It’s a $300 billion question. While everyone was distracted with
the $61 billion in Ukraine aid, Congress was quietly making
a more intriguing play, not in the Ukraine bill,
not in the Israel bill, and not in the Taiwan bill, but rather in the nebulous omnibus fourth bill,
that seemingly covered so many other things that it was just easier for the
media to gloss over those details. Uhh, full disclosure, I’m guilty there too.
Sorry! But the question in, uhh,
question is the seizure of roughly $300 billion in
Russian assets controlled by Western governments. It is a sensitive topic with
serious implications for the war. A super scientific poll of my viewers
shows a large majority supporting it. But whether you fall into that category
or are a part of the minority, and whether you call it a seizure,
or a confiscation, or proactive reparations,
or a special banking operation, both camps often miss out on some
of the subtleties of seizure— or non-seizure. Welcome to the paradoxical world where
seizure will simultaneously cause more global instability and be a force for
more global stability. For those of us who have
survived that logical migraine, on tap for today, we will cover
exactly what those frozen assets are, what Congress’ bill does to
put the pile of cash into play, the issues that will pop up with how
Russia might retaliate to such a seizure, what this will do to the international
financial system as a whole, why the West will get a hidden benefit by downgrading the safety of
foreign investments there, and we will save the best for last
with some lines on maps discussion of how seizure undermines one of
the West’s key goals for the war. But we begin with the basics of the assets. Flashback to a decade ago, when Russia first moved into
and subsequently annexed Crimea. The West responded with
what, by current standards, might be best described as light sanctions. Nevertheless, it was enough to cause
a notable financial crisis in Russia— not enough to disrupt Putin’s
position in the Kremlin. but enough to devalue the ruble
from 36 to the dollar on the date of annexation
to 61 rubles at the end of 2014. Hence the adoption of what is now called the
“Fortress Russia” strategy. This was the Kremlin’s policy aimed
to build a rainy day fund of rubles and more broadly insulate the Federation’s
economy from Western sanctions. The relevant consequence of
this for today is that the Russian Central Bank built up
$600 billion in savings by the time that the invasion of Ukraine began in February 2022. Oddly, about half of the
money sat in Western accounts. That might seem strange given that the goal here
was to insulate Moscow from foreign coercion. Nevertheless, the Western financial
system is just too widespread, and it is hard to distribute $600 billion
without parking quite a bit of it there. It may have been possible to move some
of it out on the eve of the invasion, but remember that the Kremlin anticipated
that this would be a quick operation. Kyiv’s government would fall in short order, and so there would not be time for a
Western sanctions campaign to matter. Side note: I know that what
makes this channel unique is that I can tell you what peer-reviewed
international relations research tells us about the conflicts going on in our world today. But in a bit of a reversal, I actually turned this video
into a peer-reviewed article. There is a link in the video
description for ungated access, and it is part of a larger symposium
that I organized on the war. Lots more free reading to do.
But no tests later, I promise. Anyway, it is just really cool that a
video with almost 6 million views now gets to become part of the peer-reviewed record. I am not sure this has ever
happened before in any field, so thank all of you so much for giving me
the opportunity to do this kind of thing. Now, back to the Kremlin’s optimism, we all found out in short
order that it was unwarranted. Consequently, the Western financial
system froze the $300 billion. The money is still just sitting
there—none of it has been spent. But Russia cannot access the funds. Not that we actually know where
the Kremlin would go to do that. It is unclear exactly how much of it is
divided between the United States and Europe. The bill that we will talk about
in a moment speculates that the United States has only four or five billion of it. The vast majority instead resides in Belgium. France and Germany probably
have the bulk of the remainder. However, because any further action
taken on it would likely be coordinated between the sides of the Atlantic, that
specific detail might not matter much. It is also unclear exactly how
much money that we are looking at. It was $300 billion. But the $300 billion is not just
sitting in somewhere in a vault. The funds are probably
accruing interest of some kind. Even a conservative investment
in a one year U.S.treasury bill has about a 5% rate currently. Then again, as hard as this is to
remember, interest rates were close to zero at the start of the war, so we are
not looking at $330 billion at this point. Regardless, it is something
more than $300 billion, and this interest will become important later. That takes us to what appears in the catch-all bill that Congress passed in April. We
should start with what it literally says. The key distinction is that the
bill authorizes a transition from freezing the assets
to seizing the assets. So instead of Russia being
locked out of the accounts, transfers of the money will
go into some other account. Thus, Russia will never have the opportunity to
regain access the money because it will be gone. The bill creates the following timeline: over the first 90 days
the Treasury has to figure out exactly how much Russian money
the U.S. controls and where it is. Then after another 90 days, the Treasury must report to
Congress on its findings. One month after that,
the president may “seize, confiscate, transfer, or vest” the money. That takes us to November.
Biden will still be president, but within two months it could be Trump.
