Cutting off Russia's allowance

From: POLITICO's Morning Money - Wednesday Apr 06,2022 12:01 pm
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By Kate Davidson and Aubree Eliza Weaver

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The U.S. is tightening the squeeze on the Russian economy yet again, this time with a threat that may be harder for the Kremlin to ignore: default.

The Treasury has cut off Russia’s ability to make debt payments using dollars held at U.S. banks, stepping up its effort to choke off financial resources for Russia’s military. “Russia must choose between draining remaining valuable dollar reserves or new revenue coming in, or default,” a Treasury spokesperson said Tuesday.

The U.S. and its allies are also set to level another battery of penalties today, including a ban on all new investment in Russia and tighter sanctions on financial institutions, according to people familiar with the matter.

More from your MM host and Victoria Guida: “The measures, which will also include further sanctions on state-owned Russian enterprises, government officials and their family members, are aimed at degrading key instruments of the Kremlin’s power and are meant to impose acute economic harm on Russia, the people said.

“The announcement comes as pressure has been building on Western economies to ratchet up sanctions on Russia over the apparent massacre of Ukrainian civilians, which prompted President Joe Biden to repeat his accusation that Vladimir Putin is a war criminal.”

Ukrainian President Volodymyr Zelenskyy addresses the UN Security Council via video.

Ukrainian President Volodymyr Zelenskyy addresses the U.N. Security Council via video link on April 5. | Spencer Platt/Getty Images

What does it mean? Let’s start with default.

Western sanctions have already dealt a significant blow to the Russian economy, but defaulting on its debt would bring long-term consequences that Russia has been intent on avoiding ever since the financial crisis of 1998, the last time it defaulted.

“The U.S. Treasury has realized that they have leverage, because the Russians don’t want to default,” said Tim Ash, senior sovereign strategist at BlueBay Asset Management in London. “It’s a message to the Russians: If you want to avoid default, which will have long-term ramifications on your economy, get out of Ukraine.”

A Russian default would be unlikely to trigger a global financial crisis, experts have said, given the total exposure of banks to Russia is relatively modest.

But it could create a decades-long overhang for Russia, said Josh Lipsky, director of the Atlantic Council’s GeoEconomics Center. Restructuring its debt could prove extremely difficult as long as sanctions are in place, and it won’t be able to turn to the International Monetary Fund for help.

“It will affect their credit rating, it will affect their ability to access debt for years. When they do borrow, it will be at a much higher rate,” Lipsky siad.

A default threat could also have an important psychological effect, Lipsky added. Russia has prided itself on running a tight economic ship, and has limited debt compared to other G-20 economies.

“They have always said, ‘We do not want to repeat 1998,’ the Russian financial crisis,” he said.

What about sanctions?

The U.S. is making the latest moves in coordination with the European Union and G-7 countries.

In Europe, a sanctions package proposed to member countries by the EU on Tuesday would phase out Russian coal deliveries from the bloc’s energy imports, ban Russian vessels and trucks from entering the EU and impose tougher sanctions on four key Russian banks, which would be totally cut off from the markets.

However, the European plan stops short of a full ban on Russian oil imports, amid resistance from countries led by Germany.

The problem: Russia is “making money hand over fist” from its sales of oil and gas, helping it generate a massive current account surplus, said Robin Brooks, chief economist for the Institute of International Finance. Last year, Russia’s surplus was roughly 6 percent of gross domestic product — It could be roughly double that this year, given how much energy prices have risen, Brooks said.

That has allowed the Russian central bank to support the ruble, and taken some of the sting out of Western sanctions.

“Sanctions in a current account surplus country generally have less bite,” he said. “What you really want is you want to target the current account surplus. You want to go where the money is being generated.”

After the atrocities uncovered in Bucha, Brooks said it seems Europe is grudgingly moving toward measures that would do just that, starting with limits on coal imports.

“But I think the political discussion in Europe is far from over,” he said. “My best guess is that we will see a fairly comprehensive energy embargo in the coming weeks. And conceptually that has much more bite than financial sanctions.”

