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Weaponizing Financial Systems and Networks

A new armory of weapons for punishing international transgressions or restoring global economic order has recently been displayed.

Whether it is economic sanctions imposed by the US and the EU on Russia for unprovoked attacks on Ukraine or the Canadian government breaking up a trucker blockade by freezing credit cards, central authorities are showcasing highly effective financial sanctions. The enormity of these authoritarian measures was captured by Will Mason, Upswing Capital LLC, in a note he sent me after the US and EU imposed sanctions on Russia in late February:

“Over the last 6 months we’ve seen an unprecedented weaponization of money. First, in Afghanistan after the United States’ withdrawal. Afghanistan’s reserves were simply confiscated with the push of a button. Taliban officials were apparently very perplexed, unaware that these “reserves” were simply digits on a ledger. Second, in Canada of all places. Justin Trudeau, seeking to end a trucker blockade of Ottawa, declared emergency powers and froze hundreds of checking accounts and credit cards of truckers and people who donated to them. Finally, with the war in Ukraine, Russia’s “Fortress Strategy” of building up large reserves to handle any pressure was wrecked overnight by sanctions freezing Russia’s US and EU reserves.”

Mr. Mason is not alone in viewing the weaponization of financial systems as a reminder that a small group of people with central authority really control most the money in the world.

International Commerce

Few of us have any real experience with international payment systems. Before the Ukraine invasion I didn’t understand how the SWIFT system worked and how it could be wielded as a more effective weapon than a column of tanks and soldiers.

According to a comprehensive article about the SWIFT payment system by Cnet on February 28, entitled, “What Is Swift and How Is It Being Used Against Russia” , written by Peter Butler and Dan Avery, SWIFT is really an interbank messaging system that facilitates international money transfers by allowing bank communications to validate counterparties and prevent fraud and money laundering.

A bank can be removed from SWIFT quite swiftly as we saw with several Russian banks that were jettisoned overnight. Only those Russian banks and their counter parties handling international oil settlements were permitted to use the SWIFT system. If those banks are removed from SWIFT, Russia will have to invent a gold backed Ruble currency to transact oil exports. I wonder who will ever trust Putin to honor a gold backing, so this solution is unlikely.

Rethinking The Financial Order

The sanctions imposed on Russia, Afghanistan, Iran, and Syria create real pain and visible damage to those economies. Chairman Xi of China is watching the weaponization of the world’s financial systems and probably planning a work around strategy should he view Taiwan as his new Ukraine opportunity. For now, the world’s economic system is still controlled by the US and Europe. They are safe havens for wealth all around the world and there really is no good alternative. The Russian oligarchs are learning that painful lesson.

Private Networks Are In The War

The “Financial Times” Opinion on March 7, written by Rana Faroohar also reveals the emergence of private networks in the battle for the Ukraine. She explains that private actors like Elon Musk can aid Ukraine internet communications through his Starlink System, plus Meta and Google can impede some communications and augment others. Networks become effective mercenary soldiers for isolating rogue actors, scripting the true message and rallying international opinion.

Rana Faroohar’s insight is attributed to a book by Henry Farrell and Abraham Newman called “The Underground Empire”, where the authors describe a new army of private actors. Here is how Ms. Faroohar describes the new order:

“Russia’s invasion of Ukraine is already demonstrating how their theories play out. On one hand, ‘globalization has transformed the liberal order’, as the authors wrote. It has done this ‘by moving the action away from multilateral interstate negotiations and toward networks of private actors.’ Think of Elon Musk bolstering the internet in Ukraine with his Starlink system, of Google and Meta cutting off Russian political advertisements and state media or the way in which scores of individual ‘hacktivists’ around the world are helping Ukraine in the digital war.”

A consensus characterization of Putin as a 21st century Hitler only took 2 weeks in this connected world. Whether economic measures will prevent a bloodbath in the Ukraine will be determined in the next several months.

The above commentary is for informational purposes only. Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice.

 

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Rob McCreary

Rob McCreary has more than 40 years of transactional experience as an attorney, investment banker and private equity fund manager, and has spent his career in building entrepreneurial organizations with successful track records. Founder and chairman of CW Industrial Partners (originally CapitalWorks, LLC), he is responsible for developing and maintaining senior relationships with investors and portfolio governance.

This blog represents the views of Rob McCreary and do not reflect those of CW Industrial Partners or its employees. This blog is not intended as investment advice. Any discussion of a specific security is for illustrative purposes only and should not be relied upon as indicative of such security’s current or future value. Readers should consult with their own financial advisors before making an investment decision.