Unintended consequences? Western sanctions will cause Russia to change its economic partners...for the better

Western sanctions might push Russia to deepen cooperation with BRICS states, in particular, to strengthen its ties with China, which will possibly turn out to be a big catastrophe for the US and the EU some time later. 

On March 18, the spokesperson for the Kremlin, Dmitry Peskov, claimed in a BBC interview that Russia would switch to new partners in case of economic sanctions being imposed by the European Union and the United States. He highlighted that the modern world isn't unipolar and Russia has strong ties with other states as well, though Russia wants to remain in good relations with its Western partners, especially with the EU due to the volume of deals and joint projects. 

Those "new partners" are not really new since Russia has been closely interconnected with them for almost 13 years. This is all about the so-called BRICS organization, consisting of Brazil, Russia, India, China and South Africa. BRICS represents 42 percent of the world's population and about a quarter of the world's economy, which means that this bloc of states is an important global actor. 

The BRICS countries are like-minded in regard to supporting the principles of international law, the central role of the UN Security Council and the principles of the non-use of force in international relations; this is why they are so actively performing in the sphere of settling regional conflicts. However, the cooperation between Brazil, Russia, India, China and South Africa goes beyond political aspects and is also demonstrated by dynamic trade and multiple projects in different areas. Today, in total, there are more than 20 formats of cooperation within the BRICS which are intensively developing. For example, in February the member-states came to an agreement about 11 prospective directions of scientific and technical cooperation, from aeronautics to bio- and nanotechnology. In order to modernize the global economic system, at the center of which stand the US and the EU, the leaders of Brazil, Russia, India, China and South Africa have created the BRICS Stock Alliance and are creating their own development bank to finance large infrastructure projects. On the whole, despite fierce criticism of BRICS as an organization with no future, it is developing and increasing cooperation with its members and, in fact, BRICS is showing pretty good results. 

With suspension of Russian participation in G8 and possible strengthening of economic sanctions, the experts expect some particular industries to be targeted, including limits on imported products. While the West seeks to hit Russia hard, it is important to notice that Russia is ready to switch to other markets, for instance BRICS, and increase trade volumes with countries from this bloc. 

Indeed, Russia buys significant amount of products from NATO states, for example, 50 percent of fruits and berries come from Spain, Holland and Poland. Nevertheless, Russia is intensifying its economic ties with the developing world. In 2012 Russia was buying 41 percent of its beef from Brazil, though this index has recently decreased to 20 percent, and Russia is likely to increase its import in case of need. In February 2013, Russia and Brazil reached an agreement on the long-standing problem of pork exports to Russia, as well as agreeing on a list of sanitary and quality requirements for the annual import of millions of metric tons of Russian wheat. This is a shining example of the substitute partnerships that have yielded positive results, although some problems with sanitary norms had to be resolved. In other words, it's beyond the power of the EU and US to make Russian people suffer from products scarcity since they are not the country's only trade partners. 

The biggest brick in BRICS 

© Reuters/Sergei Ilnitsky
Chinese President Xi Jinping (L) and his Russian counterpart Vladimir Putin.

It's hard to ignore the fact that the role of the biggest and strongest member of BRICS is China's, and obviously Russia will seek to improve its relations with Beijing even more than before. During the last year, relations between Russia and China have been enhancing and actively developing in various spheres. In particular, in 2013 the states signed 21 trade agreements, including a new 100 million ton oil supply deal with China's Sinopec. In October 2013, the Xinhua news agency also reported that the two governments signed an agreement to jointly build an oil refinery in Tianjin, east of Beijing. 

Moreover, China promised to pump $20 billion of investment into domestic projects in Russia, focusing on transport infrastructure, highways, ports, and airports, and it hoped to increase investment in Russia four-fold by 2020. In 2013, the trade volume between the states reached $89 billion, with bilateral economic relations showing positive signs, meaning that further cooperation will increase. 

Indeed, leaders of the states called for annual bilateral trade between the two countries to be boosted to $100 billion by 2015. Besides, the two countries are considering further partnerships in the energy sector, particularly in the gas industry. 

Currently, Russian gas is not supplied to China, though in 2013 Russia's biggest independent natural gas producer, Novatek, signed preliminary memorandums with CNPC to sell at least 3 million tons of LNG per year between Yamal LNG and PetroChina International. Another Russian company, Rosneft, which is 75 percent state-owned, is vastly expanding its LNG projects to diversify its portfolio, and is focusing heavily on eastern markets, like Japan and China. In terms of confrontation between the West and Russia, the gas contracts between China and Russia could really gain momentum. At the same time it's possible that Moscow would sign contracts on the sale of the Sukhoi Su-35 fighter to China before President Putin embarks on a visit to Beijing in May. 

