Sanctions Loopholes, Rerouting Trade, & Russia's War Machine, with Rachel Ziemba

NIKOLAS GVOSDEV: Welcome, everyone, to this edition of The Doorstep podcast. I am your co-host, senior fellow at the Carnegie Council Nick Gvosdev.

TATIANA SERAFIN: And I am Tatiana Serafin, also a senior fellow here at Carnegie Council, welcoming back Rachel Ziemba, who is head of Ziemba Insights and an adjunct senior fellow of energy, economics, and security at the Center for a New American Security. Rachel is going to help us understand why we can't quit Russia, and here we go.

Rachel, thank you so much for joining us today. We are so excited to have you back almost a year after you were here talking about the "hidden global growth crisis." At that time, events had not yet unfolded as they have. Russia had not yet I say "reinvaded"—everybody says "invaded"—Ukraine.

RACHEL ZIEMBA: I am with you on that.

TATIANA SERAFIN: The Beijing Olympics had not happened. We were in a different world. We were still importing goods from Russia and China and looking to them to grow our stagnating economy and fight inflation, and then the world blew apart. So here we are, a year later, and we thought we would have you come and help explain what is really happening.

Has anything changed? That thought has gotten to me over the last couple of days with reporting coming out that in fact Russia is hard to quit. People are still trading with Russia. The world is still functioning. Yes, maybe we are doing more with renewables but, hey, everybody still loves oil.

I was at a recent event and met two Norwegians, and they were like: "We love oil. Buy more." I am literally quoting verbatim.

I thought: Wow, oh, my gosh. Nothing has changed.

I am exaggerating for effect here, but can you work us through if anything has changed? We talked a year ago about a global growth crisis. Is there really a global growth crisis? Either/or, help us to understand.

RACHEL ZIEMBA: I will first say thanks for having me back. It is always great to chat with you guys. I always enjoy listening to other guests.

Yes, maybe things have not changed, but yet from some other perspectives a lot has changed. Russia may still be getting the goods it needs, but it is getting it from very different countries, and that sets up other problems for the future, and that is something I think we will probably talk about.

As I see it, at the start of the renewed invasion there were a lot of questions: Would the developed economies hang together? How would that work? We were some of the few people talking at the time about, "Oh, my god, these are two big agricultural-producing countries plus throw in Belarus for fertilizer." We were worried about what that looked like.

I think what we have seen, if anything, is remarkable coordination among developed economies—the G7, the G10, however you want to construct them—and it is not just about Russia. We have seen more and more fractures between the Global West and the Global South. It maps out in different ways in different geographies.

This is not only a function of Russia's war. It is also a function of U.S. and Western relations with China. Yes, we have not quit trade with China, but there are a lot more barriers in place in some of what are the most sensitive industries, and I am sure we will come back and talk about export controls in due course.

What I think Russia has been able to do is to reroute and not only sell their products to different countries—with, I would say, the support of the United States and its allies, who are worried about what the macro impact of a sudden stop of Russian oil would look like—but also has been able to source goods from other locations. I would argue that whenever a country is subject to major sanctions, other restrictions, and embargoed trade they cannot get the best products and maybe have to pay more for them, but at the end of the day Russia is still getting the inputs it needs for its war machine.

The other thing I do think that has changed beyond this rerouting is that Russia if anything has centralized around the state and military and has jettisoned what the liberal internationalist hopes are in its strategic economic interest—Nick, you and I over Twitter and in other places, have had some of those conversations—but they have focused on the strategic aims of this conflict, the existential issues as they see it, to jettison opportunities in cleaner hydrogen and cleaner ammonia, and they have said, "We don't care about being a reliable supplier of energy writ large if our customers aren't reliable."

The Russian growth challenge has been a long-term issue, first of demographics and then of lack of investment, and if anything all those issues are even greater because the mobilization of the whole economy is tilted toward the war machine. That doesn't mean that they are going to turn around—the whole cost-benefit analysis they look at is very different than how a liberal internationalist might look at it.

Of course I use those terms and I say, "I don't think what we describe how the Biden administration looks at the world is exactly 'liberal internationalist' in quite the same way." Maybe from a political and human rights perspective, yes, but not from an economic policy/free trade perspective. I do think some of these trends have been mutually reinforcing.

Why don't I stop there because I want to hear what you guys have to say and see where the conversation takes us?

TATIANA SERAFIN: I would love to stick with the rerouting because I think this is something that people don't quite understand. On a meta level there are sanctions. We feel good about that. We feel good that we have put sanctions in place—we are sanctioning individuals, we are putting a price cap on the oil—but it is not enough. We have talked over this year too, is it enough, is it really going to happen, and all of a sudden we see the latest International Monetary Fund (IMF) data saying that Russia's economy has actually grown this year as opposed to shrunk because it has been able to do a lot of this rerouting.

