Sir Humphrey is blocking Ukraine’s victory

For the past three years plus I have been active in various campaign groups trying to GET RUSSIA TO PAY, specifically for its unprovoked invasion of Ukraine and utilising therein the $330 billion in CBR assets immobilised in Western jurisdictions.

Morally it seems like a no brainer - Russia is clearly the aggressor (see various UN resolutions), it should pay for the close to $1 trillion in damage it has done to Ukraine and the costs of the war, which are close to $350 billion now in terms of Western financial support given to Ukraine to help in its defence.

Politically it also seems like a slam dunk - at least for Western politicians. I mean why should tax payers in the West pay to sustain Ukraine’s defence when there is Russian tax payer money sitting doing nothing in Western bank accounts? Indeed, when you sit down with Western politicians - I have met many MPs from all political persuasions - and you make that pitch it is literally like a Eureka moment, the penny or cent, literally drops with a clang. They then go away sign motions, bills, and lobby their governments and nothing then happens. Our Western governments then stall doing anything. Actually I describe it as the “Yes minister” effect. Older Brits might remember the succesful UK BBC sitcom from the 1970s, Yes Minister, which follows the career of an up and coming Tory minister, and how his enthusiasm for various seemingly logical and obvious policy initiatives are managed into oblivion by his crafty, wisened civil servant who essentially ends up making all the decisions in his ministry. The minister ends up as prime minister, (Yes Prime Minister) but his civil service handler still ends up running the country, while all along making the PM think he is in charge. In respect to the issue of immobilised Russian assets I think this is what is essentially happening - I think a blog of uber conservative civil servants, particularly in Western treasuries and central banks (ECB in particular) are coming up with all kinds of excuses for not doing what should be done - which is to freeze, seize and allocate the $330 billion in immobilised RU assets for Ukraine’s defence. Essentially the blog hate doing anything slightly outside the box, or their comfort zones. And these civil servant types have come up with lots of stalling excuses as to why they should not do this - there is no legal basis (there is - countermeasures) and the economic risks of seizing outweigh the benefits (just not true).

The irony for me is that when ministers, and prime ministers are freed from office, they seem to be willing then to “come out” in favour of seizing, albeit they were not able to get this over the line when they were in office - note there the recent oped from Rishi Sunak in the Economist recently and Wally Adebayo in Foreign Affairs, et al. David Cameron and Boris Johnson also also now supportive, but not in office.

Just returning to the economic threats/risks from siezing immobilised CBR assets I would argue that they are greatly overdone:

What about the risk to G7 reserve currency status?

* The move to immobilise CBR assets in 2022 could have been a clarion call to other authoritarian regimes with asset exposure in the G7 to move their assets out of these jurisdictions. And yet there is little evidence that these regimes responded by moving assets. There is some evidence of a shift of assets by China from the U.S. to Europe, but these assets remained in US dollars so still falling under US regulatory/sanctions oversight and risks. Immobilisation put CBR assets beyond Russia’s use, so one could ask whether these other authoritarian regimes would see much difference between immobilisation and full seizure. I think not. The West has made clear Russia is never getting these assets back unless it pays reparations to Ukraine. In reality if other authoritarian regimes failed to shift assets from G7 jurisdictions on immobilisation it is unlikely they will do much more with a move to full seizure.

* The reality is that for the $7 trillion in global FX reserves held by non G7/Western friendly regimes in the Gulf, China, et al, there are no safe alternative liquid global markets to reinvest these funds in. These regimes do not trust each other to invest in each others currencies and markets in sufficient scale. To put things in perspective, China’s FX reserves of $3.5 trillion is three times Saudi Arabian GDP, and equivalent to India’s total GDP. The reason that these assets were not moved on immobilisation is that there are no alternatives, and that is still the fact if we move to full seizure.

