The sanctions could end up causing more pain to US allies in Europe than Russia itself, which will probably take yet another step closer to autarky as well as its ally in the east, China.

Following Vladimir Putin’s announcement in the early hours of Tuesday morning that Russian troops could enter breakaway regions in eastern Ukraine after recognising them as sovereign states, the US has said it will unveil new sanctions against Russia on Tuesday. This follows a Reuters report on Monday, citing “three unnamed sources familiar with the matter,” that new sanctions could include could include a measure that would prevent financial institutions in the US from carrying out transactions with Russian banks.

This is apparently the ace up Washington’s sleeve, although, as Reuters pointed out in the article, the White House hasn’t publicly announced plans to force US banks to sever relationships with Russian financial institutions. But behind closed doors that is what is allegedly happening — again, according to Reuters’ three unnamed sources:

They aim to hurt the Russian economy by cutting so-called ‘correspondent’ banking relationships between targeted Russian banks and US lenders that enable international payments.

The sources also said the US would place certain Russian individuals and companies on the Specially Designated Nationals list.

It would effectively kick them out of the US banking system, ban trade with Americans and freeze their US assets.

It was unclear who the targets would be, but the sources believe top Russians lenders like VTB Bank and Sberbank could be on the list.

Experts believe it would be a meaningful blow to sanctioned bodies, as it would make it difficult to deal in US dollars – the global reserve currency.

Severing transactions between Russian banks and US financial institutions could have a harsher impact on Russia’s economy, but they could also backfire, as the New York Times recently warned. Not only could it hurt Russia’s economy by further weakening the ruble, which is currently close to a historic low against the dollar, and turbocharging inflation (already at 8.73% in January); it could also set off a ripple effect in Europe.

One of the biggest concerns in Europe is that the EU sanctions against Russia will include the forced closure of Nord Stream 2, the 750-mile, $11 billion underwater gas pipeline connecting Russia with Germany. The pipeline was finished in September 2021 but is still yet to receive final certification from German regulators. If it ever becomes operational, it will significantly boost deliveries of gas directly from Russia to Germany and then on to other parts of Europe, relieving some of the pressure in energy markets.

But the pipeline has faced intense opposition from the United States, the United Kingdom, Ukraine and other European countries, which have been calling for the project’s cancellation since it was first launched in 2015. Of course, the United States, as the world’s largest producer of natural gas, has a direct financial interest in preventing Russia, the world’s second largest producer, from increasing its market share in Europe.

Another round of sanctions against Russia will probably have a relatively muted impact on the US economy. The US imported a meagre $30 billion of goods from Russia in the first eleven months of 2021 while $13.2 billion of goods travelled the other way. However, the US could suffer indirect effects as consumer prices rise even higher due to surging energy and food prices. Russia is a major global player in the export of agricultural goods, energy and minerals, and sanctions are likely to take a toll on the marginal pricing of those goods in global markets.

Europe, by contrast, has a lot more to lose, especially if the sanctions target Russia’s energy and financial sectors. Russia is the EU’s fifth largest trading partner, with imports of $188 billion and exports of $94 billion in 2021, according to Statista. And many European countries, including Germany, are massively dependent on imports of Russian natural gas. Around a dozen European countries imported more than half of their natural gas requirements from Russia in 2020, according to the European Union Agency for the Cooperation of Energy Regulators (ACER).

Ten Years of Sanctions

Russia has faced escalating US and EU sanctions since the US enacted the Magnitsky Act in December 2012. Those sanctions were intensified in 2014 following Russia’s annexation of Crimea. The measures employed to date have included blacklisting specific individuals closely associated to the Kremlin, limiting Russia’s state -owned financial institutions’ access to Western capital markets, bans on weapons trade and other limits on the trade of technology, including for the oil sector.

Yet the sanctions have had little desired effect. All they seem to have achieved is to push Russia further along the path toward autarky as well as into the welcome embrace of China.

Now, Washington is considering taking much harsher measures, including directly targeting Russia’s banking system. The goal, according to Daleep Singh, White House deputy national security adviser for international economics, is to “devastate” the Russian economy.

But it could be Europe’s economy that will end up devastated. The biggest fear among European banks is that Russia could end up being excluded from the Belgium-based SWIFT transfer system, the backbone of cross-border payments and the global banking network. For European banks with significant exposure to Russia it would be the equivalent of an “atomic bomb” for the industry since it would prevent the repayment of debts, an unnamed banker told Reuters a week ago:

Banks in Italy, France and Austria are the world’s most exposed international lenders to Russia. Italian and French banks each had outstanding claims of some $25 billion on Russia in the third quarter of 2021, according to figures from the Bank for International Settlements. Austrian banks had $17.5 billion. That compares with $14.7 billion for the United States.

European banks with subsidiaries in Russia are most at risk of sanctions, according to JP Morgan research. The investment bank’s study pointed to a handful of banks, including Unicredit, RBI [from Austria]France’s Societe Generale and ING of the Netherlands, as having notable exposure to Russia.

RBI said its exposure was manageable, while ING said it was well prepared. Societe Generale said it was closely monitoring developments and confident about its Russian business. Unicredit did not immediately respond to a request for comment.

Interestingly, two of the four aforementioned banks — Unicredit and ING — are also among the most heavily exposed European lenders to Turkey’s embattled economy, where inflation reached a 19-year high of 48% in January and whose state-owned banks just received a $2 billion bailout.

On Friday, the White House appeared to abandon the nuclear option of kicking Russia off SWIFT, presumably after hearing a cacophony of warnings and complaints from its European allies.

“All options remain on the table. But it’s probably not going to be the case that you’ll see SWIFT in the initial rollout package,” Daleep Singh, White House deputy national security adviser for international economics, said in a briefing Friday.” We have other severe measures we can take, that our allies and partners can take in lockstep with us, that don’t have the same spillover effects.”

Other sanctions options still on the table include banning exports of high-tech products to Russia, restricting the imports of some products from Russia, and placing some Russian individuals on the Specially Designated Nationals (SDN) list, which would basically remove them from the US banking system through barring their trade with Americans and freezing their assets in the country.

Closing Nordstream 2 will put even further pressure on record-high energy prices in Europe, which are already pushing many household budgets to breaking point. In a retaliatory move Putin could even cut Europe off from Russian natural gas altogether. If that were to happen during a late-winter cold snap, it would plunge Europe into a far worse energy crisis while sending global energy prices spiraling even higher.

This is a vital point in any discussion of sanctions against Russia: the economic impact on the US will be relatively muted compared to that felt in Europe. As Yves puts it, Washington is, if anything, cutting off Europe’s nose to spite Russia’s face, while making lots of money along the way. As the Wall Street Journal reported recentlythe US energy industry is doing very nicely out of Europe’s gas shortages: “US natural-gas producers and global commodity traders are emerging as some of the biggest beneficiaries of the surging energy prices spreading pain in Europe.”

Meanwhile, Russia will take another step closer to autarky as well as deeper into the embrace of its ally in the East, China, with whom Putin recently signed a 30-year natural gas pipeline deal, one of whose clauses stipulates that the new gas sales will be settled in euros. Given its own energy pressures, China will be happy to take more natural gas off Russia’s hands. And in the short to medium term at least, Russia will be happy to divert its sales eastward.