I want to start with oil because I think this story is interesting, and I want our audience to understand the ways in which they are able to circumvent these sanctions and keep that oil machine going, which as you mentioned is driving the economy even if people say, "Oh, no, no, sanctions, price caps." Not true.

RACHEL ZIEMBA: What is interesting where energy is concerned is that I think there were different phases over last year. From the get-go there was what we called "self sanctioning," at the beginning of the war either stakeholder pressure or other things that said, "Why are we buying Russian oil?" Of course the United States never bought much Russian oil, a little bit here and there, some specific products, but it was a pretty small amount. In other countries like Canada it was even a tinier amount, but Europe was buying a lot of Russian fuel. Actually, as we speak right now at the beginning of February, they still are buying some Russian fuel, particularly oil products, but we will come back to that.

From the get-go, if anything the U.S. Treasury and its allies said: "Hey, guys, wait. We are not sanctioning Russian oil. We are not sanctioning the current production." The sanctions were earmarked toward increasing the costs and degrading Russia's future capacity. They were worried—I think justifiably—about the cost to the global economy of a sudden stop of Russian oil and other commodities.

Part of this was looking for asymmetric ways to cause more pain to Russia than to countries in this coalition. Of course Russia is looking for ways to inflict asymmetric pain on its adversaries. We can come back to who is winning there. Maybe it is a stalemate and protracted conflict economically, just like it is on the battlefield. I actually would argue that if anything it has hurt Russia more than it has hurt the global economy, but the point is it is not easy to put a lot of economic pressure on one of the largest suppliers of natural resources in the world, particularly when its interests are allied with another large supplier of natural resources, Saudi Arabia.

For the first several months of the war the U.S. Treasury went out of its way to say: "This is not sanctioned. There is an exemption. You can continue to buy Russian fuel." That changed in the middle of the year rhetorically when the Europeans said, "Let's do an embargo," but they announced it to come into effect six months from then, and that is what turned into the oil price cap. The European Union had an embargo on Europeans buying Russian crude oil but also European ships and insurance companies trading in it, and that got broadened out to the G7, but they said, "If you pay less than $60, you can still use those services."

Again, that was the U.S. Treasury and states like Germany coming in and saying: "Wait, we don't want that sudden stop of Russian oil. We want them to get less money for their resources, but we don't want it to completely disappear because then that might mean the Russians still make a lot of money on the black market and the like."

Where we are now is, yes, Russia is making less money on its oil, but it is still making a fair amount of money. Russia's own choice partway through this, in the middle of the year they decided to sharply reduce natural gas exports. You don't supply as much, you don't get paid.

When we look at Russia's budget we see that revenues have come way down, expenditures as best as we can tell have gone up, but this is still something they can survive. They are not thriving, but they are surviving.

Russia entered this war with very low debt levels, especially external debt levels, and domestically a fair amount of savings. They had underinvested for years, so it gave them more space to create this sort of war/military-industrial economy that is very challenging for the private sector in Russia, but this is not something where they are screaming and running away and saying, "We must end this war."

Of course they could also say, "It's illegal and one could end up in prison if you talk about the war," so it makes it challenging in that way, but from an energy perspective in the first half of the war you actually still had a lot of energy revenues and Russia struggled to import. The Western countries wouldn't send them items, and even the Chinese were wary.

Then you hit the middle of last year, Russia cuts off natural gas, but its imports start to pick up. That is where they began finding additional supplies via Central Asian countries or the Caucasian countries or via Turkey—Turkey was one of the first countries to step up and be an intermediary—and via China. I do think the quality of those goods has maybe diminished, but again it comes back to they are surviving.

What we are seeing right now on the energy front that I think is relevant is also that the price cap is structured so that if you want to use Western services it has to be below a certain price, but if you are willing to use non-Western services, it can be whatever price you want. The U.S. view at first was: "Our services, the Western services, are better, it is going to be costly. Who is going to want to use Russian insurance? Who is going to want to use Chinese tankers?"

I think what we found is that if the price is right people are willing to use 25-year-old tankers that the Russians bought up from the Greeks, hypothetically. That also means Russian interests and supporters in other countries that are making money not just on selling the oil but on contracting the tankers and the insurance.

