The Case for a Ceasefire

The Cold War is back. On Thursday, February 24, Russia invaded Ukraine. On Sunday, February 27, Russian President Vladimir Putin (now a.k.a. “Mad Vlad”) put Russia’s nuclear deterrent on high alert in the face of a barrage of Western reprisals for his war on Ukraine, which said it had repelled Russian ground forces attacking its biggest cities. The US said Putin was escalating the war with “dangerous rhetoric,” amid signs that the biggest assault on a European state since WWII was not producing rapid victories but instead generating a far-reaching and concerted Western response.

What happens next? Assuming as I do that Putin won’t use nukes, here are some of the considerations that might influence the course of events:

(1) Military setbacks for Russia, but perhaps not for long. The first few days of the Ukraine invasion have not gone as well for Russia as Putin had expected. However, his troops reportedly are encircling the major cities of Ukraine. They may lay siege to the cities rather than risk urban warfare. It will be hard, if not impossible, for other nations to deliver the weapons they have promised the Ukrainian army. A stalemate would be painful for both sides of the conflict and provide a strong incentive for negotiators, who started meeting on Monday, February 28, to agree on a ceasefire. The severe economic sanctions imposed on Russia should increase Putin’s willingness to agree to a negotiated solution even if his military position improves in coming days.

(2) Russia losing the economic war. Russia has been trying to sanction-proof its economy since 2014 (when it invaded Crimea), including by reducing its dependence on the dollar by transacting in other currencies. But the US currency still accounts for about one-third of Russia’s imports and more than half of its exports. Unless Putin is totally isolated from reality, he must be aware of the severe impact that sanctions already are having on his economy.

The Russian ruble has collapsed 26% since the start of last week through February 28 to 107.19 rubles per dollar (Fig. 1). The Russian central bank raised its key interest rate to 20.0% from 9.5% on Monday in an emergency move, and authorities told export-focused companies to sell foreign currency as the ruble tumbled to record lows (Fig. 2). The 10-year government bond yield was 12.52% on February 25 (Fig. 3).

Since Monday, lines at ATMs have been snaking down sidewalks and around buildings in Moscow and at Russian banks in Europe as depositors have rushed to withdraw cash. Russia’s CPI was up 8.7% y/y through January (Fig. 4). It is likely to head much higher as a result of the war and sanctions. These economic and financial shocks are bound to feed an already vocal anti-war (and anti-Putin) movement within Russia.

(3) Frozen reserve assets. Russia’s non-gold international reserves rose to $498 billion during January (Fig. 5). The February 28 NYT reports, “Russia has spent the last several years bolstering its defenses against sanctions, amassing $643 billion in foreign currency reserves in part by diverting its oil and gas revenues and reducing its holdings of U.S. dollars.”

Russia was never a large holder of US Treasuries, compared to China and Japan. It held around $100 billion of them during H1-2017 and started to reduce them during H2-2017; by year-end 2018, they were close to zero (Fig. 6). That might have been the tip-off that Russia has been preparing for this war for a long time.

On Monday, the US Treasury Department further cut off Russia from the global economy by freezing Russian central bank assets that are held in the US and imposing sanctions on the Russian Direct Investment Fund, a sovereign wealth fund that is run by a close ally of Mad Vlad. The move was coordinated with European central banks. Japan joined with Western allies in imposing the central bank sanctions, freezing Russia’s yen-denominated foreign reserves.

Russia’s ability to use its international reserves to support its currency has been severely curbed.

(4) Frozen oligarchs. The NYT article cited above also reports: “Switzerland, a favorite destination for Russian oligarchs and their money, announced on Monday that it would freeze Russian financial assets in the country, setting aside its tradition of neutrality to join the European Union and a growing number of nations seeking to penalize Russia for the invasion of Ukraine. The country said it would immediately freeze the assets of Mr. Putin, Prime Minister Mikhail V. Mishustin and Foreign Minister Sergey V. Lavrov, as well as all 367 individuals the European Union imposed sanctions on last week.”

(5) Possible solution in negotiations? I doubt that Putin is intent on annexing all of Ukraine and making it part of Russia. I believe his goal is to install a puppet government in Kyiv. Either way, he would face protracted conflict with Ukrainian resistance forces and no end to sanctions. His fallback position might be to withdraw his forces from all but the two “independent republics” he carved out of eastern Ukraine last week in exchange for a guarantee that Ukraine won’t join NATO. Of course, I can’t rule out a regime change in Moscow, though that seems unlikely since Putin undoubtedly has surrounded himself with Praetorian guards.

(By the way, Wall Street legend Art Cashin recalled his frightening experience during the Cuban Missile Crisis when there were rumors that Russia had launched rockets and the Dow took a dive near the bell. He wrote: “I cleaned up my desk and raced to the Moosehead, as animated as only an 18-year-old can be. Jack was already there and as I burst through the door, I shouted: ‘Jack! Jack, there was a strong rumor that the missiles were flying and I tried to sell the market but failed.’ Jack said “Calm down kid! First buy me a drink and then sit down and listen to me.’ I ordered the drink and meekly sat down. Jack said—‘Look kid, if you hear the missiles are flying, you buy them. You don’t sell them.’ ‘You buy them?’ I said, somewhat puzzled. ‘Sure you buy them!’ said Jack. ‘Cause if you’re wrong, the trade will never clear. We’ll all be dead.’” Hat tip to Barry Ritholtz and his The Big Picture blog.)

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