In 2014, Russia and China have a full agenda for bilateral cooperation, which includes not only trade but also such spheres as energy, aircraft building, mechanical engineering, military and science cooperation, tourism, etc. At the same time, cultural ties between the two nations are also strengthening, with 2014-2015 being named years of youth exchange. The leaders of Russia and China also decided to prepare jointly celebration events for the 70th anniversary of the victory over German fascism and Japanese militarism in 2015. 

Another important aspect of cooperation between Russia, China and India touches upon Afghanistan. The trilateral involvement of those nations into the Afghan issue has been actively developing since 2013 and could become a major factor for the Afghan leadership following the US withdrawal. It is important to note that the Afghanistan issue is vital to the regional security of Russia, China and India. 

Once again, the recent Olympic Games emphasized the specific character of relations between China and Russia. The Chinese president, unlike European leaders, was present at the Opening Ceremony, which is especially demonstrative given that it was the time of the Spring Festival in China, when the Chinese prefer not to leave their homes except for visiting relatives and close friends. 

Thus, China may become the biggest beneficiary of the sanctions against Russia since it means further rapprochement between Russia and China. One should remember that China has always been mainly interested in doing business and for sure it would be silly for Beijing to lose such a great opportunity to strengthen its ties with Russia. If I were someone responsible for decisions in Brussels or Washington, I would revise my opinion on implementation of sanctions against Russia. I wouldn't call it a possible revival of the "Sino-Soviet axe" which existed during the Cold War and was an ideological counter-balance for the West, although this time the West itself is pushing one of its main rivals closer to another, creating a massive power that would surpass both the US and the EU by a long chalk. So the question is whether the West really wants this to happen? And what will it do when the Chinese dragon and Russian bear form an alliance? 

Brazil is not only about meat 

© Agence France-Presse/G20RUSSIA
Dilma Rousseff, President of Brazil, (L) speaks before the BRICS summit in Saint Petersburg in the sidelines of the G20 summit on September 5, 2013.

As was already mentioned, another BRICS-member Brazil is one of the Russian suppliers of meat, and trade in this industry is likely to rise if the West resorts to economic sanctions. However, meat import isn't the only thing that binds these states. Over the last few years, Russia has also imported Brazilian coffee, sugar, juices and alcohol and exported mainly fertilizers. Moscow and Brasilia made a commitment to develop comprehensive cooperation in various areas, although for the moment particular attention is being paid to the military sphere. For instance, in December 2012 the states signed a treaty on supplies of Russian helicopters to Brazil. 

The total trade volume between Russia and Brazil in 2013 made up $5.7 billion, however the two states seek to increase it up to $10 billion in the near future. The trade index in January 2014 reached $438.9 million, which was $25 million higher in comparison with January 2013. The distinctive feature of the cooperation between the two countries is the complimentary character of their economies, which makes ties between Brazil and Russia even stronger. In fact, there is a great potential for Russian-Brazilian cooperation and results of these ties could also be disappointing for the West. 

I is for India 

© Agence France-Presse/Prakash Singh

In his speech at a joint session of parliament on March 18, Russian President Putin thanked both India and China for their stance on the Ukrainian crisis. But why is India supporting Russia? Maybe the Indian government equates some similarities with Crimea in the history of Sikkim's referendum and further merger with India when it became the 22nd Indian state in 1975 with Russian support. Maybe India is just seeking to develop closer ties and mutually beneficial partnerships with Russia. 

Anyway, let's look at some facts and figures. In 2012, bilateral trade volume reached $11,000 million which is rather modest in comparison with China or Brazil. Moreover, in 2013 this index slightly decreased. However, 2014 promises the renewal of bilateral contracts between India and Russia. For example, Defexpo India 2014 has reaffirmed the special relationship that exists between the defense industries of Russia and India, with a pavilion that houses exhibits of Russian companies being visited by top members of the Indian establishment. In general, the defense interactions between Russia and India are quite diversified, with almost every defense contract providing the creation of joint ventures or licensed production. In 2013, India's import of Russian weapons reached $4.78 billion. Another industry which attracts India is computer-guided weapons, produced by the Russian Morinformsystem-Agat Concern. 