There is a big question: What happens if there is an oil spill? What happens if there is an accident, and undoubtedly there will be one at some point? For me, who is thinking both about the market impacts but who also likes to look ahead and ask, "How is the balance of power shifting," I think this market that was highly dominated—insurance highly dominated by Britain, for example, and shipping that was highly dominated by Southern European countries, Greece, Cyprus, etc.—and suddenly there are new entrants.

Sometimes we can look at it from a political science lens and say, "Sometimes when you use your leverage is it there anymore?" That doesn't mean don't use it, but it does mean that there are some of these tipping points. That is something I'm watching on the service side as well as of course what is happening with currency usage. I still think the dollar is very dominant as a saving currency, but we are starting to see the Russians try to engage in new financing and payment systems. Russia and Iran clubbing together for the payment system helps them, but it doesn't change the global balance of power, but there are some of these tipping points that start to open up. I don't want to overestimate or underestimate them, but I think when we look back we will see a dynamic where the fact that you had extensive sanctions on Russia but also export controls on China both in 2022 will be an important tipping point.

I think it also comes at a time where a lot of countries, especially in the Global South, are thinking about their own interests: What are the political groupings? Is it regional? Is it mini-lateral? How do they hedge? This isn't the same nonaligned movement of many decades ago, but it is one of realignment, and I don't think we know exactly how that is going to shake out.

NIKOLAS GVOSDEV: My students are very interested in following several things. One is the fact that policymakers have to reconcile disparate objectives. On the one hand, you want to starve Russia of the wherewithal to continue its operation in Ukraine and you want to produce pressures that will either force the Kremlin to withdraw or that create significant problems in Russia, but at the same time you have doorstep considerations around the world of what people are willing to pay for food, fuel, and commodities, so you are trying as you said to find these measures.

We don't have replacements for everything that Russia supplies—natural gas, oil, strategic minerals, food, and fertilizer—so some Russian products still have to find a way to market, but the other thing, and you talked about this with the Global South, is the rise of what we might see as these "intermediary" countries, not just China but as you mentioned Turkey and India, which are aligned and partnered with the West but also are maintaining these conduits to trade and transact with Russia and to do so in a way that allows for—Tatiana, going back to your encounter with the Norwegians and others—people in the West in a way to have the sense that they have clean hands: "We're importing oil"—or gas or commodities—"that have come from a Turkish exchange or that have been resold from India, so we're not buying directly from Russia."

At the same time, Rachel, you and I and others have been looking at these fascinating end-of-year charts that have been coming out and seeing that, yes, European direct exports to Russia, particularly of electronics, is way down. Then you see this massive spike of European exports to Armenia, to Azerbaijan, to Uzbekistan, and to Kazakhstan.

It is not as if suddenly Kazakhstan has this insatiable demand for electronics. Again, there is a bit of that "clean hands" of, "Once we sell it to Kazakhstan, I think it is resold to Russia, but we are abiding by sanctions." Do you see these questions of intermediaries, these middle powers that are integrated into the Western world—Turkey certainly as a member of NATO—but also saying, as you said: "It's in our interest to facilitate trade with Russia, and if Russia has to discount sales to us and then we get to increase the price to resell to Italy or someone else, why wouldn't we?" Is that going to be the next challenge of how we are going to go to a Turkey or an India and say, "We would like you to do less of this facilitation?"

RACHEL ZIEMBA: I think it has been a challenge. It comes in waves because what happens is loopholes close off and then they reopen. I think there has been a concern about what happens. Do you restrict and say, "You can't sell more"—fill in the blank—"refrigerators to Kazakhstan than you did last year?"

Actually I am conscious of the history here. This is not the first time this has been an issue. Nick Mulder's great book that came out last year, The Economic Weapon: The Rise of Sanctions as a Tool of Modern War, talks about the ways in which the combined Franco-British efforts in the First World War tried to set targets for neutral countries. Then the question is: Where do you set it? What happens if there is a one-off, and which products? Maybe refrigerators is an easier thing to do in those cases. In the First World War sometimes it was about energy, food products, or the like, things that of course we are generally exempting from sanctions now for good reason. But how do you assess for what is the actual demand of neutral countries? Yes, it is a big issue.

It is complicated by a couple of factors. One is that the United States and more broadly the coalition of sanctioning countries is going to India or Turkey and saying, "There are certain things you can buy from Russia at certain prices and there are certain other things we really wish you wouldn't buy from Russia or supply to them," and there are certain things, technology export controls, that the United States and to a lesser extent its allies are trying to have enforcement actions on.

Some of the challenge is that in addressing the doorstep issues that you guys do such a great job articulating, especially around food and fuel writ large and trying to keep those flowing, there can be a mixed message of, "If we can buy those things from Russia, how do we avoid having a big external deficit with Russia," which is an issue for Turkey and India, and China as well but in a different way.

