biden and his advisors felt confident that not only would most of the world support these measures, but that sanctions would decisively crush the Russian economy and force Putin to capitulate to American demands to abandon his military campaign in Ukraine. However, as has happened so often with ill-advised US foreign policy in the recent past, the law of unintended consequences has prevailed – not only have the sanctions failed spectacularly but the inability of the US to orchestrate a cohesive effort to force Putin’s hand in Ukraine demonstrates that the global balance of power is dramatically changing.

This paper discusses the scope of the sanctions, their unintended consequences (i.e. what really happened), and four key trends that have undermined their effectiveness.

Scope of Sanctions

The scope of these sanctions is unprecedented – shortly after the start of the war, both the US and its EU allies announced sweeping measures that affect nearly every aspect of the Russian economy. Furthermore, they have declared that they will enforce these sanctions even after any future end of hostilities. As noted in multiple press releases issued by the White House and the EU Council:

The international assets of two of Russia’s largest banks, Sberbank and Alfa Bank, as well as state-owned enterprises, have been frozen. (“Fact Sheet: US, G7 and EU Impose Severe Costs on Russia”; “Fact Sheet: US Takes Further Actions”).
US citizens have been forbidden from investing in any Russian Federation (RF) businesses (ibid).
Russia has been blocked from paying international debts with any funds that have been frozen by these sanctions (ibid).
Western companies have been prohibited from exporting key technologies to Russia (ibid).
Named Russian individuals’ have had their foreign assets frozen, and in some cases, confiscated (e.g., the super-yachts of Russian oligarchs) (ibid).
And most importantly, severe limitations have been imposed on energy products (e.g., oil, natural gas, and coal) and other commodities exported from Russia to EU markets (and to a lesser extent, US markets) (“EU Sanctions against Russia Explained”).

US and EU officials argue that these sanctions “impose immediate and severe economic costs on Russia, cut off access to high-tech technology, sap its growth potential, and weaken its military for years to come” (“Fact Sheet: US Bans Imports of Russian Oil”).

Interim Results

Unintended Consequences

If one were to believe western governments and mainstream US media, these measures have been so harsh that they should have crushed Russia to the point where it could no longer sustain military operations in Ukraine. However, that hasn’t been the case – if anything, Russia has prospered in the first half of 2022. Although the Russian ruble initially collapsed, it has since recovered to its trading range for the last seven years (“Russian Rouble (RUB) to US Dollar (USD) Exchange Rate”). And while energy export sanctions should have shut down Russia’s primary source of foreign currency, the opposite has happened – sanctions have forced oil prices higher and Russia has diverted energy exports to willing buyers in Central and East Asia (Mufson). As a result, Business Insider reports that Russia is projected to earn $285 billion in 2022, up 20% from last year (Tan, “Russia Is on Track to Make More Money”). And by all accounts from the war zone, Russia has more than enough military resources to prosecute its invasion of Ukraine (Dewan).

Conversely, while Russia has survived and thrived, the sanctions have backfired on the EU, where many countries are dependent on oil and natural gas imported from Russia. Because of the interdependencies in the EU markets, one can argue that their collective economies are now teetering on the brink of disaster – to wit:

The Euro has collapsed (against the US dollar) to its lowest point since 2004, driving up prices for US products and services (“Euro (EUR) to US Dollar (USD) Exchange Rate”).
Energy-dependent industries in Germany are at risk of collapsing due to dwindling natural-gas supplies – the 40% share of Germany’s gas imports previously supplied by Russia cannot be easily substituted with sources from the open market (Tan, “Entire Industries in Germany Could Collapse”).
Because of the cascading impact of oil and natural gas shortages, seasonal electricity prices in key European markets have risen more than 300% and governments are warning citizens to prepare for heating shortages this coming winter. The EU just announced on July 26, 2022, that member countries have agreed to reduce natural gas consumption by 15% (Ainger and Nardelli).
Finally, Gazprom, the primary operator of Russia’s natural gas pipelines to Europe, recently announced it was invoking force majeure (termination of a contract due to forces outside one’s control) (Payne). Gazprom has since rescinded its force majeure claim, but in its place has simply reduced natural gas deliveries to Europe via Nord Stream I, its primary pipeline, to just 20% of capacity (Wallace). The extent and duration of this reduction are unknown, but even a short-term disruption will likely have severe consequences for countries like Germany.

