Gold News

Financial War: Chances & Impact

Russia, the EU and US are facing off over Ukraine. Financial war may follow...
As the UKRAINE CRISIS unfolded, threats of financial war came from Russia and to a lesser extent from the EU and the US, writes Julian Phillips at The Goldforecaster.
These threats were not carried out beyond a few sanctions targeting key personnel in Russia. They were shrugged off and the crisis appears to have dropped to a series of posturing by both sides. A sigh of relief crossed the developed world and investment life went back to normal.
In the past we have had similar events that were defused in a similar way. But history teaches us that that the world can suppurate easily and quickly in tense situation like this. The First World War started because of one shot from a pistol. The Second World War were preceded by trumpeting of 'peace in our time' as mistaken politicians thought they had made peace with Germany.
For today's investors, these are signals that should be taken seriously if your portfolio is not to be taken by surprise. After all, when such situations are ignited, events move too fast to prevent an assault on investments. Most of us tend to feel that if we can't actually see the storm clouds and hear the thunder then the storm isn't coming. It's a certain lemming-like quality where if we see the man in front of us moving forward then we do too. In this case an investor shouldn't do this he should take preventative action even when he doesn't see the storm. To start with, we should ask if both sides are capable of carrying out the threats.
The overall threat of financial war was accompanied by invidious pressure on global investors to reduce their sizeable holdings in Russia. For more than a decade Russia has sought more trade and investment with and into Russia. Trillions of Dollars have flowed into companies controlled by the state. If these were to exit, the economy would be severely damaged.
Over the last four years, western investors have sunk $325 billion into stocks and bonds issued by Russian companies and the country's government, according to the research firm Thomson Reuters. Of that, $235 billion has been directed toward corporate borrowings by the likes of Gazprom and state-owned banks like Sberbank. Demand has been so strong that Pimco, the world's largest bond manager, introduced a socially responsible emerging market bond fund in 2010. According to its prospectus, the fund looks to invest in companies that are reducing governance risks. It also reserves the right to steer clear of the bonds of countries that are listed at the bottom of the World Bank's corruption indicator or are subject to sanctions by the United Nations. Now that Russia looks like one of these, can we expect some heavy handed action to disinvest?
As of the end of 2013, Russian corporate and government bonds accounted for 31% of the fund's $292 million in assets, nearly three times the weight in its benchmark, a J.P.Morgan emerging-market bond index. Pimco has declined to comment.
Gazprom, the Russian energy giant supplies so much gas to Europe it has to be a possible target of the EU or a weapon in Russia's hands. It has the American mutual fund giants Pimco and BlackRock among its largest investors and creditors. While the last year has seen the fortunes of the company alongside its share price sag, an attempt to sell the entire US share ownership of theirs would hurt the company and the Russian stock exchange, very badly. 
Will the US & the EU be allowed to strangle inflows of capital or remove it from Russia without resistance? In the event of the start of a financial war, we believe that Russia would not allow that capital to exit and would take measure to insulate themselves against capital flows from the country. This implies that exchange controls would be imposed to encourage inflows and prevent outflows. With China as an alternative investor and on neither sides of the potential conflict, they would likely come in to pick up the pieces cheaply.
This is the most potentially visible of the weapons that would be used. The weapons to be used would extend from the financial to the economic. For instance, Russian companies selling to Europe and the US would switch to buyers in China, the largest consumer of nickel. This was the opinion of eight out of 12 nickel producers, traders and analysts in the Asia-Pacific region. Punitive measures would increase global prices at least in the short-term. This is one aspect of the confrontation. 
A second is the sale of gas by Russia to Europe. Europe is heavily dependent on Russian gas and would be badly hurt in the event of either higher prices or a cutback in supplies. In such a war, the weapons such as these extend across a wide spectrum. For sure the investment climate in both Europe and Russia would deteriorate drastically. 
The biggest danger would be the attitude in such a confrontation because this justifies punitive actions that hurt the wielder of such weapons as much as it does the victim. What do we mean? In the German finance minister's words, "The objective is to uphold international law. It is of secondary importance whether there is an economic or financial cost." This is a typical posture that precedes war-like situations.
Investors, after the event, would see the heightened risk and either withhold funds, or demand significant premiums on good investments. Sovereign risks on the EU and Russia would elevate borrowing costs and slow the flow of funds where they continue to exist. 
It is likely that additional collateral would be required that is outside the pledges of either side. These would be extreme times and so require commensurately non-national assets like gold to be used. We would see gold/currency swaps routed through the BIS to facilitate the continuation of the monetary system as we know it now. Gold would move to a pivotal position internationally in such an event. Nations would scramble to get it, to be able to get international liquidity. Where would they get it from?
