From Russia, with Lavrov

Mar 17th 2014, 14:53 by Buttonwood

The Economist

           

THE big question for investors after the Crimean referendum (which in its one-sided result, only added to the 1930s parallels of the crisis) is what will be the extent of Western sanctions against Russia, and what will be Mr Putin's response. The latest figures from the Fed suggest that the Russians have been following the famous rugby tactic of "getting their retaliation in first". The Fed's custody holdings of Treasury securities fell by $104 billion in the week to March 12, with the sell-off generally attributed to Russian actions.

That is far and away the biggest weekly move for years, although the bond market should hardly be panicking; the Fed still has $2.86 trillion of bonds in custody. Ten year treasury bond yields are lower than they were a month ago, indicating that there are plenty of alternative holders.

Alan Ruskin of Deutsche Bank says that Russia has been slimming its US holdings for a while; they peaked at 37% of reserves in 2010 but were down to 28% by end-December. (Russia may own some dollar assets that are not Treasury bonds or bills, of course). But where else could Russia put its money? The euro is the next most liquid currency and already comprises around 41-42% of Russian reserves, but the EU is likely to take part in any sanctions. It is not easy to move your money into renminbi. So look out for some excitement from gold bugs on the grounds that the Russians are bound to buy more bullion.

The Russians could also retaliate by freezing Western assets. Here again, money is already moving to avoid the hit. Capital Economics says that one way of tracking the flows is to compare Russia's current account surplus with the central bank's net purchases of foreign currency.

the latest data (to 14th March) suggest that net capital outflows might have totalled around $50 billion (2.5% of GDP) since the start of the year. At the current rate, they are on track to top $70 billion (3.2% of GDP) in Q1.

Outflows have put pressure on the rouble and have necessitated a rise in Russian interest rates already. Capital adds that

Coming at a time when the economy is already extremely weak, we think this could push Russia into a technical recession

The other area for Russian sanctions is to cut off energy supplies to Europe. (An 1860s parallel here. In the American civil war, the south embargoed cotton supplies in the hope of putting pressure on Britain to recognise the Confederacy. It didn't work.)

An ING research note shows that, in 2012, Europe imported 130 billion cubic metres of gas from Russia, around 30% of the 446.3 billion total. In terms of total energy consumption, the countries that depend the most on Russian gas are Hungary, Slovakia and Turkey; Germany is only tenth.  A mild winter means that Europeans have currently quite high levels of gas in storage; it is also spring and, as Arthur Scargill discovered when he called a miners' strike in March 1984, that is not the best time to exploit producer power.