* France has hinted that Saudi Arabia has warned it would move assets ($450bn in FX reserves, plus likely closer to $1 trillion plus including Aramco and PIF) from G7 juridications on a move to full seizure of CBR assets. But this looks like a hollow threat given the risks to Saudi Arabia from such a move. Any such move would be seen by G7 countries as an unfriendly move by KSA, and they might well respond by pulling their risking security backstop to Saudi Arabia. Would Saudi Arabia really risk its own security for Russia? Practically any move by Saudi Arabia to sell USTs, Bunds, Gilts et al would pose huge economic and financial risks to the global economy and hence back to Saudi Arabia. Selling USTs would put downward pressure on their prices, increase yields, and global borrowing costs. Higher global interest rates would slow global growth, put downward pressure on oil prices, still a signficant source of budget financing for Saudi Arabia. Saudi Arabia would see higher budget deficits, higher borrowing costs, and likely more limited market access at a time when MBS is looking to fund an expansive Vision 2030 programme to transform his country. This project would be in doubt which would then cause political risks to MBS. Actually the global turbulence caused by any move by Saudi to sell its huge holdings of G7 securities would risk economically and financially destabilising Saudi Arabia itself - it could risk capital flight and pressure on the Saudi Rial peg to the dollar - and financial instability and high inflation as a result. The risks to the global economy actually might then see a flight back to safe havens, actually underpinning global demand for reserve currency assets. So any such Saudi Arabian, or indeed Chinese, move would be totally counterproductive and would just likely underpin the reserve currency status of G7 currencies. It is simply not going to happen - there are no alternatives to G7 currencies as a reserve currencies.

What about the threat of retaliation by Russia, seizing Western assets in Russia?

* The reality is that this has already happened as the Kremlin has forced sales of Western assets in Russia at knockdown prices to friends of the regime. A recent Reuters article cited a figure of $107 billion in such Western losses on assets in Russia.

* But let’s not forget that these investments were private sector investments that failed to take into account the geopolitical risks, long clear, of investing in an authoritarian regime. The Biden administration long signalled (at least as far back as 2021) the risks of an invasion of Ukraine by Russia, and warned of an aggressive sanctions response. These Western companies could have long left Russia, but thought they knew best, chose to put profit over conscience and so why should they now be bailed out, in effect by Western tax payers by not risking seizing CBR assets? And why should Western national security interests - which should be to seize CBR assets to limit resources available to Russia to regenerate its military capability - be made subordinate to the selfish interests of Western private business?

Actually I would look to arguing the counter factual here - what are the risks and costs of failing to seize and utilise immobilised RU assets for Ukraine’s defence?

First, failing to use immobilised RU assets for Ukraine’s defence risks short changing Ukraine in its defence, and therein in the least bad (but still terrible) scenario extending the war, causing the loss of innocent Ukrainian lives, and in the much worst case scenario risking Ukraine’s defeat. Imagine the result of the latter - it would mean tens of millions of Ukrainians fleeing West, straining the economic, social and political core of Europe, further boosting far right populist movements in Europe. It would mean Russia captures Ukraine’s huge military industrial complex - the two largest military industrial complexes (Russia plus Ukraine) would now be reigned against Europe. Europe would have to increase defence spending, likely not just from 2% of GDP at present to 3% of GDP, but back up to the 5% or so maintained during the Cold War. That would mean an increase in defence spending of up to €1 trillion more per annum by Europe. Imagine what that means - higher budget deficits, higher borrowing costs, higher interests rates and lower growth. All that would be a sledgehammer blow to confidence in the European project, and the euro as a result. Indeed, I would argue that not spending the money from immobilised RU reserves to fund Ukraine’s defence is a bigger risk to the reserve currency status of the euro than seizing and allocating the assets.

