Blain’s Morning Porridge 1st March: Financial Blitzkrieg – It Works!

Russia thought it would roll over Ukraine, but the West’s Financial Blitzkrieg now threatens to trigger the unravelling of Putin’s autocracy. Excellent! The West needs Russia and Russia needs the West. It’s Putin’s kleptocracy we could all do without…   

Blain’s Morning Porridge 1st March: Financial Blitzkrieg – It Works!

Sometimes life played with him, sometimes it hung on him like a stone round the neck of a drowned man.

This Morning: Russia thought it would roll over Ukraine, but the West’s Financial Blitzkrieg now threatens to trigger the unravelling of Putin’s autocracy. Excellent! The West needs Russia and Russia needs the West. It’s Putin’s kleptocracy we could all do without…   

Dydd Dewi Sant Hapus! Happy Saint David’s Day to my Welsh Readers… (And she-who-is-Mrs-Blain)

Well, this is new and exciting… We’ve invented a whole new way to wage war! And it might even work.

It only took a day – but what we’ve already learnt about Financial Blitzkrieg is you can’t have half-measures. You need to go in brutal, all-out and nasty from the get-go. Don’t worry how messy it gets – go in hard and don’t stop punching. Don’t bring a knife to a financial fight – bring machine guns and lots of sanctions.

Messy it will get. Citicorp’s $10 bln exposure to Russia is a rounding error, but Austria’s Raiffeisen’s $9 bln number will hurt. (Austria is also 100% dependent on Russian energy.) Not surprisingly, French and Italian banks are on the hook for some $25 bln – no surprises there – but even that is “acceptable” blue-on-blue collateral damage.

The Aviation industry will take a potential pasting from aircraft leased to Russian operators – with some $5 bln of planes at risk. BP will take a thumping divesting from Rosnef, but they should be talking to the UAE – which is holding firm on its Russian positions, waiting to see what happens – while sending clear signals about where they see themselves in the future as neutral geopolitical ground. Londongrad property? Ouch.

The West surprised everyone – especially ourselves – with the scale of the weekend financial assault on Russia. The crunch moment that swung Europe behind stronger sanctions was a call with Ukrainian President Volodymyr Zelensky. He told them he didn’t expect to survive to speak to them again. Even the Germans were moved. Zelensky is that good.

Europe and the West should now go much further.

Completely freeze all Russian access to Swift. Worry not about Energy in Europe – it might be short-term painful, but the long-range weather forecast is for a mild European spring.  Seize any and all Russian assets, including the half-sunken Oligarch gin-palace a Ukrainian engineer tried to sink. Squeeze the pips till the b*st*rds choke.

And make sure the Russian people know why. Make clear to every Russian how they behave today determines their personal future tomorrow. The West is watching – which is why oligarchs like Abramovich are trying to play both ends and their kids are breaking ranks. Better to lose $1 bln, keep $100mm, than be a head on a spike with nothing.

Yesterday conclusively demonstrated no nation exists on its own when it comes to global money. Especially an intrinsically weak and suspicious state like Russia. Nations remain interconnected. What use is Russia’s Fortress-economy when it ends up under economic siege? Its carefully rebuilt foreign reserves neutralised on a pen-stroke. Millions of Russians finding their savings blocked. And asking why… and for what..? Maybe they aren’t aware its Ukrainian cities their Katyusha rocket artillery is flattening…

And some point soon, a leading oligarch or a general will be on the phone to one of Russia’s most successful new business enterprises, the Wagner Group, to offer them a new contract. In Moscow. Perhaps they will reassign their operatives currently in Kyiv looking to assassinate Ukrainian President Zelensky.

If I can figure that might happen.. imagine how Vladimir Putin feels this morning… looking around, wondering who will betray him? Belarus hackers mounted a cyber-attack on their own nation’s infrastructure yesterday.

The reality is simple. The West needs Russia’s commodity resources. Russia needs the West’s open markets. That’s a win/win trade.

The alternative for Russia is bleak: become a price taker from China, which will prove entirely sub-optimal. China will treat them abysmally, and probably seek to integrate mineral-rich Siberia into their co-prosperity sphere.  The alternative upside is to stop trying to f*ck with the West – and become part of it.  Share the mutual prosperity… access to Western goods, tech and services.. or become China’s serf? Russia – You Choose.

Russia still has a chance to make this good. The chances… who knows?