Why Sanctions Are Failing - 4 Trends

What happened? How could such far-reaching sanctions backfire so spectacularly? On the one hand, Russia continues to make progress militarily in Ukraine (“Ukraine War in Maps”) while managing to sustain exports to support its domestic economy and war effort (Tan, “Russia Is on Track to Make More Money”). And yet, as noted above, the EU’s economy is sputtering in a way that gives one cause to think perhaps the sanctions were against Europe.

The West’s failure to twist Russia’s arm economically highlights four important trends that should give US and EU leaders pause regarding their short and long-term strategies, not only as it pertains to the Russo-Ukrainian War, but in a much broader sense:

First, the interdependencies inherent in a globalized economy make it extremely difficult to isolate a single country with economic measures against its commodity exports (e.g., oil, natural gas, and grains), especially when that country is a dominant supplier in regional and world markets. On the one hand, commodities sanctions have cascading effects on countries dependent on a supplier’s customers, as has happened with the EU and Russian natural gas exports. And on the other hand, it is relatively easy for exporters to pivot to other markets, as has happened with Russian oil sold to China, India, and other Asian countries (Haass).

Second, sanctions only work when all the players in the room support them, and that has not happened with the sanctions against Russia. The major emerging economies, consisting of Brazil, Russia, India, China, and South Africa (collectively known as the BRICS), as well as numerous other less-developed countries, have openly defied the US-EU power block and have not only continued trading with Russia but have deepened their economic and political ties with the Putin administration (“Tracking Sanctions against Russia”). This is no small dissenting minority – as Chinese leaders are quick to point out, the BRICS account for 40% of the world’s population.

A third trend is the growing chorus of countries that have started to question whether global assets are safe in the event of a dispute with the US. China, Iran, India, and even Saudi Arabia are now openly trading with currencies other than the US dollar (Glover). Some are reducing their portfolios of US Treasuries (Person and Chavez-Dreyfuss). And lest one is tempted to discount the significance of this, it’s worth noting that the only way the US has been able to finance its $30 trillion debt is because the rest of the world has been willing to buy that debt (“Federal Debt Held by Foreign and International Investors”). One can conclude that sanctions have sent a message to US creditors that the underlying system of trust that is the basis for global finance may not be as safe and secure as previously thought.

And last, but not least, is the tectonic shift of economic power away from the so-called Group of Seven, consisting of the US, the UK, Japan, Germany, France, Italy, and Canada (collectively known as the G7), to the BRICS. According to the consulting firm PricewaterhouseCoopers, by 2045 the BRICS’ economies may be almost twice the size of the G7 (PricewaterhouseCoopers). Furthermore, it’s increasingly likely that other major players, such as Iran, Saudi Arabia, and Indonesia, will join the BRICS to form a coalition far more powerful than the G7 (Krishnan).

Conclusion

A Bad Bet in a Shifting Geopolitical Landscape

US-led sanctions against Russia were a bet that the balance of geopolitical and economic power accrued to the West’s advantage. That assumption has proven to be wrong – the sanctions have not only failed to force Putin’s hand in the Russo-Ukrainian War but have had the unintended consequence of massively disrupting western economies, notably in the EU. This failure extends far beyond the war itself – it is a much more profound indicator that the global balance of power is changing, perhaps faster than anyone in Washington is willing to admit.

Notwithstanding expectations that sanctions would trigger a collapse of the Russian economy, a combination of sustained high prices in energy products, and redirected markets, notably in China and India, have enabled the Russian economy to remain resilient for most of 2022.

As shown in the adjacent USD-RUB (EUR-RUB) exchange rate history, except for an initial hiccup when sanctions were first imposed, Russia’s currency has remained relatively stable.

USD-RUB / EUR-RUB - FX History

(hover chart to view data)

Data Source – Statista

NOTES

References and Disclaimers

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Works Cited

Ainger, John, and Alberto Nardelli. “EU Nations Back 15% Gas-Cut Target as Russia Reduces Flows.” Bloomberg.com, Bloomberg, 26 July 2022, https://www.bloomberg.com/news/articles/2022-07-26/eu-nations-reach-agreement-to-reduce-gas-use-for-next-winter.