In February the two states also confirmed their plans to boost cooperation in nuclear energy, with the former backing the construction of more units at the Kudankulam Nuclear Power Project (KNPP) and other parts of the country. Besides, India and Russia are set to sign an agreement aimed at productive cooperation in many spheres: space and military cooperation, trade, construction of a pipeline from Russia to India, and plans to set up a Joint Study Group to look into the scope of the CECA (Comprehensive Economic Cooperation Agreement) with member-countries of the Customs Union (the Russian Federation, Kazakhstan and Belarus). It is certain that after this issue is addressed, trade volumes between Russia and India, as well as between the Customs Union and India will increase significantly. 

Costs for the West 

It's not really rational for the US and the EU to antagonize and try to isolate Russia. And there are several reasons for this. First of all, Russia is the largest oil and gas producer in the world and it simply means that imposing economic sanctions on Russia would shake up the global energy market and, therefore, the entire global economy. Not to mention the EU's dependency on Russian gas. Are the global economies ready to witness a new crisis, given that they are still recovering from the latest financial crisis? It's doubtful. 

Second, Russia is investing massively in the US financial market, especially in Treasury bonds, and consequently, if Russia decides to withdraw its investments in response to Western sanctions, it would hit the US economy and cause a real financial crisis. So, crisis again. 

Finally, during the last few years the Russian market has become one of the world's largest markets for EU goods, products and services, while the EU is actively investing in Russia. In case of further worsening of relations between Russia and the West, the EU will have a serious headache, searching for new markets and suffering lasting damage because of suspended joint contracts. 

So is it really worth pushing for such a gloomy future, or is it better to recognize the will of the Crimeans and give the whole of Ukraine a chance for a better life?

http://www.sott.net/article/276210-Unintended-consequences-Western-sanctions-will-cause-Russia-to-change-its-economic-partners-for-the-better

The Chinese Yuan Is Collapsing

The Yuan has weakened over 250 pips in early China trading. Trading at almost 6.22, we are now deeply into the significant-loss-realizing region of the world's carry-traders and Chinese over-hedgers. Morgan Stanley estimates a minimum $4.8bn loss for each 100 pip move. However, the bigger picture is considerably worse as the vicious circle of desperate liquidity needs are starting to gang up on Hong Kong real estate and commodity prices. For those who see the silver lining in this and construe all this as a reason to buy more developed world stocks on the premise that the money flooding out of China (et al.) will be parked in the S&P are overlooking the fact that the purchase price of these now-unwanted positions was most likely borrowed, meaning that their liquidation will also extinguish the associated credit, not re-allocate it.

While widening the trading bands keeps some semblance of rationality, this is anything but an orderly unwind of the world's largest carry trades:

For some context, this is the biggest quarterly drop in CNY since Q4 1993...

How Much Is at Stake?
In their previous note, MS estimated that US$350 billion of TRF have been sold since the beginning of 2013. When we dig deeper, we think it is reasonable to assume that most of what was sold in 2013 has been knocked out (at the lower knock-outs), given the price action seen in 2013.

Given that, and given what business we’ve done in 2014 calendar year to date, we think a reasonable estimate is that US$150 billion of product remains.

Taking that as a base case, we can then estimate the size of potential losses to holders of these products if USD/CNH keeps trading higher.

In round numbers, we estimate that for every 0.1 move in USD/CNH above the average EKI (which we have assumed here is 6.20), corporates will lose US$200 million a month. The real pain comes if USD/CNH stays above this level, as these losses will accrue every month until the contract expires. Given contracts are 24 months in tenor, this implies around US$4.8 billion in total losses for every 0.1 above the average EKI.

Below we have tried to simplify what is happening as much as possible... (since there are many pathways into and out of all of these positions) to try and enable most to comprehend the problem

Virtuous circle... (last few years)

• Specs sell USD/JPY/EUR, Buy CNY
• Use CNY to buy copper/commodities
• Use copper to finance credit
• Use credit to finance working capital/real estate purchases
• Real estate goes up, more credit available
• Copper goes up, more credit available
• encourages more buying CNY to start virtuous circle...

BUT what happens when one of these chains start to break? OR ALL OF THEM? (now!)

• Thanks to PBOC, can't roll debt via shadow banking system
• Can't rely on local govt to bail out cashflow
• Sell copper/commodities to meet cashflow needs
• Copper price goes down, credit tightens
• Credit tightens, Real estate prices drop
• Real estate prices drop, specs start exiting CNY
• CNY weakens...