Some of it is, how much can you target and reshape that trade? Just as Russia is creating new routing the United States is using tools that we have not used before. This price cap is a very new tool. The kind of embargo, this weaponization of insurance dominance, is an element—Newman and Farrell's work on "weaponized interdependence"—and finding those chokepoints that someone can control I think is a good one to look back at and ask, "What happens if you try to create a chokepoint and you don't actually control that chokepoint" or as one country you don't control that chokepoint?

Maybe that is where some of the challenges with the semiconductor export controls in China come into play, though I think the United States has done an effort after the fact to build out that coalition. We will see what the lessons learned from that are. I think there is that element, going back to Russia.

The other one that I think the U.S. Treasury is focused on is instead of just saying to Kazakhstan, "Don't sell more than that," because some of it is state capacity to monitor and control the borders at a time when these countries have also had a lot of Russians fleeing mobilization come into their countries, which of course has boosted their domestic demand. It has put pressure on housing and food. Unsurprisingly growth is stronger in those countries because suddenly their population is bigger in a way that we don't count very well as macroeconomists.

The way the U.S. government and allies have tackled this is by trying to restrict some of the alternate payment systems. There was a window earlier in the year where some of Russia's neighbors and friendly countries were starting to align with Russia's Mir system, their domestic payment system, that helped them kick Visa and MasterCard out of the country for domestic payments, and it did connect into a few neighboring countries, places like Turkey and Kazakhstan. There was a trial they did in India.

What happened was that I believe late in the summer the U.S. Treasury put some of the Russians involved in running these networks on the sanctions list. They did not sanction the system exactly, but they basically went to Turkish and other banks and said: "This person is on the sanctions list and therefore the network. I think there is a lot of risk to doing business there," and sure enough, the flows trickled out.

I will get back to the point, which is that you close one loophole and a new one opens up. It is a game of whack-a-mole to some extent. Sanctions enforcement is like that.

Tatiana, you mentioned the IMF data and so on. My work on sanctions in Russia, Iran, and elsewhere tells me the story that in the absence of escalating new measures countries and markets adjust, so you find loopholes, especially when there is not a unity from all trading partners around isolating the country, and here clearly that is not the case.

I think the Chinese are picking and choosing what areas they trade with Russia. I do think that unlike some U.S. worries China has not been directly supporting the military. Of course they are selling them electronics that then the Russian military can repurpose, so maybe I am drawing too fine a line there, but yes, this is clearly an element where these loopholes have materialized, and it means that even though sanctions are having an effect some of that effect is in centralizing and consolidating power within Russia. So it is becoming smaller but also more centralized, more military- and government-led, but at the same time these loopholes are opening up.

I think there are a lot of countries looking out for what's the arbitrage here, first of all, because they don't want to suddenly turn around and say: "The price cap worked really well. Maybe we can apply it to another country" or a different industry. I know there is talk that something that could be done with certain other minerals. I think critical minerals, for example, is a tricky one because the United States and allies do not dominate that sector, so I think it would be a dangerous one to throw out in that way. There is fear that they could be on the receiving end.

There is also an element of countries looking around and asking, "What is in our national interest?" If you are the United Arab Emirates or Saudi Arabia, you might say, "We could get cheap crude oil that can serve our domestic market, and then we can sell our own crude oil at a higher price." That arbitrage looks quite attractive. Maybe there are some other elements here.

I think the net result is one where, as you said, Nick, how do you balance those different policy objectives and the timelines as well. There is a debate going on right now, and maybe it has been going on since February 20, of to what extent do you do not maximum pressure but a big bang of sanctions that really imposes costs—of course that is going to impose costs on the global economy as well because Russia is a major supplier—in the hopes of bringing the war to a close more quickly, so you incur that pain in the short term, versus an economic war of attrition? I come down to of course the war of attrition is not a good outcome, but the challenge with sanctions has always been one of the things of buying time for the military assistance and the other support to have effect.

TATIANA SERAFIN: I would like to stay on this idea of choices and arbitrage and deciding. It is not just at the government level, and I want to go down to the company level.

What we are seeing with the data that has come up too is that in the end some companies said, "We are going to shut down our subsidiaries," but then if you look at the overall number, the percentage is really low. Not every company pulled out, some companies are pulling accounting tricks by writing off the asset, and—to your point—waiting it out, and then if things change all of a sudden they will go back in with very little damage to their accounting overall.