Dewan, Angela. “Ukraine and Russia's Militaries Are David and Goliath. Here's How They Compare.” CNN, Cable News Network, 25 Feb. 2022, https://www.cnn.com/2022/02/25/europe/russia-ukraine-military-comparison-intl

Eddy, Melissa. “Russia Announces Deeper Cuts in Natural Gas Flows to Germany.” The New York Times, The New York Times, 25 July 2022, https://www.nytimes.com/2022/07/25/business/russia-gazprom-germany-gas.html.

“EU Sanctions against Russia Explained.” European Council, 28 June 2022, www.consilium.europa.eu/en/policies/sanctions/restrictive-measures-against-russia-over-ukraine/sanctions-against-russia-explained/.

“Euro (EUR) to US Dollar (USD) Exchange Rate History.” Exchange Rates, https://www.exchangerates.org.uk/EUR-USD-exchange-rate-history.html.

“Fact Sheet: United States Bans Imports of Russian Oil, Liquefied Natural Gas, and Coal.” The White House, The United States Government, 8 Mar. 2022, www.whitehouse.gov/briefing-room/statements-releases/2022/03/08/fact-sheet-united-states-bans-imports-of-russian-oil-liquefied-natural-gas-and-coal/.

“Fact Sheet: United States Takes Further Actions to Counter Sanctions Evasion by Russia.” The White House, The United States Government, 2 June 2022, www.whitehouse.gov/briefing-room/statements-releases/2022/06/02/fact-sheet-united-states-takes-further-actions-to-counter-sanctions-evasion-by-russia/.

“Fact Sheet: United States, G7 and EU Impose Severe and Immediate Costs on Russia.” The White House, The United States Government, 6 Apr. 2022, www.whitehouse.gov/briefing-room/statements-releases/2022/04/06/fact-sheet-united-states-g7-and-eu-impose-severe-and-immediate-costs-on-russia/.

“Federal Debt Held by Foreign and International Investors as Percent of Gross Domestic Product.” FRED, 29 June 2022, https://fred.stlouisfed.org/series/HBFIGDQ188S.

Gillespie, Todd. “European Power Prices Hit Fresh Highs as Winter Concerns Mount.” Bloomberg.com, Bloomberg, 30 June 2022, www.bloomberg.com/news/articles/2022-06-30/european-power-prices-hit-fresh-highs-as-winter-concerns-mount.

Glover, George. “Russia and China Are Brewing up a Challenge to Dollar Dominance by Creating a New Reserve Currency.” Business Insider, Business Insider, 24 June 2022, https://markets.businessinsider.com/news/currencies/dollar-dominance-russia-china-rouble-yuan-brics-reserve-currency-imf-2022-6.

Haass, Richard N. “Economic Sanctions: Too Much of a Bad Thing.” Brookings, Brookings, 28 July 2016, https://www.brookings.edu/research/economic-sanctions-too-much-of-a-bad-thing/.

Krishnan, Ananth. “BRICS Group May Soon Expand, Says China.” Return to Frontpage, The Hindu, 27 May 2022, https://www.thehindu.com/news/international/brics-group-may-soon-expand-says-china/article65467886.ece.

Mufson, Steven. “Where Are Russia's Barrels of Oil Going?” The Washington Post, WP Company, 11 May 2022, https://www.washingtonpost.com/climate-environment/2022/05/11/russia-oil-gas-china-india-ukraine/. Payne, Julia. “Exclusive: Russia's Gazprom Tells Europe Gas Halt beyond Its Control.” Reuters, Thomson Reuters, 18 July 2022, www.reuters.com/business/energy/russias-gazprom-declares-force-majeure-gas-supplies-europe-2022-07-18/.

Person, and Gertrude Chavez-Dreyfuss. “Japan, China Cut Holdings of U.S. Treasuries to Multi-Year Lows -Data.” Reuters, Thomson Reuters, 18 July 2022, https://www.reuters.com/markets/us/japan-china-cut-holdings-us-treasuries-multi-year-lows-data-2022-07-18/.

PricewaterhouseCoopers. “The World in 2050.” PwC, 2022, www.pwc.com/gx/en/research-insights/economy/the-world-in-2050.html.