And then... (tomorrow)

• Plenty more firms piled on to use the inexorable trend in CNY strengthening as their carry-trade piggy bank (or merely to hedge their export receipts)...
• Those derivative (over-hedges) are now losing money very rapidly...
• Liquidate hedges - downward pressure on CNY
• downward pressure on CNY, more losses...

Remember carry-traders are little more than sophisticated leveraged momentum players - so when the trend is no longer your friend, no amount of carry-arbitrage will cover MtM losses on the notional...

Arguing that the PBOC can defend the currency is moot (they clearly do not wish to); Arguing that the PBOC will manage liquidity via their huge FX reserves is moot (they have done so with the banks - who are awash with liquidity as noted by the low repo rates) - this is about forcing the shadow-banking system to shrink before the bubble becomes totally untenable... unfortunately, we suspect it already has...

Oh dear, remember the Chinese corporation that untenably insolvent but "promised" it would meet interest payments in July and not default... well:

• *BAODING TIANWEI BOND TRADING SUSPENDED BY SHANGHAI EXCHANGE

Uh oh...

All the carry-funded idiocy of the world is starting to unwind

As the world slowly realizes the Fed's growing hawkishness (what are they afraid of? or do they really believe that the economy is growing organically?)

http://www.zerohedge.com/news/2014-03-19/chinese-yuan-collapsing

Euro strong as Ukraine crisis develops

The EUR/USD has had a steady uptrend since Feb.  Analysis of any sanctions against Russia suggest that the US or the EU may be more negatively impacted.  For the time being, EUR/USD seems to be getting a boost from real money flows - as concerned parties sell their USD for EUR.  But how long with that last?  If the EU is a net loser of this situation, be it from sanctions, or the close proximity to Ukraine, it will certainly put pressure on the Euro.  But if Russia and China retaliate, the US would feel the most economic pressure (for example by Russia/China dumping USD on the market).  These opposing pressures will make it difficult for EUR/USD to have a clear direction in the coming months as the crisis unfolds.  Also, volatility can be expected in any Euro or US Dollar denominated pair, if any significant actions are taken by a state (such as China flooding the market with USD which they have in large supply).  See the below daily EUR/USD chart:

Daily EUR/USD 

Russia’s $160 Billion Stick Hinders Crimean Sanctions

As U.S. and European officials began imposing sanctions in their face-off with Russia over Ukraine, Vladimir Putin’s $160 billion in oil and natural gas exports may be his most potent weapon to limit punitive measures.

The U.S. and its European allies have few levers to deter Putin even as they warn Russia not to annex Crimea after a referendum in Ukraine’s southern region yesterday. The European Union today imposed travel-visa bans and assets freezes on 21 individuals and President Barack Obama issued an executive order naming seven Russians for sanctions.

Russia, the world’s largest oil producer, exported $160 billion worth of crude, fuels and gas-based industrial feedstocks to Europe and the U.S. in 2012. While shutting the spigot on Russian energy exports would starve the Moscow government of essential flows of foreign cash, the price may be too high for European consumers and it may not alter Putin’s plans, said Jeff Sahadeo, director of Carleton University’s Institute of European, Russian and Eurasian Studies.

Related:

• Putin Is No Mad Man to Russians as Power Play Trumps Economy
• Obama Imposes Sanctions on Seven Top Russians After Crimea Vote
• EU Adopts Sanctions on Russians After Crimea Referendum
• Ukraine’s Culture Is Bloody, Splendid and Chekhovian
• West Warns Russia Not to Annex Crimea After Referendum
• Opinion: Sanction Russia? Reagan Tried It With No Luck

“In the short term, this would be very difficult to do and it’s not clear it would even affect Russian behavior,” Sahadeo said in a phone interview from Ottawa. If the West “puts down the card of energy sanctions, it becomes a question of who blinks first.”

Economic Pain

German Chancellor Angela Merkel, leader of the European Union’s biggest economy, said last week her nation is prepared to bear the economic pain that would accompany Russian retaliation to any sanctions.

“If Russia continues to interfere in Ukraine, we stand ready to impose new sanctions,” Obama said in a press conference today.

Analysts from Goldman Sachs Group Inc., Bank of America Corp. and Morgan Stanley said Europe probably won’t back sanctions that limit flows of Russia’s oil and gas. European members of the Paris-based International Energy Agency imported 32 percent of their raw crude oil, fuels and gas-based chemical feedstocks from Russia in 2012.

