In a crisis that is turning into the worst East-West confrontation since the Cold War, Europe and the United States are gearing up to confront Moscow over Russia's incursion into Ukraine. But this time, the key weapons will be banks, not tanks.
The European Union and the United States are moving with unexpected alacrity in lining up targeted economic sanctions against Russia and even in keeping the prospect of blunt, Iran-style sanctions on the table.
U.S. Secretary of State John Kerry warned on March 11 that sanctions against Moscow could "get ugly fast," while German Chancellor Angela Merkel said on March 13 that Russia is risking "massive" political and economic damage.
This comes despite Russia's profound integration into the global economy and the inevitability that international sanctions against Russia will have palpable costs for the West as well. Analysts say Russia's ability to impose painful countermeasures on the West may be much less than commonly believed, even given Europe's dependence on Russian natural gas.
Europe is the main market for Russian oil and natural gas, revenues from which continue to make up the lion's share of the Russian budget. In addition, Russian companies, both private and state-controlled, rely on Western banks for crucial funding.
Western Tax Havens
Anders Aslund, a senior fellow at the Peterson Institute for International Economics in Washington, says that Russia's financial center is London.
"And Russia is now highly dependent on the global financial situation. We saw that in the fall of 2008 -- how the Russian stock market fell from May 2008 until October by no less than 80 percent," Aslund says.
According to Bloomberg, Russian companies took $58 billion in Western loans in 2013, up from $38 billion the previous year. About $8 billion in loans are currently being negotiated, "The Moscow Times" reports, and those talks are in jeopardy because of the tensions over Ukraine. At the same time, the sharp decline in the Russian stock market since the crisis began is already making borrowing more expensive for companies with reduced market capitalization, and the cost of insuring their debts is already on the rise.
In addition, the Washington-based NGO Global Financial Integrity (GFI) issued a report
last month that found the Russian economy is deeply intertwined with Western tax havens. Cyprus, although it has a total GDP of just $23 billion, is both the largest source of, and destination for Russian foreign direct investment. Cyprus "is a major money-laundering machine for Russian criminals," the report found.
Dev Kar, the GFI's lead economist and an author of the report, says: "In 2011 [Russia's underground economy] was 35 percent of GDP. Official GDP has increased by leaps and bounds [since 1994], and that's the reason why, as a share of GDP it has come down, but the absolute scale is very large."
According to the International Monetary Fund, other top investors in Russia and recipients of Russian investment include the Netherlands, the British Virgin Islands, Bermuda, the Bahamas, and Luxembourg.
Europe is currently reliant on Russia for natural gas.
The profits from these transactions for Western financial structures are enormous and the financiers who benefit from them often wield considerable political clout. This has led some observers -- and perhaps Russian President Vladimir Putin himself -- to conclude that countries like Britain and Germany would resist serious sanctions.
Ben Judah, a British journalist and author of "Fragile Empire: How Russia Fell In And Out Of Love With Vladimir Putin," says that "Whereas the Russian elite 15, 20, 30 years ago feared the European establishment as former SS officers and MI6 and other fearsome people about to dismember the Soviet Union, now they know full well these same European elites are the ones helping them plunder Russia."
"Because it is British bankers, it is French lawyers, it is German accountants who are the ones placing their money in the West," he says.
However, the unexpectedly tough talk out of Washington and European capitals in recent days seems to belie such concerns. On March 11, the European Parliament overwhelmingly passed a measure to crack down on anonymous shell companies by making the identities of corporate beneficiaries public.
GFI spokesman Clarke Gascoigne notes that Britain is a driving force behind this effort: "The U.K. is pushing strongly. The U.K. announced in October that they were going to create their own public registry of beneficial ownership information. And they've really been leading the charge on this. The U.K. is 100 percent behind this."
Economist Aslund agrees that these accounts make Russian businesses and the state officials connected to them extremely vulnerable not only to possible new sanctions, but also to stricter enforcement of existing due diligence and money-laundering regulations.
"When the crisis hit in Cyprus [in 2012], it was a great surprise that people did not move out their money -- that is, Russians and Ukrainians. And it turned out that a large number of them were state officials who could not move the money to another country simply because state officials are usually not allowed to open bank accounts," Aslund says.
Aslund says that because of the role many Russian state companies play in enabling officials to plunder the Russian economy, they are essentially "organized-crime syndicates."
Russian officials have said that any sanctions will be met with countermeasures. But Moscow's ability to inflict economic pain on the West may, in fact, be limited.
Changes in the global energy market, particularly the massive growth in U.S. natural-gas production, mean that Europe might well be able to withstand a total cut-off of Russian natural gas.
Moreover, Russia's integration into the global economy might make it difficult for Moscow to shut off gas to Europe, even in the event of Western sanctions, says Jonathan Stern, a senior research fellow at the Oxford Institute for Energy Studies.
"The first thing that would happen -- before we talk about [Europe's] survival -- is that the Russians would lose vast sums of money. Not just because they wouldn't be delivering gas but they would be in breach of their contracts. That is, I'm assuming you have a scenario where the Russians cut off the gas, not that the Europeans refused to receive the gas," Stern says.
"What everyone forgets about in all this talk about cutting off gas is this is not something that happens because somebody feels like doing it. This is under internationally binding contracts with arbitration and massive punitive damages."
After any sanctions war ended, Moscow would have to deal with those damages to reintegrate into the global economy and restore its reputation.
In addition, a rupture in economic relations between Europe and Russia would fast-track the EU's efforts to eliminate its energy dependence on Russia and give new impetus to measures such as the one the European Parliament passed this week to crack down on money-laundering. After a sanctions spat, Russia could face a very different and much less attractive position in the global economy.
It remains unclear how much these issues figure into Putin's calculus as he copes with the Ukraine situation. Andrew Wood, U.K. ambassador to Russia in 1995-2000 and currently an associate fellow at Chatham House, believes Putin is emotionally involved in the Ukraine situation.
"There is huge emotional content in this. And, for him [Putin] personally, since he came back in May 2012, he has increasingly relied on mass propaganda, on a basically conservative electorate rather than on those who are forward-looking," Wood says.
"And 'hurrah patriotism' works well in that context and has bolstered his support in the short term."
As a result, Wood says, Putin may be willing to bear a considerable amount of pain.
"Sanctions would -- if they went to the extent of interfering with bank funding and so on -- have a considerable effect on the Russian economy. But whether they would have an effect on Putin's attitude is another thing," Wood says.