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Weaponized Finance is still War 

Following months of groundwork, frenzied late-night phone calls and a potent pressure campaign from Ukrainian leaders, the U.S. and Europe banded together to impose what is shaping up to be the biggest coordinated package of sanctions ever levied against a major economy.

Over the past few days, that coalition of countries, representing some of the world’s biggest democracies, hit Russia with a series of increasingly severe economic penalties over its invasion of Ukraine. These sanctions and economic penalties range from direct sanctions on Russian President Vladimir Putin, foreign minister Mr Lavrov and their Oligarchs, to restrictions on Russia’s central bank by blocking some seven Russian financial institutions from Swift, an international payments system … all the way to the closing of Airspace to Russian airplanes and the closing of the airwaves to the Russian TV and other Media outlets…

In response President Putin played the “Nuclear Trigger” card, and the world entered into another high stakes game of brinkmanship, while inflation runs amok in all the industrialized nations and their dependencies.

Tellingly the old journalist who always called a spade a spade, reminds us: “The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin.” –Ernest Hemingway

swift

In 2006, the management team of the Russian bank VTB came to a London investment bank hoping to woo fresh investment capital from the West. They had traveled to the Financial Capitals of London and New York, in order to showcase their investment opportunity in their pre-IPO roadshow. 

The CEO of VTB bank, gave his elevator pitch touting all about the promise of growth because of more Eastern European growth, a robust resource economy, underbanked populations, a newfangled Democracy etc.

When it got to the Q&A, all the questions were about the 5% stake in EADS (the parent company of Airbus) that VTB had acquired just a few days before their roadshow.

Q: Was the stake strategic? 

A: No, opportunistic. 

Q: Why EADS? 

A: It’s cheap. 

Q: What metric is it cheap on?

A: Various metrics…

Q: What other equity investments does the bank hold? 

A: None.

I started to feel bad for the guy.

It was embarrassing and he knew it. 

He was on the road asking investors for money and had to pretend that spending $1 billion on an unrelated stock, trading at a multiple of … he didn’t know exactly what, that just had a huge profit warning, was a normal thing for a commercial bank to do.

From his halting responses, it was obvious to everyone in the room that the “investment” was made on orders from the Kremlin so that Russia would have some influence over Airbus.

Our mostly British team was too well-mannered to ask: “Did Putin tell you to buy it?” 

But they didn’t have to, because the CEO’s non-answers told us exactly that.

We went through the motions for the rest of the meeting, but it was clear none of these people would be recommending buying this bank’s shares or even offering it to our friends, family or even trading partners and clients.

Investors wouldn’t be interested for the same reason that Gazprom perpetually trades on 3x P/E: Sure, they make oceans of money. And investors might occasionally even see some of it. 

But, ultimately, those cash flows belong to the Kremlin because Gazprom’s oil and gas will always flow in a direction dictated by global geopolitics, and not by shareholder returns.

Fact if that for investors, finance and geopolitics don’t mix well.  

But mix they do. Especially in Russia.

The war in Ukraine is taking that toxic mix of finance and geopolitics to new levels of both toxicity and consequence.

Yet now we are all talking again about a new Era of Detente otherwise known as Mutually Assured Financial Destruction

I’m old enough to remember the Cold War and its not-so-cold proxies. 

Those proxy wars were largely about each side indirectly imposing costs on the other.

The four decades since the fall of the Iron Curtain have been defined by the globalization and financialization of world economies, one result of which is that costs can now be imposed on unfavored nations via the financial system.

Restricting access to the SWIFT messaging system and freezing central bank assets are an effort to impose costs on the Russian economy via bank runs and inflation.

Those costs are borne immediately: Reports from this weekend suggested that Russia’s ATMs have already been emptied of foreign currencies.

The images of Russian citizens lining up to withdraw what money they can is photographic evidence that finance has been weaponized.

The “Nuclear Option” is real in this New World War and it may be that weaponized finance is a less deadly way to fight wars — but deadly it is. 

Yet it may also be that financial warfare is so effective that it could lead to nuclear warfare.

Back in the day — we all remember how the Soviet Union imposed “terrible costs” on the US by backing North Vietnam and how the US imposed “terrible costs” on the Soviet Union by backing the Mujahideen in Afghanistan.

The costs were high, but not existentially so, partly because they were borne over many years.

Today, the West can take Russia out of the financial system and Russia can retaliate by withholding supplies of oil and gas, both with immediate effect.

Just as with the mutually assured destruction of nuclear weapons, this is sort of by design: Germany originally started importing natural gas from Russia with the hope that the commercial ties would intertwine Russia’s interests with the rest of Europe’s.

To the degree that it raised the cost of a conflict between Russia and Europe, it worked. The stakes are high. 

Much higher and also much more immediate than the stakes were in the US/Soviet proxy wars.

The stakes are, in fact, so high that freezing the assets of the Central Bank of Russia is routinely referred to, metaphorically, as “the nuclear option.”

But after Putin responded by raising Russia’s nuclear alert level, I can’t help but wonder just how metaphorical it is.

As it turns out, Nuclear “Accidents” happen … and they happen quite frequently all over our world and not just in Chernobyl or Fukushima.

Since the escalations of the First Cold War, in the 1960s, the US Air Force kept some number of nuclear-armed bombers constantly circulating in the air. If the Soviet Union managed to pre-emptively take out all of the land-based nuclear launchers, the US would retain the ability to strike back.

In 1961, one of those bombers came apart during an in-air refueling mishap, dropping two nuclear bombs onto the state of North Carolina. Each was 100x more powerful than those dropped on Hiroshima and Nagasaki.

One bomb got caught in a tree: Five of the six safety mechanisms failed. 

The other fell irretrievably into a bog, where it remains buried to this day. Recovered parts suggest it was fully armed, so it’s unclear why it didn’t detonate. 

That was just one of 32 nuclear accidents reported by the Department of Defense to have occurred between 1950 and 1980.

I don’t know what a heightened state of nuclear alert in Russia entails.

But it seems certain that the new age of financial war has raised the risk of nuclear war to some degree.

For those of us who are lucky enough to be out of harm’s way thus far, I suspect there likely is a 99% chance that things will be OK. 

But the 1% tail risk is still way too high for my liking since the prospect of global nuclear annihilation is not a small thing.

Yours,

PS:

The VTB Bank that was suspended from the international SWIFT payments exchange system this weekend, is the same investment bank that sought to go public in the West via an IPO back in 2006 — but its role in geopolitics today, has gotten a whole lot more significant.

And that is a frightening development.

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