Collectively, the EU, Turkey, Norway, Switzerland and the Balkan countries got 30 percent of the natural gas they burned from Russia last year, much of it pumped through pipelines that cross Ukrainian territory, according to the U.S. Energy Department in Washington.

Failed Attempt

Abstaining from Russian oil and gas would be “off the table” for Europe, said Marc Lanthemann, Eurasia analyst with Stratfor, a geopolitical intelligence company based in Austin, Texas. Europe risks a replay of its failed attempt six years ago to punish the Kremlin for going to war with the Republic of Georgia, when it was unable to impose sanctions after acknowledging its dependence on Russian energy.

“We’re not expecting sanctions with many teeth coming through,” Lanthemann said.

While the ruble, Ukrainian hryvnia and other regional currencies have tumbled as the conflict escalated, global oil markets aren’t reacting to the potential for a sanctions-induced supply disruption.

Brent crude futures traded in London, the benchmark for more than half the world’s oil, traded at $107 a barrel today, a decline from March 3, after Russia’s Parliament approved the use of its military in Ukraine.

U.K. gas for next month, the EU’s benchmark contract traded on ICE Futures Europe, fell 1 percent to 58.44 pence a therm at 2:57 p.m. London time, down from 61.70 pence on March 3.

‘Counterproductive Instrument’

Crimea, a dominion of Russia and then the Soviet Union for more than two centuries before the Communist empire collapsed in 1991, voted yesterday to join Russia. The plebiscite was called after a popular uprising forced Russian-backed President Viktor Yanukovych to flee the Ukrainian capital of Kiev last month.

“Our partners understand that sanctions are a counterproductive instrument,” Russian Foreign Minister Sergei Lavrov told reporters after meeting with U.S. Secretary of State John Kerry on March 14.

The U.S. and Europeans will likely disagree over any energy sanctions and how much should be curtailed, said Seva Gunitsky, an assistant professor at the University of Toronto’s Munk School of Global Affairs.

Sanction Traction

“In order to get any traction with sanctions you have to bring the EU in and I think that will be a difficult task because of their dependence on Russian oil and gas resources,” Gunitsky said.

The EU’s bill for Russian oil and gas amounted to $156.5 billion in 2012, 38 times what the U.S. spent for Russian energy, according to the International Trade Centre’s Trade Map, a venture sponsored by the World Trade Organization and the United Nations.

Sanctions that crimp the lifestyles of Putin’s billionaire friends, such as visa restrictions and bank account freezes, might “be more effective and easier for Europe to stomach than sanctions on Russian gas,” Gunitsky said.

And energy sanctions may backfire if cutting off Russian shipments raises prices and triggers a backlash from angry European consumers.

“The sanctions might hurt the current customers of Russia at least as much as they hurt Russia,” said Judith Dwarkin, chief energy economist at ITG Investment Research in Calgary. “It’s a double bind. The European market is very important for Russia and Russia is very important for the European market.”

http://www.bloomberg.com/news/print/2014-03-17/russia-s-160-billion-stick-hinders-crimean-sanctions.html

Russia 'planned Wall Street bear raid'

There is a cynicism in the relationship between Russia and the US, being played out in the Crimean crisis, which is deep, rooted in history and shows that the triumph of capitalism over communism wasn't the end of the power game between these two nations.

The depth of mistrust between the two was highlighted in the interview given by Hank Paulson, the former US treasury secretary, for my recent BBC Two documentary, How China Fooled The World.

The excerpts I am about to quote never made it into the film, because they weren't relevant to it. But they give a fascinating understanding of the complex relationship between Washington and Moscow.

Mr Paulson was talking about the financial crisis of the autumn of 2008, and in particular the devastation being wreaked on Fannie Mae and Freddie Mac, the two huge underwriters of American mortgages - huge financial institutions that had a funny status at the time of being seen by investors to be the liability of the US government, which in legal reality were not exactly that.

“Start Quote

This person told me that the Chinese had received a message from the Russians which was, 'Hey let's join together and sell Fannie and Freddie securities on the market'”

Here is Mr Paulson on the unfolding drama:

"When Fannie Mae and Freddie Mac started to become unglued, and you know there were $5.4tn of securities relating to Fannie and Freddie, $1.7tn outside of the US. The Chinese were the biggest external investor holding Fannie and Freddie securities, so the Chinese were very, very concerned."