The EU agreed on a framework for its first sanctions on Russia since the Cold War. This places the EU in step with the USA. The determination we are seeing from the EU is more than expected and sets the tone for more action and retaliation. The big question is just how far will the two sides go? 
Certainly the Dollar and the Euro are threatened as are all their 'dependent' currencies'. The damage that Russia could do to Europe is far more direct because they are neighbours. 
All global financial markets will feel at least a ripple from the Tsunami that will happen, once matters go too far. The least vulnerable and the bloc most likely to gain whatever advantages may come amongst the rubble of the financial system would go to China.
Senior Putin adviser Glazyev said last week that if the United States were to impose sanctions on Russia over Ukraine, Moscow might be forced to drop the Dollar as a reserve currency and refuse to pay off loans to US banks. While his remarks were later refuted by Russia, the possibility of such action remains. What harm would such moves do?
Glazyev also said that Russia could reduce to zero its economic dependency on the United States if Washington agreed sanctions against Moscow over Ukraine, warning that the American financial system faced a "crash" if this happened. 
He said that if Washington froze the accounts of Russian businesses and individuals, Moscow will recommend to all holders of US treasuries to sell their US government debt. Do his remarks have credibility? Apparently, Glazyev is often used by the authorities to stake out a hard line stance. He does not make policy but has the ear of Putin and would be aligned with the more hawkish elements in the Russian government and military. He further threatened that Russia could stop using Dollars for international transactions and create its own payment system. 
Russian firms and banks would also not return loans from American financial institutions. "An attempt to announce sanctions would end in a crash for the financial system of the United States, which would cause the end of the domination of the United States in the global financial system," Glasyev added. His comments were likely sanctioned by the Kremlin and by Putin himself. They would appear to be a warning to the US regarding isolating Russia politically and imposing economic sanctions. So far they have not been carried out. But are your investments vulnerable?
In the state the global financial system is in at the moment such threats followed by any sort of action will produce ripple effects that in themselves will produce turbulence and collateral damage in global financial markets that go far beyond the borders of Europe and the US. The hegemony of the Dollar will be threatened if not mortally wounded, for sure. Simply the loss of stability in financial markets will rupture many markets. Russia would turn once again to China after trying to sell the Dollar. Again, such actions would be cutting of its nose to spite its face. But that's what war is.
The Dollar is so entrenched as the globe's reserve currency, that even a small action against it would cause disproportionate damage to its exchange rate. A strong seller of the Dollar would hurt it badly. If that seller were known to be a central bank, then the damage would be considerably heavier.
The consequences of even starting down this road are so dramatic that we deem the likelihood of a financial war as most unlikely. The Crimea and the Ukraine were part of the USSR. Hence we do not believe that either the US or the EU will stake so much for so little potential gain. The results would be too horrible to contemplate.
But having said that, prudent investors, as we warned at the beginning of the article, won't wait for these events to happen. They will not only be protecting themselves from the consequences, they would be positioning themselves to benefit from them. And they would do this now, well ahead of such possibilities, or go the way of lemmings.
With gold the clear benefactor in such situations we expect that if markets perceived the bigger danger to be imminent the gold price would surge. That such rhetoric is already taking place between diplomats is a salutary reminder that gold will rise in extreme times like these, and that to buy gold ahead of armed conflict is the wise course.

JULIAN PHILLIPS – one half of the highly respected team at – began his career in the financial markets back in 1970, when he left the British Army after serving as an Officer in the Light Infantry in Malaya, Mauritius, and Belfast.

First he worked in Timber Management and then joined the London Stock Exchange, qualifying as a member and specializing from the beginning in currencies, gold and the "Dollar Premium". On moving to South Africa, Julian was appointed a macro-economist for the Electricity Supply Commission – guiding currency decisions on the multi-billion foreign Loan Portfolio – before joining Chase Manhattan and the UK Merchant Bank, Hill Samuel, in Johannesburg.

There he specialized in gold, before moving to Capetown, where he established the Fund Management department of the Board of Executors. Julian returned to the "Gold World" over two years ago, contributing his exceptional experience and insights to Global Watch: The Gold Forecaster.

Legal Notice/Disclaimer: This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Gold Forecaster/Julian D.W. Phillips have based this document on information obtained from sources they believe to be reliable but which it has not independently verified; they make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold Forecaster/Julian D.W. Phillips only and are subject to change without notice. They assume no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, they assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information, provided within this report.

See full archive of Julian Phillips.

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

Follow Us

Facebook Youtube Twitter LinkedIn



Market Fundamentals