'Golden Sanction' to halt Putin in Ukraine has eluded U.S.

Bloomberg News

As Russian-backed separatists advance in southeastern Ukraine, the U.S. and European Union are still searching for a sanction that can force Vladimir Putin to stop and think again.

More than 1,000 of the Russian president's troops are operating inside Ukraine, manning sophisticated weaponry and advising local separatists, the North Atlantic Treaty Organization said yesterday. The escalation, denied by Russia, prompted a warning of "consequences" from U.K. Prime Minister David Cameron, and German Chancellor Angela Merkel said EU leaders would discuss new sanctions this weekend.

The U.S. and EU have been trying since March to come up with measures that would impose sufficient costs to make Putin call off his effort to destabilize eastern Ukraine while causing only minimal harm to Russian citizens and European and U.S. economies and businesses.

"There have been many attempts over many years to find the silver bullet, or golden sanction, and I'm pretty convinced it doesn't exist," said Gary Hufbauer, a sanctions specialist at the Peterson Institute for International Economics in Washington. "What does exist are very, very heavy sanctions. That's not what the U.S. and western Europe are doing."

So far, the sanctions effort has failed, former U.S. Treasury and State Department officials say. New measures would have to strike more deeply and broadly, hitting Russia harder and bringing unavoidable economic pain to Europe, and to a lesser extent the U.S., they said, speaking on the condition of anonymity to discuss internal policy deliberations.

Widening Sanctions

Last month, the U.S. and EU widened their sanctions on Russia's $2 trillion economy. On July 29, the EU agreed to stop Russian state-owned banks from selling shares or bonds in Europe; restricted the export of equipment to modernize the oil industry, a key prop for Russia's economy; and barred the sale of technology with military uses. The U.S. limited funding for some Russian banks, oil giant OAO Rosneft and natural-gas producer OAO Novatek in July.

"The sanctions that we have already applied have been effective," Obama told a press conference in Washington yesterday. He said he plans to discuss "additional steps" with allies in Europe when he travels there next week. "I think there are ways for us to deepen or expand the scope of some of that work."

Limited Impact

All told, though, U.S. and European sanctions have a direct impact on less than 1 percent of Russia's economic output, Hufbauer said, not nearly enough to force Putin to change course or to persuade the businessmen who surround him to pressure him to retreat even though the ruble dropped yesterday to a record low against the dollar.

The existing sanctions have cut about $1 billion from Russia's economy, Vladimir Popov, who advises the Department of Economic and Social Affairs at the United Nations, has estimated. Retaliatory sanctions by Russia, he's said, will have roughly 10 times that effect on the Eurozone.

"You're at the point now where you would want to think about going toward a more comprehensive set of transactions" to be sanctioned, said Robert Kahn, a former Treasury Department official who's now a senior fellow for international economics at the Council on Foreign Relations in Washington. "And I would expect Russia to retaliate."

Gazprom Off-Limits

The most effective ways to strike at Russia include cutting off natural-gas exports and isolating the country from the global financial system, analysts say. Yet a glaring omission among the companies that the U.S. and EU have targeted is Gazprom. Russia supplies about 40 percent of Germany's natural- gas demand and a quarter of Italy's demand, according to a report by the International Monetary Fund released last month.

"Gazprom hasn't been touched by the U.S. or EU, and that would get Putin's attention like probably nothing else," said David Kramer, a former U.S. assistant secretary of state and now president of Freedom House, a Washington-based nonprofit.

Kramer also advocates expanding the restrictions on dealing with Russian financial and energy firms -- known as sectoral sanctions -- and said they should prohibit U.S. and European companies from doing business with companies in those industries.

Yet Gazprom may be one of the last companies targeted because it's so important to Russia and Europe that sanctioning it would be a major escalation of the economic duel, said a U.S. official involved in the discussions who asked not to be named because he wasn't authorized to speak publicly.