Or to put it another way, the Chinese government owned $1.7tn of mortgage-backed bonds issued by Fannie Mae and Freddie Mac, and it was deeply concerned it would incur huge losses on these bonds.

Mr Paulson: "I was talking to them [Chinese ministers and officials] regularly because I didn't want them to dump the securities on the market and precipitate a bigger crisis.

"And so when I went to Congress and asked for these emergency powers [to stabilise Fannie and Freddie], and I was getting the living daylights beaten out of me by our Congress publicly, I needed to call the Chinese regularly to explain to the Central Bank, 'listen this is our political system, this is political theatre, we will get this done'. And I didn't have quite that much certainty myself but I sure did everything I could to reassure them."

In other words, China had lent so much to the US that Mr Paulson needed to do his best to persuade its government and central bank that China's investment in all this US debt would not be impaired.

Now this is where we enter the territory of a geopolitical thriller. Mr Paulson:

"Here I'm not going to name the senior person, but I was meeting with someone… This person told me that the Chinese had received a message from the Russians which was, 'Hey let's join together and sell Fannie and Freddie securities on the market.' The Chinese weren't going to do that but again, it just, it just drove home to me how vulnerable I felt until we had put Fannie and Freddie into conservatorship [the rescue plan for them, that was eventually put in place]."

For me this is pretty jaw-dropping stuff - the Chinese told Hank Paulson that the Russians were suggesting a joint pact with China to drive down the price of the debt of Fannie and Freddie, and maximize the turmoil on Wall Street - presumably with a view to maximizing the cost of the rescue for Washington and further damaging its financial health.

Paulson says this guerrilla skirmish in markets by the Russians and Chinese didn't happen.

But this kind of intelligence from China on Russian desire and willingness to embarrass the US in a financial sense may help to explain - in a small way - why President Obama shows little desire to understand Crimea as seen by Mr Putin.

And maybe if the US is being a bit more robust than the EU in wanting to impose economic and financial sanctions on Russia, that may not all be about America's much lesser dependence (negligible dependence) on Russian gas and oil.

http://www.bbc.com/news/business-26609548 

The Russians Have Already Quietly Pulled Their Money From The West

Earlier today we reported that according to weekly Fed data, a record amount - some $105 billion - in Treasurys had been sold or simply reallocated (which for political reasons is the same thing) from the Fed's custody accounts, bringing the total amount of US paper held at the Fed to a level not seen since December 2012. While China was one of the culprits suggested to have withdrawn the near USD-equivalent paper, a far likelier candidate was Russia, which as is well-known, has had a modest falling out with the West in general, and its financial system in particular. Turns out what Russian official institutions may have done with their Treasurys (and we won't know for sure until June), it was merely the beginning. In fact, as the FT reports, in silent and not so silent preparations for what will be near-certain financial sanctions (which would include account freezes and asset confiscations following this Sunday's Crimean referendum) the snealy Russians, read oligarchs, have already pulled billions from banks in the west thereby essentially making the biggest western gambit - that of going after the wealth of Russia's 0.0001% - moot.

From the FT:

Russian companies are pulling billions out of western banks, fearful that any US sanctions over the Crimean crisis could lead to an asset freeze, according to bankers in Moscow.

Sberbank and VTB, Russia’s giant partly state-owned banks, as well as industrial companies, such as energy group Lukoil, are among those repatriating cash from western lenders with operations in the US. VTB has also cancelled a planned US investor summit next month, according to bankers.

The flight comes as last-ditch diplomatic talks between Russia’s foreign minister and the US secretary of state to resolve the tensions in Ukraine ended without an agreement.

Markets were nervous before Sunday’s Crimea referendum on secession from Ukraine. Traders and businesspeople fear this could spark western sanctions against Russia as early as Monday.

It probably will. What it will also do is force Russia to engage China far more actively in bilateral trade and ultimately to transact using either Rubles or Renminbi, and bypass the dollar. Perhaps even using gold, something which the price of the yellow metal sniffed out this week, pushing itself to 6 month highs. It will also make financial ties between the two commodity-rich nations even closer, while further alienating that "imperialist devil," the US.

Of course, the west thinking like the west, and assuming that all that matters to Russia is the closing level of the Micex, believes that a sufficient plunge in Russian stocks would have been enough to deter Putin. After all, the only thing everyone in the US cares about is if the S&P 500 closed at yet another all time high, right?