I think that is important to understand because in the beginning of this second invasion there was this "Don't buy Russian caviar," no Russian this, no Russian that. I am not hearing the same right now on a lower level, and anecdotally I don't think companies are feeling that pressure. From the data it looks like they are just waiting it out: "It might be over soon and then we can just restart our operation," because 100 percent of U.S. and European countries that said they would pull out have not.

RACHEL ZIEMBA: I think we have to, without being apologists or anything like that—which I know is not as easy as it ought to be—I understand the different subsets of the companies who stayed. Also this is the kind of thing where sometimes sitting in the United States it is how do you play through what we do or what allies do, what the response is from Russia or the target. It was perhaps self-serving, but some companies said, "If we pull out and just leave, we are handing over equipment and other assets and people to the Russians, so the net result of our leaving and abandoning"—that is where I think different sectors create different issues. Of course the Russians have zero interest in making it easier to repatriate equipment, money, and the like, so that is one issue.

Say you were a company that had a franchise, a bazaar or a retail company, it is a lot easier to pull out than, say, if you were a capital-intensive oil service company. That does not mean that they haven't left. As you say, there is an accounting trick—maybe they sold to a local partner or something like that. What do you do if the asset you had in-country was intellectual property that had been developed from people working over time and coming at a time where for a lot of places it wasn't easy for Russians to leave?

I just talked about people fleeing across the border, but across Europe they are no longer issuing visas to many Russians and so on. So I do think there are challenges, especially for companies that are like, "We don't want to just abandon our Russian staff." Again, without saying, "Of course, one shouldn't leave," when you get down to the nuts and bolts there are some complications.

The other challenge that comes into play come back to this whole question of: What happens when the United States and allies are trying to pick and choose which trade with Russia can go ahead? You actually needed a circumstance where some businesses, especially banks, continued to have certain levels of operation there. I have talked to some companies, who say, "Our lawyers all picked up and left and moved to Dubai." It has always been a murky, illegal situation in Russia with potentially arbitrary application of rules, but what does the exit look like? So there can be waves of unintended consequences.

But you are right. I think there are a lot of entities that are waiting and seeing and a lot that are like: "We want to leave, but we have money in the bank. We want to take that with us." Some of them maybe want that money and also have written down.

I have not looked at it in detail, but the new Yale School of Management and Kyiv School of Economics, has just done an update on where the companies are. The considerations I am talking about are what I hear from Western companies. Some of those from emerging-market economies are even more likely to stay put or continue.

What I have not seen, though, are major new investments in emerging-market economies and countries. Say there was a Turkish company partnered with a U.S. company and maybe there has been a little bit of selling out to that partner or to the Russian partner, but there has not been a lot of new investment. That is rational for all the reasons we have talked about just from an economic perspective irrespective of the bigger moral imperative.

I do think some of it is going to depend a lot on sectors, but I think some companies have held on too much, but it is that tradeoff of at the end of the day in leaving do you transfer your assets to the Russian military machine but staying you are complicit with implementing mobilization and all sorts of things, and those tradeoffs are difficult for companies. I think some of them have scaled down to very small operations and are just trying to figure out how to do the least damage, and some are probably just waiting around.

I do think there is an interesting question. We are far from a point where we can start to think in a realistic manner about what sort of sanctions lifting would look like, though I always think —especially with an analyst hat on—that a tool is most effective if you think about what reversing it might look like, so making sure you have the ability to do that.

One thing that I think is going to be interesting to watch is that we have seen this trend toward asset seizure and forfeiture. It hasn't happened yet, but a lot of countries in the sanctioning coalition—Canada first followed by the United States, and maybe Europe is coming—are changing their legal systems to allow for frozen assets to be seized and go toward Ukraine.

That checks a whole bunch of boxes: How do you pay for reconstruction? Russians ought to pay for part of that. It allows them to send a message that some of these oligarch assets were ill-gotten illicit gains. Of course there might be a dynamic of, "If the assets are seized and forfeited, there can't be sanctions relief down the line," so I think there are a lot of these different things in play.

From our perspective, thinking about not only what happens with Russia but what messages are being taken away by other countries raises interesting questions about how we deal with the proceeds of kleptocracy—something I know you guys have talked a lot about and done a lot to bring to the fore—but also how does foreign investment evolve, especially certain questions vis-à-vis what the structures are in China? A lot of these are things where I can see things changing and we don't know exactly how they are going to change.

TATIANA SERAFIN: We are going to keep looking for changes and hope to have you back to help explain it and bring awareness to this rerouting and these loopholes because that is important. We can't just say, "We're done now and we are just fighting the war." I think that is an important discussion to have as we are getting more of this data in.

Thank you so much for joining us today and explaining all this.

RACHEL ZIEMBA: My pleasure. Thanks for having me.