I got a panicked call yesterday asking what I knew about Russian default. Wow. That triggered some memories. Russia has broken itself before. It’s doing it again.  Yesterday, someone in the Kremlin announced Russian borrowers would stop repaying foreign loans, triggering immediate speculation it was an “event of default”. The comment was swiftly withdrawn. But it was an interesting moment…

Somewhere in a box up in my loft are some defaulted Tsarist bonds I bought back in the 1980s. I bought Russian bonds again in 1998. But, I couldn’t get my hands on the definitive bonds because unlike Tzar Nicholas’ debt, they actually matured and paid out! Which was a most pleasant surprise.

Russia managed to conclusively wreck their economy during the 1990s as the excesses and corruption of communism we replaced by naked financial banditry. According to the numpties on the extreme right in the USA – who for some curious reason seem to love Putin – it was entirely the West’s fault. Sovereign responsibility – just like personal responsibility – is naebody’s responsibility but yer own!

The Russians have historically demonstrated an extreme talent for fiscal, monetary and political instability for centuries. (Don’t get me wrong – I love Russians, they are charming, funny and passionate people. I love the culture, even their dark and melancholy souls. My favourite authors include Tolstoy, Sholokov (Quiet Flows the Don), and Pasternak… but they do have a talent for picking bad leaders.)

The 1998 Russian collapse occurred because Russia was broke, over-extended, exhausted by the costs of invading Chechyna, facing a chronic funding imbalance just as liquidity dried up as investors lost confidence in the pace of reform. Does that sound familiar? The country was under pressure all round – striking miners, transport workers and an increasing sense of grievance at Boris Yeltsin’s chronically mismanaged, ineffectual government and his blind eye to corruption and the state capture by oligarchs. Ring any bells?

It was Boris that brought in the relatively unknown former spook (and occasional St Petersberg taxi driver) Vladimir Putin as the new head of Federal Security.

The crunch came when the Ruble was devalued, the country defaulted and a moratorium was announced. Yeltsin was gone by the Autumn. History is kind of circular.

Trump recently said Putin was a genius. Unusually, there is an element of truth in that. Putin leveraged his position into the Presidency, inserted himself into every pie, and ensured he got the bulk of every kopek the kleptocracy ripped out of the Russian peoples’ soul. Evil genius indeed.

I remember the Russia default well. Back in August 1998 I was on holiday in Greece with two very young kids when LTCM, the “smartest hedge fund on the planet” with more Nobel prize winners than you could point the proverbial sharp-pointy stick at, collapsed in a liquidity storm. It was floored by a tidal wave of collateral mayhem triggered by a succession of “3-Sigma” market events – at least that was their excuse. At the core was the Russian Debt Crisis.

My then wife was singularly unimpressed as I spent days on my phone trying to fathom our positions, exposures and opportunities.. This was back in the days when phones were relatively new and simple things.. mine was dead modern – it could store and memorise up to 100 numbers! You definitely could not send emails or access the internet from it. Myself and half-a-dozen other bankers at the same resort ran out of fax-paper.

Among other things.. LTCM collapsed because they’d bought Russian domestic debt. As Russia unwound, LTCM got caught in a cascade of exits triggering a one-way market that crushed asset prices across multiple global markets. (Russia was not the only trade they got badly wrong – their losses on Russia were a fraction of what the collapsing swap market cost them, but it was all broadly interconnected and there are always consequences.)

As the Fed desperately tried to stop LTCM’s collapse becoming a run on the global financial system, the big US banks met to discuss a rescue. Apparently, the hold-out was my firm, Bear Stearns. The tensions in that room in 1998 apparently set the tone for 10-years later when the same banks let Lehman go to the wall… but that’s a story for another day..

Today, the west can weather whatever the coming, dare-I-say inevitable, Russian default and financial denouement throws up. What will be more interesting is how the West ensures it doesn’t happen again by making sure Russian V.3.1 is more honest, more liberal and less kleptocratic than what’s gone before. The Russians are good people. Their leaders are not..

Five Things to Read this Morning:

BBerg: There’s no table long enough to shield Putin

FT – Investors struggle to trade Russian Assets as sanctions hit market plumbing

FT – UK working through a hit list of Russian Oligarchs to face sanctions

WSJ – The West Severs Russian Economies Ties to Rest of World

Torygraph – Putin is doomed, but he can still do terrible damage

Out of time, and back to the day job..

Bill Blain

Strategist – Shard Capital