What the west didn't realize, as we predicted a month ago, for Putin it is orders of magnitude more important to have the price of commodities, primarily crude and gas, high than seeing the illusion of paper wealth, aka stocks, hitting all time highs. Especially since in Russia an even smaller portion of the population cares about the daily fluctuations of the stock market. As for the oligarchs, if there is someone who will be delighted to see their power, wealth and influence impacted adversely, if only for a short period of time, it is Vladimir Vladimirovich himself, whom the west misjudged massively once more. Not to mention that the general population will be even more delighted, and boost Putin's rating even higher, if these crony billionaires are made to suffer by the west, if only a little.

(Here we would be remiss not to comment on his easy it supposedly is for Obama to freeze the assets of a few corrupt Russian billionaires, and yet the very proud Americans who nearly brought the entire financial system to the brink in 2008, are now richer than ever.)

In the meantime, some of Russia's oligarchs are effectively welcoming the challenge. Bloomberg reports:

Alisher Usmanov, the country’s richest person, controls his most valuable asset, Metalloinvest Holding Co., Russia’s largest iron ore producer, through three subsidiaries, one of which is located in Cyprus, an EU member nation. The 60-year-old also owns a Victorian mansion in London that he bought in 2008 for $70 million, according to a May 18, 2008, Sunday Times newspaper report. He’s lost $1.5 billion since the crisis began, according to the Bloomberg ranking.

“We are concerned with the possible sanctions against Russia but don’t see any dramatic repercussions for our business,” Ivan Streshinsky, CEO at USM Advisors LLC, which manages Usmanov’s assets, including stakes in Megafon OAO and Mail.Ru Group Ltd., said in an interview at Bloomberg’s offices in Moscow today.

“Mail.Ru and Megafon revenue is coming from Russia and people won’t stop making calls and using the Internet,” he said. “Metalloinvest may face closure in European and American markets, but it can re-direct sales to China and other markets.”

Great job, Obama: you just pushed Russia and China even closer by necessity! Furthermore, it should come as no surprise that while Russians were pulling their money from the west, western firms were getting out of Dodgeski.

One senior Moscow banker said 90 per cent of investors were already behaving as if sanctions were in place, adding that this was “prudent exposure management”.

These moves represent the flipside of the more obvious withdrawal of western money from Russian markets that has been evident over the past fortnight.

Traders and bankers said US banks had been particularly heavy sellers of Russian bonds. According to data from the Bank for International Settlements, US banks and asset managers between them have about $75bn of exposure to Russia.

Joseph Dayan, head of markets at BCS, one of Russia’s largest brokers said: “It’s been quite an ugly picture in Russian bonds the last few days and some of it has to do with international banks reducing exposure.”

Although foreign banks have not yet begun cutting credit to Russian companies en masse, bankers said half a dozen live deals to fund some of Russia’s biggest companies were in limbo as lenders waited to see how punitive western sanctions would be.

So the bottom line is that Russia, thinking a few steps ahead, already has withdrawn the bulk of its assets from the West, and why not. Recall that a year ago it was revealed that the same Russians who were supposed to be punished in Cyprus had mostly withdrawn their funds in advance of the bail in: they tend to know what is coming. It was the ordinary Cypriot citizens, who had done nothing wrong, who were most impaired.

And so while the Russian response is already known, we wonder just how true is the inverse: just how prepared is the west, and especially Europe, to exist in a world in which a third of Germany's gas is suddenly cut off? We can't wait to find out early next week.

http://www.zerohedge.com/news/2014-03-14/russians-have-already-quietly-pulled-their-money-west

The Tanks Are Coming While Russia, US "Remain At Odds" Over Ukraine

With Interfax reporting that Belarus has begun full-scale military drills in a "readiness check", images from Russia and Ukraine suggest the worst-case scenario - that Russia is making preparations to invade Ukraine, not just Crimea but perhaps as far west as Kharkiv, or even beyond - is more possible. Talks have broken down:

• *LAVROV SAYS RUSSIA, U.S. REMAIN AT ODDS ON UKRAINE: INTERFAX
• *LAVROV SAYS RUSSIA TO RESPECT `WILL' OF CRIMEAN PEOPLE

Russia now has a massive force of tanks, troops, artillery, aircraft, and naval forces in position to potentially invade mainland Ukraine from Crimea in the south, but also from positions east and north of Ukraine.