Cutting off natural-gas imports from Russia would double the energy cost for western European residences and factories that run on the fuel, the Peterson Institute's Hufbauer estimated. That would be a heavy burden on a stagnant economy with unemployment that remains higher than 10 percent.

Another move, though one less likely to be implemented, would be to use language similar to that in the sanctions imposed against Iran, which forced the Society for Worldwide Interbank Financial Telecommunication, or SWIFT, to bar Iranian banks from using its financial-messaging services, cutting them off from most international business.

"The payment system is where all the power is," Kahn said.

That threat is of enough concern to Russia that its government has drafted a bill to create a new Russian system for domestic bank transfers, Deputy Finance Minister Alexey Moiseev said on Aug. 27, according to the Russian news service Itar- Tass.

Obama will meet with his European counterparts next week at a NATO summit in Wales, and he said yesterday that he plans to discuss sanctions.

In the meantime, Ukraine may suffer the most. Now that it's clear Russia won't let the country defeat the pro-Russian separatists, its economy will collapse, said Ian Bremmer, president of the Eurasia Group, said in a Bloomberg television interview yesterday.

"There was a belief -- a belief on the part of the Ukrainian government and a belief on the part of markets -- that has been critically mistaken, that the Ukrainians might somehow be allowed to retake their territory," Bremmer said. "They've failed, and of course this is going to lead to much greater economic implications, negative implications, for the Europeans, as well."

Russian trade with the EU was valued at about $390 billion last year, while commerce with the U.S. was about $44 billion. EU Energy Commissioner Guenther Oettinger will hold talks with his Russian counterpart today in an attempt to prod Russia to allow natural-gas flows to Ukraine to resume temporarily.

Russia already has reacted to prohibitions by the U.S. and EU by banning western food imports for a year. It also has shut down eight McDonald's restaurants, citing consumer-safety watchdog inspections. The ban on EU food imports cut off about $6.6 billion (5 billion euros) in trade and prompted the bloc to announce aid for growers of perishable fruits and vegetables and the dairy industry.

New prohibitions almost certainly will be slapped on Russia, said Timothy Ash, chief economist for emerging markets at Standard Bank Plc in London, because not doing so would be an invitation for more Russian intervention in Ukraine and would threaten security elsewhere in eastern Europe. That also will imperil the gains Russian stocks have made since the first sanctions were imposed in March, he said.

"I think it is very difficult for investors to justify holding positions in Russian assets," Ash said. "If you don't understand what you are investing in -- and I honestly don't think many investors do these days when it comes to Russia -- get out or reduce exposure significantly."

Still, the U.S. and EU are deluding themselves if they think sanctions will ever force Putin to back down, said Samuel Charap, a senior fellow for Russia and Eurasia at the Washington branch of the International Institute for Strategic Studies, a London-based policy group.

"It's second to national survival in the hierarchy of national security priorities," Charap said. "It's kind of hard for us to imagine how important it is" to Putin.

The alternative -- compromising with Putin to convince him to withdraw his troops from Ukraine -- is politically unacceptable in the U.S. and Europe, where leaders have built momentum behind the idea of punishing him, said Clifford Gaddy, a senior fellow at the Brookings Institution and a Putin biographer.

Possible Precedent

The concessions it would take to mollify Putin might include an agreement not to enlarge NATO further or bring Ukraine into the organization, pushing Ukraine to further decentralize political power to regional governments and a trade deal that doesn't disadvantage Russia, Charap said.

That concept harks back to the 1955 Austrian State Treaty, which persuaded the Soviet Union to withdraw its post-World War II occupation forces by making Austria independent and guaranteeing it would never join NATO. Yet agreeing to a similar deal for Ukraine would mean reneging on the 2007 U.S. NATO Freedom Consolidation Act, which called for Ukraine to join the alliance.

It also would contradict Obama's statements yesterday. "This ongoing Russian incursion in Ukraine will only bring more costs and consequences for Russia," he said.