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Rusal, Deripaska and the US’s latest sanctions debacle

US sanctions on Oleg Deripaska and Rusal create chaos in world aluminium market, hurt US pension funds, force US Treasury to backtrack

In the immediate aftermath of the US Treasury Department’s extraordinary decision to impose sanctions on the Russian businessman Oleg Deripaska and by extension his Rusal group, a very interesting article penned by the financial analyst Tim Ashe appeared in the Financial Times.

Discussing the sanctions imposed on Deripaska and Rusal, Ashe made this highly interesting comment

The sharp drop in Russian markets over the past few days and the limited contagion to global markets will have been noted by the US sanctions team. I think they have previously been very nervous over this idea of backdraught from their actions, hurting US institutional investors and causing systemic risks to other emerging markets and indeed global markets. The fact that the April 6 sanctions designations only really impacted Russian markets raises the prospect that the US can roll out asymmetric sanctions against Russia, that officials can be less worried about their actions having a more global impact. This means the Treasury is more likely to follow on from its April 6 actions, assuming no improvement in the relationship with Russia.

(bold italics added)

Rarely have comments spoken with such confidence been proved wrong so quickly.  In fact they provide a classic case study of why when analysing events it is essential to hold back and see how they will develop before rushing to give dogmatic opinions about them.

Since Ashe wrote those words on 10th April 2018 Russian markets have stabilised as has the rouble, which has proved resilient in face of the pressure which is hitting hard the currencies of other so-called ’emerging market’ economies and which is coming from the stronger dollar and from talk of more interest rate hikes in the US.

The rouble at least for the time being appears to have stabilised at a rate of 62 to 64 roubles to the dollar – an exchange rate which I consider healthy – despite the Russian Central Bank refusing to take steps to support it, and refusing to raise interest rates.

By contrast the currencies of other so-called ’emerging market’ economies have taken a hammering, with the worst performer being the Argentinian peso, which is coming under exceptionally heavy pressure, forcing the Argentinian Central Bank to raise interest rates to an eye-watering 40% to support it.

In the meantime, as Russian markets have stabilised, the world aluminium market in which Rusal – the world’s second biggest aluminium producer – is a major player, has descended into chaos.

Aluminium prices at one point surged up 30%, with the hike in aluminium prices and general shortages of aluminium caused by the sanctions impacting on industrial users of aluminium worldwide, including the US and German car industries.

It is only a matter of time before the instability in the world aluminium market also hits the other major industrial consumer of aluminium: the aircraft building industry, in which the US is a major player.

Meanwhile the sudden increase in risk for holders of Russian debt caused by the US Treasury Department’s implicit threat to impose sanctions on any and every Russian businessman (“oligarch”) perceived as too close to the Kremlin irrespective of what they do, has hurt Western institutional investors including US pension funds.

The result is that the US Treasury Department is – without of course admitting the fact – beating a retreat.

Investors have been given more time to unwind their positions in Rusal – though that does not explain how they are supposed to do that if the sanctions remain in place – US Treasury Secretary Steven Mnuchin has said that the US has no wish to destroy Rusal, and – following not so secret negotiations between the US and the Kremlin which are known to have taken place – a compromise is being sought whereby Deripaska will sell some but by no means all his stake in Rusal’s parent company in return for the sanctions on Rusal being lifted.

Meanwhile Bloomberg is calling the sanctions a mess

I remain convinced that Deripaska was chosen because his company deals in aluminum — the target of Trump’s import tariffs, which are meant to revive domestic production. The opportunity to kill two birds with one stone — punish Russia and get a major foreign player off the U.S.  aluminum market — must have looked too good to pass up.

But no one in the Treasury Department appeared to have considered the consequences for the global aluminum market, where Rusal was included in international value chains.

Aluminum prices jumped (which can only be bad for U.S. buyers), Australian-British Rio Tinto was forced to search frantically for new buyers for its alumina (a raw material for aluminum production), and a Rusal plant in Ireland was threatened with closure, creating the potential for job losses and an alumina shortage throughout Europe.

These problems, reported to Treasury, appeared to soften Mnuchin’s heart. “The U.S. government is not targeting the hardworking people who depend on Rusal and its subsidiaries,” his department quoted him as saying. The U.S. government’s problem, Mnuchin said, was limited to Deripaska himself.

The new edition of the Rusal sanctions gives the company an extra six months, until October 23, to wind down its U.S. operations, but Mnuchin has clearly indicated that if Deripaska divests Rusal shares, the company could be taken off the sanctions list.

Business partners will still be leery of dealing with Rusal, and they’ll still work on contingency plans, but at least there’ll be less urgency about it. That’s been reflected in an aluminum price drop almost as sharp as the spike after the original sanctions announcement.

The sanctions the US Treasury Department imposed on Deripaska and Rusal were the most ambitious and far reaching sanctions that the US has imposed on Russia since the sectoral sanctions which the US and the EU imposed on Russia in July 2014.

What this episode has illustrated is a point which I have repeatedly made: the 2014 sanctions were carefully calibrated to cause the maximum hurt to the Russian economy, and the minimum hurt to the US economy and to the world economy upon which the US depends.

Any sanctions that go significantly beyond the sanctions which were imposed in 2014 risk hurting the US as much or even more than Russia in that, even if their economic effect is less their political effect risks being greater.

Certainly no US President is going to risk a cost crisis in the US car and aircraft building industries simply out of some juvenile desire to spite Russia.

A US President like Donald Trump, whose electoral success depends heavily on the votes of blue collar workers with jobs in the US manufacturing industries, which he has set out to revive, is going to be even less willing to risk such a crisis.

Trump’s decision to refuse to impose the further sanctions on Russia that people like Nikki Haley and Steven Mnuchin were pressing him to impose following the Syrian missile strike illustrates the point.

The big question is whether following the Rusal debacle the US will now draw back, finally accept that the sanctions route of pressuring Russia has been exhausted and has failed, and starts looking instead for other ways of dealing with Russia.

Given the pathological hatred of Russia of so much of the US political class a further sanctions offensive against Russia is not impossible, with officials in the US Treasury Department possibly hunting around for targets against whom sanctions would cause less disruption to the US and world economies than the sanctions against Deripaska and Rusal did.

My own view is that so long as Donald Trump remains in the White House that is unlikely to happen, not because Trump is some sort of stooge of Russia but because he has now seen the hurt further sanctions on Russia can cause to the people who make up his electoral base.

If so then with the Rusal debacle ‘peak sanctions’ has passed.

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