Lavrov adds:

• *LAVROV SAYS RUSSIA TO RESPECT CHOICE MADE AT CRIMEAN REFERENDUM
• *LAVROV SAYS KERRY `DIDN'T THREATEN RUSSIA WITH ANYTHING'
• *LAVROV SAYS WESTERN SANCTIONS WOULD BE COUNTERPRODUCTIVE

And subtley poitning out the hypocrisy:

• RUSSIA'S LAVROV SAYS IF KOSOVO WAS A SPECIAL CASE THEN CRIMEA SHOULD BE A SPECIAL CASE TOO

Then Lavrov said this:

• RUSSIA HAS HAD AND CAN HAVE NO PLANS TO INVADE SOUTHEAST OF UKRAINE - LAVROV

Which seems to run counter to the following images pouring in from across Russia of even more firepower on the move.

And images suggest more to come...

And finally:

• *LAVROV SAYS `EVERYONE UNDERSTANDS WHAT CRIMEA MEANS FOR RUSSIA'

Which we suspect is why all the tanks are rolling

http://www.zerohedge.com/news/2014-03-14/russia-us-remain-odds-over-ukraine-sanctions-counterproductive-and-tanks-are-coming

Crimea Bank Runs Begin As "Bail-In" Risks Arise

While the sight of Russian flags, pro-Russian troops, and Russian navy ships in Crimea is now a day-to-day thing; this morning brings a new normal for the eastern Ukraine region - long lines at bank ATMs as the bank runs have begun. We noted last night the dreaded inversion of Ukraine's yield curve, the greater-than-50% yields on 3-month Ukraine government debt, and the pressures on local bank debt maturities as the ability to garner dollars cost-effectively was becoming a problem but on the heels of concerns by the head of the central bank that moving cash in Crimea was difficult, ATM withdrawal limits have been cut. People in long ATM lines are reported to be concerned because "banks are closing" but it is Deutsche Bank's comments this morning that raised many an eyebrow as they suggest that Ukraine's debt is pricing in a "burden-sharing" haircut for bondholders (which as we have seen in the past - in Cyprus - can quickly ripple up the capital structure and become a depositor haircut).

Quiet calm bank runs are beginning in Ukraine...

h/t @MarquardtA

As Deutsche Bank raises the prospect of bail-ins and Private-Sector-Involvement (PSI) in bailing-in the banks and government...

...given the recent experience of IMF programs it is natural to ask whether some form of 'private sector involvement' (PSI) will be proposed as part of any package of support.

The IMF itself recently published a consultation paper arguing that private sector debt restructurings had “often been too little, too late” and that the fund should look at ways to avoid its “resources eing used simply to bail out private creditors”. The ongoing consultation process which this paper nitiated is one reason why concerns over IMF-sponsored restructuring are more prevalent for Ukraine now than they have been in similar situations in the past. However, we think it unlikely that there will be  ignificant change in the Fund’s approach towards Ukraine, given that the consultation is still ngoing, views are divided and its outcome remains uncertain. Nevertheless, that does not mean that some form of PSI will not be considered, condoned, encouraged or even mandated and so it is useful to onsider the pros and cons from the perspective of the Ukraine (and its potential official sector inanciers) and the implications for private sector creditors.

[Of course PSI can take on many forms from debt-extensions to bondholder haircuts to further up the capital structure depositor haircuts]

...current market prices are relatively consistent with such a scenario of PSI-lite. Indeed, the current relative pricing of Ukrainian bonds are very unusual: the pricing of short-dated bonds are distressed, implying a relatively high probability that they won’t redeem at par, but on the other hand the narrow range of prices across the curve suggests that the market assumes a high recovery in the event of a default/restructuring.

Such pricing would be fair, considering a baseline scenario involving an IMF program and an orderly adjustment. However, it leaves little compensation for a more disorderly scenario. Tensions with Russia show no sign of abating and could escalate further. Also there is no guarantee that the new government has a strong enough popular mandate to carry through the necessary reforms. PM Yatseniuk has emphasized that the road ahead for Ukraine will not be easy, but only time will tell how united the country will be in following the path he intends to take.

We suspect a brand new populist PM is unlikely to remain in power long if depositor haircts were engaged - and would certainly not imbibe the eastern Ukraine region with the country's new leader.

It is also notable that these bank runs are focused on local Ukraine/Russian banks...

http://www.zerohedge.com/news/2014-03-13/crimea-bank-runs-begin-bail-risks-arise