One of the major international news stories over the past two years has been the unrest in the Ukraine that ultimately led to an overthrow of the previous government and a standoff between the nation of Russia and the Western powers. This resulted in the United States and many European nations imposing economic sanctions against Russia. What has not as well reported is that Russia responded by imposing sanctions of its own against these nations, which have had a noticeable effect on European farmers. Since that time, relations between the two sides have continued to sour. This can be seen quite clearly in recent events in Syria. These escalations in tensions have prompted some Russian lawmakers to propose ways for that nation to react and one of these proposals could prove devastating for the Western financial system.

The two conflicting sides of this geo-political situation first came into conflict in March 2014 when Russian soldiers annexed the Crimean Peninsula, which formerly belonged to the Ukraine, following a disputed referendum in which the citizens of the Crimea voted to become part of Russia. In response to this incursion, the United States ordered travel bans and asset freezes of those Russian individuals believed to be responsible for this military action. The European Union and other major Western powers followed by imposing similar sanctions of their own. Since that time, most of these nations have imposed stricter economic sanctions.

Three days after the United States imposed its first round of sanctions against Russia, the latter country imposed travel bans against ten American citizens and four days later against thirteen Canadian citizens. These counter-sanctions also escalated as their Western counterparts’ did, to the point where Russia banned nearly all imports of agricultural products from those countries that had imposed sanctions against Russia.  This has had a devastating effect on Western farmers, particularly European ones, as European food exports to Russia totaled €11.8 billion prior to the imposition of the sanctions. This has caused some European farmers to protest against the sanctions imposed on Russia.

As many of you reading this are undoubtedly aware, Russia is a major exporter of various commodities, including natural gas, oil, nickel and other metals, and timber. This has resulted in the country building up a substantial amount of foreign exchange reserves (approximately $377.3 million as of September 2015). This has also enabled the country to establish its own sovereign wealth funds, the size of which stands at approximately $168.8 billion between the nation’s two funds. This money, along with private money held by the Russian people, has been at least partially used to invest abroad. As of the time of writing, the total assets of the Russian Federation located in NATO countries is approximately $1.2 trillion. This has understandably led to some concern among the Russian leadership that the NATO countries may seize or otherwise confiscate these assets should tensions between the two powers continue to escalate. However, Russia’s mineral wealth has led to significant foreign investment into that nation as well. At the time of writing, the NATO countries possessed approximate assets of $1.1 trillion in Russia. Thus, Russian Presidential Aide Sergey Glazyev has officially proposed to the Russian Security Council that should the NATO nations confiscate Russian assets in their countries then Russia should do the same to NATO assets in Russia.  Given the roughly equal investments, the net result in this scenario would be a wash although some Western companies with significant assets in Russia, such as ExxonMobil (XOM), would be significantly impacted.

It is the second part of Mr. Glazyev’s proposal that could potentially prove more dangerous to the Western financial system. The Russian Federation and its companies have approximately $1 trillion in short-term debt owned to entities in the NATO countries.  Mr. Glazyev has proposed that, “If the emerging trend of freezing Russian private assets of Russian legal entities and individuals continues, then Russia should consider a full or partial moratorium on the servicing of loans and investment from the countries involved in the freezing.”  Thus, a high-ranking Russian official has effectively proposed that the nation should default on over a trillion dollars in debt owed to the Western powers in retaliation for the escalating sanctions being imposed on it.  Here is his rationale (from Zero Hedge):

“The fact is that Russia has lost access to Western credit and cannot rollover its debt with its creditors.  So Russia will have to pay the principal and interest as it comes due.  That is a trillion dollars plus interest.  Russia also cannot import anything from the West without paying double for it.  So arguably the country may now be in the very position it will be in if Moscow opts for default.  Thus, Russia would have nothing to lose by a default – as the damage is already done.”

Thus, Mr. Glazyev believes that the Russian Federation would have nothing to lose from a default.  The same cannot be said for the Western powers, however.  In order to see why this is, we merely have to look at the history of the Financial Crisis of late 2008.

Arguably, the Financial Crisis began on Monday, September 15, 2008 when investment bank Lehman Brothers announced that it would be filing for Chapter 11 bankruptcy following a few quarters in which the bank suffered a multi-billion dollar loss. At the time of the filing, Lehman Brothers had a total of $613 billion in bank debt, $155 billion in bond debt, and assets valued at $639 billion. In other words, its liabilities exceeded its assets by $129 billion. However, it is worth noting that Lehman Brothers was not the first bank to fail during this period.  Over the February 2007 to March 2008 period, over 100 mortgage lenders and the investment bank Bear Stearns failed due to losses on subprime loans (as well as an inability for many mortgage lenders to securitize and sell off loans). Over the July 2007 to March 2008 period, various Wall Street firms suffered aggregate write-downs of $175 billion. By November 2008, this increased to an aggregate total of $750 billion, enough to eliminate most of the capital in the worldwide banking system. This is around the time that Central Banks and governments around the world began to step in, with the $700 billion Troubled Asset Relief Program being passed on October 3, 2008. In total, the Federal Reserve, European Central Bank, and other central banks spent at least $2.5 trillion buying troubled assets of of the banks and the governments of the world spent at least another $1.5 trillion bailing out their own banks, generally through the purchase of newly issued preferred equity. However, the important takeaway here is that total asset write-downs were only $750 billion in November 2008 when the system was on the verge of collapse.  Mr. Glazyev is proposing to default on $1 trillion.  Despite the strengthening of the financial system since the Financial Crisis, this will still be sufficient to create a similar situation.