IT’S WEDNESDAY — Brace yourselves: We’ve got Janet Yellen testifying in the morning, Fed minutes in the afternoon and a new sanctions announcement from the White House. Go ahead, have that extra cup of coffee.

And while you’re at it, send us those tips, story ideas and feedback: kdavidson@politico.com or @katedavidson, or aweaver@politico.com or @aubreeeweaver.

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Driving the Day

National Economic Council Director Brian Deese speaks at Christian Science Monitor breakfast at 9 a.m. … Treasury Secretary Janet Yellen testifies at House Financial Services on the state of the international financial system at 10 a.m. … Senate Banking nomination hearing on U.S. Mint, Treasury nominees at 10 a.m. … SEC meeting on security-based swap execution facilities rules at 10 a.m. … Richmond Fed’s Tom Barkin speaks at 10 a.m. … House Select Committee on Economic Disparity hearing on market concentration, compensation and prices at 12 p.m. … Fed meeting minutes released at 2 p.m.

TREASURY SANCTIONS RUSSIAN CRYPTO EXCHANGE — Our Sam Sutton: “The Treasury Department on Tuesday announced fresh sanctions against a Moscow-based cryptocurrency exchange and a prominent darknet marketplace in a crackdown on foreign online services that facilitate ransomware attacks and other criminal activity.

“The Office of Foreign Assets Control sanctioned Garantex, a trading platform used by Russian cybercriminals, along with Hydra, where ransomware software and other illicit goods are traded for virtual currency. The action comes amid rampant speculation about crypto’s utility as a tool to subvert economic restrictions imposed after Russia’s invasion of Ukraine.”

Federal Reserve governor Lael Brainard testifies at her nomination hearing on Capitol Hill on Jan. 13.

Federal Reserve governor Lael Brainard testifies at her nomination hearing on Capitol Hill on Jan. 13. | Drew Angerer/Getty Images

BRAINARD: REDUCING ELEVATED INFLATION IS ‘OF PARAMOUNT IMPORTANCE’ — WSJ’s Nick Timiraos: “A top Federal Reserve official said the central bank is strongly committed to taking steps that will reduce inflation this year, including by approving significant reductions in its $9 trillion asset portfolio at its policy meeting early next month. Fed governor Lael Brainard, who is awaiting Senate confirmation to serve as the Fed’s vice chairwoman, said she anticipated shrinking the asset portfolio — sometimes referred to as a ‘balance sheet’ — and a series of interest rate increases to move the Fed’s policy stance to a more neutral position that no longer provides stimulus to the economy later this year.”

GLOBAL TAX DEAL COULD HAVE DISASTROUS EFFECTS — Our Bernie Becker: “More than two dozen advocates for low-income housing and community investment are sounding the alarm over the global tax deal agreed to by the U.S. and dozens of other countries. The advocates specifically are worried about proposed rules for a global minimum tax, which businesses and experts believe could undercut the value of key domestic tax incentives.”

—Meanwhile, Poland on Tuesday vetoed an EU bill designed to implement the initiative, which G-20 countries agreed on last fall in a wider bid to obliterate tax havens and ensure that tech giants pay their fair dues, our Bjarke Smith-Meyer reported.

SENATE CLEARS WAY FOR VOTE ON FHA COMMISSIONER — Our Katy O’Donnell: “The Senate moved on Tuesday to advance the nomination of Julia Gordon to be the next commissioner of the Federal Housing Administration, all but assuring her confirmation to the post. Vice President Kamala Harris broke a tie to discharge Gordon’s nomination, which can now be called for a confirmation vote by Senate leadership.”

FIRST IN MM: LUCAS TO INTRODUCE ‘OSTRACIZE CHINA ACT’ — Rep. Frank Lucas (R-Okla.) will introduce legislation this morning intended to combat what he says is the greatest political and economic threat to America’s security: China. The “Ostracize China Act” would direct specified financial regulators to exclude representatives of China from certain banking organizations, in the event that China threatens the security of Taiwan or its social or economic systems.