Regardless, whoever is in charge will then have the power to take the
Russian money and send it to Ukraine to address damage resulting from the invasion. The bill also instructs that such
measures are to be done alongside the G7, European Union,
Australia, and any other parties holding Russian funds. This puts a new sense of importance
on the upcoming G7 meeting, to be held in Italy from June 13 to the 15. Now, this all sounds like upside
for the West on the surface. The reality, though, is more complicated.
Let’s cover the main concerns and analyze just how problematic
they are or they are not. First up is tit-for-tat
issues from the Russian side. This has been the main thrust
of the Kremlin’s media response. Basically, the United States takes things,
and so Russia takes things back. The difference, of course, is a significant
asymmetry between the two parties. Investing Russian state assets
in the West made fiscal sense. In contrast, Western states haven’t exactly looked at Russia as a great place to
store some dollars or Euros. Thus, Uncle Sam does not have a
frozen piggybank in Moscow that the Kremlin can simply raid in response
to Washington raiding Russian assets. Consequently, the retaliatory threat is for Russia
to seize the private assets of American, British, or European citizens, according to
former president Dmitri Medvedev. The extra layer of complication
here is that when this happens, the private American citizens getting raided
will undoubtedly sue the U.S. government. Yes, Washington did not directly
take their money. But there is a clear causal pathway by which the
government’s actions led to the loss. Now, I am not a lawyer, so I do not care to
speculate on what will ultimately happen there. But I can tell you that you
might get an injunction to freeze the seizure of the frozen Russian assets. Yep, that’s two layers of ice there. And if the courts rule in
favor of the private citizens, Ukraine will not get any of the money
until those citizens are made whole. The whole thing turns into
a complicated reallocation of assets without any benefit to anyone. The second category of problems is with future
investment and the Western financial system. The United States and, to a lesser degree,
the European Union benefit from being the de facto caretakers
of the world economy. This has a whole bunch of intangible benefits. But to briefly describe one, you get to borrow
money denominated in their own currencies. So, if you are the United States and you
somehow became desperate to pay back a loan, you could always literally print
the money to satisfy the payment. In contrast, imagine that you are Argentina and you want to borrow money
on the international market. Well, lenders will offer you dollars.
So you take the money. And when the loans come due, the lenders
expect to receive dollars in return. Consequently, if you do not
have those dollars on hand, you will have to turn to the international markets to buy dollars
to pay off the debt. Actually, the fact that other
countries want to borrow in dollars makes the dollar stronger
and in turn enriches the United States. Combine that with the fact that U.S. treasuries
are basically the safest investment that exist, and you end up with a system
where the United States can borrow money for ridiculously low rates. That’s a good thing when you
have a $34 trillion national debt and, in 2023, ran a $1.7 trillion deficit. And, actually, access to cheap
credit is major reason why these figures exist at all. As it relates to the seizure of Russian assets, there is a major concern here
regarding other foreign governments. Ordinarily, they would want to store some money in Western institutions. But they may
become worried that their assets could also be seized. Then they pull out of the U.S. treasuries market, and suddenly interest rates
for Washington skyrocket. There is some concern that this
is already happening with China. Indeed, China held just over a trillion dollars
in U.S. treasuries on the eve of the invasion. Now, it is down to $775 billion. To be clear, Beijing had started selling off
treasuries prior to war. This run began in 2018, with $1.2 trillion being the local
maximum amount that China held. But the pace has accelerated since
the tanks spilled over the border. And, overall, this would lead
to a weakening of the dollar, which is bad news for the U.S. economy. There is a good chance you have heard some
version of this argument before. But we should spend some time examining why this is
not obviously a net negative for the West. Think of a spectrum of countries based
on how likely they are to do dodgy things from the collective Western perspective. So one end you have Canada,
where I was once threatened to be beaten up and then his friend interjected that
they must do so politely. True story. And on the other end we have, say, North Korea. Everyone on this end does not think
twice in making Western investments. Everyone on the other end is already too
scared to hand over their financials. Let’s mark these for later. In between is where it matters.