Second, the civil servants in Europe seem to think that spending Western tax payer money to support Ukraine is a relatively costless approach relative to seizing and allocating immobilised RU assets. Wrong, wrong, wrong. The reality is that there is not an unlimited appetite on the part of Western tax payers to fund Ukraine - we have spent roughly $100 billion a year in defence of Ukraine, but that has not been enough. Ukraine is on the back foot, and it could lose. The policy of using Western tax payer funding is failing/has failed in terms of bringing an early end to the war. And even though we have underfunded Ukraine, the sums spent are still huge, and this has presented a gift to Trump, MAGA and other far right movements across Western democracies. They have argued why should Western tax dollars be spent supporting Ukraine, when there are plenty of competing spending priorities at home. They have a point when we think that no Western tax payer dollars could have been spent if three years back our politicians had been brave enough to freeze and seize Russian central bank reserves and to have used them back in 2022 to fund and ensure Ukraine’s victory.

But where are we now?

Well Sir Humphrey, and his French, German, Italian and particularly his Belgian counterparts, in Western bureaucracies now face a dilemma. Alarm bells are ringing as at the end of July EU sanctions which ensure the immobilisation of Russian assets fall due for renewal. And it is entirely possible that Hungary blocks their renewal - a unanimous decision is required, not majority qualified voting. If Hungary succeeds in blocking the renewal of sanctions with respect to immobilised RU assets the consequences will be that Russia will receive back the $330 billion in CBR assets which will no doubt be used to further regenerate its military machine to be used against Europe. It will also leave the G7 countries on the hook for the $50 billion ERA facility agreed to front load the future interest stream on mobilised RU assets. Under the terms of the ERA, the loss of the underlying capital would mean G7 countries would have to repay the facility. So not only will $330 billion in CBR assets flow out of G7 jurisdictions - itself a risk event for reserve G7 currencies but G7 countries will have to write another cheque for $50bn. And if they fail to do this, Ukraine will face a $50 billion hole in its financing equation for 2025-26. If Ukraine fails to cover this shortfall it will be short of funds to purchase munitions for its defence, but likely will also suffer a balance of payments crisis, destabilising its macro and making it even more difficult to fight the war.

One hopes that European politicians have countermeasures in place for the end of July - enough leverage over Orban to force him to agree to renew sanctions or measures at the EU or individual country level to keep Russian CBR assets immobilised. But this still begs the question why Europe left itself so exposed to blackmail from Orban, and the catastrophe of the underlying assets being returned to Russia. It still begs the question as to why the underlying assets have not already been seized and allocated to Ukraine. If we had already seized the assets we would not be currently facing blackmail from Orban or the jeopardy of assets being returned to Russia.

Now I would argue that the legal basis for seizure has been made - as per Zelikow, Zoelick and Zyskind, et al. But even if Sir Humphrey is still mounting the legal defence there are still plenty of solutions - and note these were all laid out three years ago. See my various writings herein:

The $330 billion in CBR assets could be immobilised, seized and put in a sovereign wealth like fund managed by Ukraine jointly with G7. This fund could hire outside investment teams to manage the assets, aiming to increase the returns from the low single digits now being earned by assets immobilised at Euroclear, and used as the basis for the ERA, to say 8-10% annually. The $30 billion plus generated could then be used to part fund Ukraine - the underlying asset would remain untouched, and available to be returned to Russia in the low probability event that Russia wins a court case against confiscation. And if the $30 billion annual interest flow to Ukraine was not sufficient to win the war, then the underlying asset held in the sovereign wealth fund could be used to buy Ukrainian bonds - Russia would retain ownership rights of the underlying asset, which Ukraine might still opt to repay in the future dependent on the state of negotiations over reparations. But Russia’s fundamental ownership rights would not be undermined. Rather than owning bunds, gilts or oats, they would now be invested in Ukrainian sovereign bonds.

The West just needs to wake up, think outside the box, as Putin does, or risk losing the battle for Ukraine and the war for Europe. And herein our politicians should be standing up to their Sir Humphrey’s in their civil services, and central banks. Politicians should be making the decisions in Europe’s national security interests which should be centred on ensuring Ukraine’s speedy victory against Russia.