 

DON'T MISS ANYTHING FROM THE 2022 MILKEN INSTITUTE GLOBAL CONFERENCE: POLITICO is excited to partner with the Milken Institute to produce a special edition "Global Insider" newsletter featuring exclusive coverage and insights from the 25th annual Global Conference. This year's event, May 1-4, brings together more than 3,000 of the world’s most influential leaders, including 700+ speakers representing more than 80 countries. "Celebrating the Power of Connection" is this year's theme, setting the stage to connect influencers with the resources to change the world with leading experts and thinkers whose insight and creativity can implement that change. Whether you're attending in person or following along from somewhere else in the world, keep up with this year's conference with POLITICO’s special edition “Global Insider” so you don't miss a beat. Subscribe today.

 
 
Fed File

FED'S GEORGE SAYS RATE HIKE DEBATE MUST INCLUDE BALANCE SHEET — Bloomberg’s Steve Matthews: “I think 50 basis points is going to be an option that we will have to consider, along with other things,’ George said in a Bloomberg News interview with Michael McKee on Tuesday. “We have to be very deliberate and intentional as we remove this accommodation. I am very focused on thinking about how the balance sheet moves in conjunction with policy-rate increases.”

BROWN PUSHING TO CONFIRM FED NOMINEES THIS WEEK — Bloomberg’s Steven T. Dennis: “Senate Banking Chairman Sherrod Brown said he and Majority Leader Chuck Schumer are pushing to confirm all four Federal Reserve nominees this week, but doing so will require Republican cooperation. The Ohio Democrat said that without agreement from Republicans it would take 30 hours of debate to get to Jerome Powell’s nomination to a second term as Fed chair — too long to finish all the nominations this week. ‘It’s up to McConnell to agree to shrink the number of hours,’ Brown said, referring to Senate GOP Leader Mitch McConnell. ‘Powell will be last. I want to do them all.’”

 

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Economy

DEUTSCHE BANK PREDICTS U.S. RECESSION IN 2023 — Bloomberg’s Rich Miller: “The U.S. will tumble into a recession next year as the Federal Reserve jacks up interest rates to combat high and widening inflation, Deutsche Bank economists David Folkerts-Landau and Peter Hooper said in a report on Tuesday. … Deutsche Bank is one of the first major banks to forecast a U.S. recession.”

IF THE ECONOMY IS BOOMING, WHY ARE ECONOMISTS WORRIED ABOUT A RECESSION? — NYT’s Ben Casselman: “Rapid inflation, soaring oil prices and global instability have led forecasters to sharply lower their estimates of economic growth this year, and to raise their probabilities of an outright contraction. Investors share that concern: The bond market last week flashed a warning signal that has often — though not always — foreshadowed a downturn. Such predictions may seem confusing when the economy, by many measures, is booming.”

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Fly Around

JPMorgan Chase on Tuesday started to allow holders of depositary receipts in Russian companies to cancel them, two sources familiar with the matter said, giving some investors a way to liquidate what have largely been frozen holdings. — Reuters’ Sinead Cruise and Carolina Mandl

The U.S. dollar hit its highest in nearly two years on Tuesday, boosted by hawkish comments from Federal Reserve officials who pushed for a quick reduction in the central bank's bloated balance sheet, with one of them expressing openness to hefty rate increases of half a percentage point. — Reuters’ Gertrude Chavez-Dreyfuss

ADD DECLINING IMMIGRATION TO PROBLEMS WEIGHING ON THE LABOR MARKET — WSJ’s Michelle Hackman: “The slowdown has left the U.S. with 2.4 million fewer immigrants of working age —about 1% of the working-age population—than if pre-2017 immigration trends had continued, according to Giovanni Peri, a labor economist at the University of California, Davis.”

 

INTRODUCING DIGITAL FUTURE DAILY - OUR MORNING TECHNOLOGY NEWSLETTER, RE-IMAGINED:  Technology is always evolving, and our new tech-obsessed newsletter is too! Digital Future Daily unlocks the most important stories determining the future of technology, from Washington to Silicon Valley and innovation power centers around the world. Readers get an in-depth look at how the next wave of tech will reshape civic and political life, including activism, fundraising, lobbying and legislating. Go inside the minds of the biggest tech players, policymakers and regulators to learn how their decisions affect our lives. Don't miss out, subscribe today.

 
 
 

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