“Russian Rouble (RUB) to US Dollar (USD) Exchange Rate History.” Exchange Rates, https://www.exchangerates.org.uk/RUB-USD-exchange-rate-history.html.

Tan, Huileng. “Entire Industries in Germany Could Collapse Due to Russian Natural-Gas Supply Cuts: Union Head.” Business Insider, 4 July 2022, www.businessinsider.in/policy/economy/news/entire-industries-in-germany-could-collapse-due-to-russian-natural-gas-supply-cuts-union-head/articleshow/92647288.cms.

Tan, Huileng. “Russia Is on Track to Make More Money off Oil and Gas Exports This Year than It Did in 2021, and It's Got the EU to Thank.” Business Insider, Business Insider, 2 June 2022, www.businessinsider.com/russia-make-more-money-off-energy-exports-thanks-to-europe-2022-6#:~:text=Russia's%20coffers%20have%20been%20bolstered,oil%20and%20gas%20in%202021.

“Tracking Sanctions against Russia.” Reuters, Thomson Reuters, https://graphics.reuters.com/UKRAINE-CRISIS/SANCTIONS/byvrjenzmve/.

“Ukraine War in Maps: Tracking the Russian Invasion.” BBC News, BBC, 28 July 2022, https://www.bbc.com/news/world-europe-60506682.

Wallace, Joe. “Russia to Cut Europe's Gas Flow via Nord Stream to 20%.” The Wall Street Journal, Dow Jones & Company, 25 July 2022, https://www.wsj.com/articles/nord-stream-gas-flows-to-drop-to-20-of-capacity-russias-gazprom-says-11658760473.

Economic Bits (our side hobby)

"Things change gradually at first...

...then all at once..."

China GDP vs UST Holdings (2010-22) (billions)

(click/tap legend to filter data)

China GDP vs UST Holdings (2010-22) (billions)

Data Source – World Bank

Global FX Exchange Reserves (2001-22) (% of total)

(click/tap legend to filter data)

Global FX Exchange Reserves (2001-22) (% of total)

Data Source – World Bank

Global FX Exchange Reserves (2001-22) (% of total)

(click/tap legend to filter data)

Global FX Exchange Reserves (2001-22) (% of total)

Data Source – World Bank

Western media is starting to pay attention to China’s efforts to influence members of the so-called Global South, or more specifically the BRICS+ and Shanghai Cooperation Organization (with substantially overlapping membership), to denominate international trade in the Chinese Renminbi (RMB), aks the Chinese Yuan (CNY) and/or other local currencies. For very different reasons, Russia has promoted the idea of an entirely new currency for trade settlement. This is an accelerating trend among countries that have formed close economic and political relationships with China.

Coincident with the pivot to the RMB for trade settlement is a growing sentiment among the BRICS+ and SCO members that holding USD as their primary reserve currency poses a risk in the event the US declares sanctions and/or freezes a country’s assets, as happened with Russia and Belarus in 2022.

The combined effect of these two trends should be observable in a country’s US Treasuries holdings, and that’s exactly what we’re seeing in the chart above – China’s USD and Treasuries holdings peaked at $1.277 trillion in 2013 and declined by more than 32% in 2022.

Things change “slowly at first, then all at once”...
Ernest Hemingway, The Sun Also Rises Tweet

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Unintended Consequences of US Foreign Policy in Ukraine

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Introduction

US Response to Russia's Invasion of Ukraine

Scope of Sanctions

Interim Results

Unintended Consequences

Why Sanctions Are Failing - 4 Trends

Conclusion

A Bad Bet in a Shifting Geopolitical Landscape

USD-RUB / EUR-RUB - FX History

(hover chart to view data)

NOTES

References and Disclaimers

Related Research and Articles

Economic Bits (our side hobby)

"Things change gradually at first...

...then all at once..."

China GDP vs UST Holdings (2010-22) (billions)

(click/tap legend to filter data)

China GDP vs UST Holdings (2010-22) (billions)

Global FX Exchange Reserves (2001-22) (% of total)

(click/tap legend to filter data)

Global FX Exchange Reserves (2001-22) (% of total)

Global FX Exchange Reserves (2001-22) (% of total)

(click/tap legend to filter data)

Global FX Exchange Reserves (2001-22) (% of total)

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