Those marginally over here will be spooked by a Russian asset seizure and divest. Those marginally over here
will not like what is happening But they were never likely to
draw the ire of the West anyway and thus they stay in the system. So we have four total groups. The question beyond the paygrade
of us keyboard warriors is just how far down the line the dividing point
between the two middle groups goes. If the split is up here, then the precedent of seizure hardly
impacts the world economic structure. If the split is over here…
well, that is the point where Washington needs to worry that enough
of the world wants an alternative that China will then be greatly
incentivized to invest in a new system. And as a consequence, the West will
lose the more moderate coercive lever of freezing assets the next
time something like this happens. But there is another factor at play here. All of the discussion is on
the precedent that seizure sets and how it affects the
thought process of these guys. What receives less attention is the precedent
that would be set by not seizing the assets and how it affects the
thought process of these guys. Think about those middling
countries that would stick with the system despite registering
complains about U.S. overreach. We’ll use a Bizarro World version
of Ireland as a placeholder here, who apparently is hellbent on dying
America’s precious waterways green. Before, when the opportunity to go rogue
arose, they did not see too much of a downside. Go green! But fast forward to the post-seizure
world, and there is a big fat minus c cost in their calculations
because their assets too will be taken. So they simply pass on going rogue in the
first place, and Americans can drink safely. Thus, the Western power
play loses coercive leverage over this group
but increases it over this group. I leave it to the experts to figure
out which has the greater net impact. Finally, we get to the main event
of the evening. Get excited, because it’s time for some lines on maps. Today’s
focus is the problem with imposing one-time costs. In other words, a cost that a country can only suffer
one time and will not reset over time. Attacking a refinery is not
a one-time cost, for example, because Russia can repair the damage, and
then Ukraine can impose that cost again. In contrast, the asset seizure
would be a one-time cost. As funny as it is to think about
the Kremlin calling in to buy more treasury bills in the immediate
aftermath of the West’s seizure, that will not happen. The basic problem is as follows.
You have your standard white line to represent a hypothetical
expected territorial outcome of the war if it fought to a military conclusion. And then you have Russia’s red line, with the gap between the two
reflecting Russia’s costs of fighting. If you want Russia to withdraw to
at least the January 2022 borders as part of the final settlement of this war, then you need the red line pushed
back somewhere around here. That is either accomplished by
arming Ukraine to the teeth so that the expected outcome of
war is very favorable to Kyiv or you impose so many costs on Russia that even a favorable territorial outcome from Moscow’s
perspective is still a large net negative. Now, the problem with
any one-time cost is that you can only impose it … well …
one time. And if Western countries do that now,
then they cannot do it again. Moreover, it is hard to imagine that it would be possible to undo any seizing given that
the money will already be redispersed. Thus, once the seizure occurs,
it is no longer a cost of war. It is just a fact of life that exists regardless
of Russia’s future war and peace decisions. But that means that Russia’s cost of
fighting until there is a military outcome shrinks. And that means that the red line actually
goes further into Ukrainian territory. As a result, for the purposes
of pushing the red line back, it is better to leverage the threat of seizure
than it is to actually do it—or at least not do it until after the military outcome
of the war has been realized. That is the whole reason that
the West froze the assets in the first place. They create bargaining leverage. Now, the cleavage between the West
and Ukraine here is interesting. Ukraine is all for the seizure
despite the red line problem. The reason is because even if
the redline moves unfavorably, Kyiv is adding a big fat $300 billion
to its war outcome regardless. In that sense, the asset transfer and
line shift are a zero-sum proposition between Russia and Ukraine. One
exactly cancels out the other. In contrast, compared to Ukraine, the United
States places relatively more value on the war ending in any fashion and therefore prefers
having the leverage rather than acting on it. That said, there are a few
ways around this problem. First, you could sell the seized assets, raise
money, and then buy more weapons for Ukraine. This narrows the location of the
redline because of the lost leverage, but it shifts the expected
outcome line back the other way, which pushes the red line along with it. The net effect is therefore nebulous. If the weapons are pivotal to the war,
for example, then it is possible that the change in expected outcome more
than compensates for vanishing cost. Of course, you might want to
point out here that the House bill calls for this money to go toward repairing
the damage from Russia’s invasion. But remember that money is fungible.
That is, if more money suddenly starts flowing to humanitarian ends,
then coalitions partners and the Ukrainian government suddenly
have more money to spend on things that go boom—
and not just the finger guns. This is basically the sanctions problem,
where carving out humanitarian exceptions ends up funding the target’s military,
but in reverse. Second, it is possible that war
counterintuitively becomes easier to resolve when the costs for one party are lower. My self-respecting academic alter ego
has spent a lot of time researching that, and he tells the non-self-respecting version of me that the conditions for this
happening are not present right now, so we might as well move on. If you really want to know how that
works, then we actually did an entire video on the subject last year. But
that is superfluous for right now. The last workaround is less of a
solution and more of a compromise. Rather than touch the $300 billion principal, Western states will just
seize the interest accrued. And, again, with a T-bill generating
about 5% annually right now, even a very conservative investment strategy
still yields about $15 billion per year. The reason that this is not
actually a solution is because, under a complete freeze, the interest
would go back into Russia’s account. Consequently, when interest funnels
back into the principal, every year that the war continues, the effect on the red line is a small increase.
$15 billion here. $15 billion here.
And $15 billion here. And actually, giving the
interest payments to Ukraine means that the red line decreases
every year due to inflation. $300 billion just does not buy what it used to. But good news: my books on the war still cost under
$300 billion. Power to the people. You can check the video description
for more information on them. And if you enjoyed this video, please like, share, and subscribe, and I will
see you next time. Take care. By the way, this stock photo from
earlier is actually Biden getting briefed on the Wagner rebellion from almost a year ago.
It’s funny that the “what the flub” expression on his face is virtually identical to
the one that we all had at the time.
