THE BLOG
01/21/2015 12:32 pm ET Updated Mar 23, 2015

Beware the Blowback From Russia Sanctions

Last month, as President Obama prepared to sign tougher sanctions legislation aimed at Russia, the top White House economist, Jason Furman, boasted that the West's economic warfare was already bringing Russia to its knees.

"If I was chairman of President (Vladimir) Putin's Council of Economic Advisers, I would be extremely concerned," Furman said. Declaring that Putin and his circle were "between a rock and a hard place in economic policy," Furman crowed that "the combination of our sanctions, the uncertainty they've created for themselves with their international actions and the falling price of oil has put their economy on the brink of crisis."

There's no denying the perilous state of Russia's economy. In November, Russia's Finance Minister, Anton Siluanov, had predicted that sanctions and lower oil prices would cost the Russian economy as much as $140 billion, equal to about 7 percent of GDP. Over the course of 2014, the ruble lost 46 percent of its value, only to drop another 7 percent on the first day of trading in 2015. Russia's central bank estimates that the country suffered net capital outflows of $134 billion last year, setting the stage for a painful depression.

But as scholars and pundits have been telling us for years, in today's globalized world, no major problem--economic, political, or military--stays local for long. Punishing Russia for its annexation of the Ukraine and its continuing support for Ukrainian rebels is likely to create a host of unintended and costly repercussions for the United States and Europe.

Unlike some targets of U.S. sanctions, like Cuba or North Korea, Russian's economy is big enough to matter. Its free-fall may well drag the precarious EU economies part way down with it.

Asked by Bloomberg whether the world could see a financial contagion result from Russia's economic plight, West Shore Funds Chief Global Strategist James Rickards said, "I think we will. . . There's a lot of dollar-denominated corporate debt [in Russia] that they may not be able to pay. . . . If that stuff starts to default, who owns it? Well, it's owned by U.S. mutual fund investors, it's in 401Ks, some of it's in European banks. If you own Banco Santander and Banco Santander has a big slug of Russian corporate debt, how does it go down? They can point a finger at the Russians, but when that debt goes down, it's going to come back to haunt us."

New York Times columnist Thomas Friedman has also sounded the alarm: "Russia's decline is bad for Russians, but that doesn't mean it is good for us. . . . If Russia, an economy spanning nine time zones, goes into recession and cannot pay foreign lenders with its lower oil revenues -- and all this leads to political turmoil and defaults to Western banks -- that crash will be felt globally."

Europe has doubts

European leaders appear to be having second thoughts about the wisdom of playing a game of economic chicken when their own national economies are so weak. Austrian, French, German and Italian leaders, meeting at a Brussels summit in December, all warned that Russia's financial crisis could blow back against their own economies.

"The goal was never to push Russia politically and economically into chaos," said Germany's vice chancellor, Sigmar Gabriel.

In a similar spirit, French President François Hollande told a radio interviewer that sanctions--which included the cancellation of the delivery of two Mistral helicopter carriers to Russia--were both unnecessary and counterproductive.

"Mr. Putin does not want to annex eastern Ukraine," Hollande said. "What he wants is to remain influential. What Mr. Putin wants is that Ukraine not become a member of NATO."

As for sanctions, Hollande said, "I'm not for the policy of attaining goals by making things worse. I think that sanctions must stop now."

Such concerns did not dissuade Congress last month from unanimously passing tough new bans on financing and technology transfers--along with $350 million in arms and military equipment to the Ukraine and $90 million for anti-Putin propaganda and political operations in Russia. Former Rep. Dennis Kucinich noted that this momentous legislation passed the House of Representatives late at night with only three members present.

Be careful what you wish for

Promiscuous use of sanctions against Russia and a host of other international targets ironically could come back to haunt the United States by undermining the very neo-liberal principles it has championed for decades to undergird U.S. economic expansion.

Putin sounded more like a leader of the Trilateral Commission than an ex-KGB officer when he warned last fall, "Sanctions are already undermining the foundations of world trade, the WTO rules and the principle of inviolability of private property. They are dealing a blow to [the] liberal model of globalisation based on markets, freedom and competition, which, let me note, is a model that has primarily benefited precisely the Western countries."

Ian Bremmer, president of the Eurasia Group and foreign affairs columnist for Time magazine, echoed Putin's comments in his recent global survey, "Top Risks 2015," which warned that "American unilateralism is stoking dangerous trends" around the world.

With regard to economic sanctions, Bremmer observed, "The most important near-term challenge is the damage inflicted on transatlantic relations. Europe will become more frustrated with an American unilateralism that Europe (and European banks) must pay for. . . Over the longer term, though, others will diversify away from reliance on the dollar and US-dominated institutions, particularly in East Asia, where China has the muscle and the motive to create its own institutions, and where there is less dollar-denominated debt to complicate the process."

As a further concern, he noted, "Governments targeted by sanctions will increasingly treat companies that comply with them as instruments of American power. This will expose these firms to heightened risks of retaliation-- from regulatory harassment to contract discrimination to cyber-attacks. The US financial sector is particularly vulnerable on this count."

The danger of extremism

The long-term consequences of such sanctions could extend far beyond the cost to our own and other Western economies. Already U.S.-Russian cooperation on arms control has been imperiled. Pushed to the wall, Russia may decline to continue its essential cooperation with regard to resupply corridors into Afghanistan, the Iran nuclear negotiations, and a political settlement in Syria--all of which rank far higher in any rational list of priorities than the fate of the Eastern Ukraine.

As Bremmer warned, "A Kremlin that feels antagonized and isolated but not substantially constrained is a dangerous prospect. An aggressively revisionist yet increasingly weak Russia will be a volatile actor on the global stage in 2015, posing a top risk to Western governments and businesses throughout the year." He predicted the possibility of more stealth cyber-attacks, confrontations with NATO, and tighter bonding between Russia and China at the expense of the West.

If, as many Russians believe, the real aim of sanctions is regime change--just as President Nixon promoted a military coup against Chile's Salvador Allende by ordering policies to "make the economy scream"--most observers agree the West could end up with a far more antagonistic regime post-Putin.

In the short run, of course, sanctions simply inflame Russian nationalism and bolster Putin's popularity. But in the longer run, observed Russia expert Angus Roxburgh in The Guardian, "Pouring fuel on Kremlin clan wars that we barely understand would be the height of folly. We have no idea what the outcome might be - and it could be much worse than what we have at present."

The longer the Ukraine conflict simmers, the more extremists on both sides gain leverage. Writing last September in The Moscow Times, Natalia Yudina noted that "a significant number of right-wing Russian radicals are now actively fighting in Ukraine. Whereas they previously took part in social networks, historic war battle reenactment groups and all sorts of quasi-military training camps, they are now gaining real-world combat experience. Following the conclusion of the conflict, most will inevitably return to Russia, where their long-standing dreams of staging a 'Russian revolt' or 'white revolution' will no longer seem so difficult an accomplishment. And that means that one more consequence of this war will be a sharp escalation of activity by right-wing radicals -- only this time, in Russia itself."

Without a crystal ball, we have no way of knowing whether the new cold war with Russia will thaw or go into a deeper freeze. But it seems abundantly clear that economic sanctions and political confrontation over the fate of the Eastern Ukraine magnify the risks to global order far out of proportion to any real U.S. and Western interests.

It's worth remembering, with the centenniary of World War I just past, that economic collapse and social disruption are more likely to sow the seeds of extremism and conflict than to make the world safe for democracy. If policy makers look to history for policy guidance, they would be well advised to study the lessons of Versailles rather than staying fixated on those of Munich.

Note: A longer version of this essay appeared in Consortiumnews.com.