Historical Parallels for the Loopholes in the New Sanctions Against Russian Banks: 1914 and 2014

30 07 2014

In the wake of the recent events in eastern Ukraine, the EU and the US have announced new sanctions against Russian business interests. The sanctions introduced earlier this year were so-called smart sanctions, targeted at just a handful of named individuals close to the Russian leadership. The sanctions that go into effect today are much broader and target entire sectors of the Russian economy. A number of Russian banks have been targeted by the sanctions, which go into effect today. However, the sanctions contain a number of loopholes regarding the UK subsidiaries of the Russian bank holding companies. Apparently, these UK-registered banks will continue to be able to operate.  (See here, here, and here). Moreover, Russia’s biggest bank, Sberbank, is exempted from the sanctions.

A columnist for Forbes magazine in the United States had this to say about the UK’s approach:

As for the UK’s David Cameron, although he likes to sound Churchillian, his core constituency, the London financial district, is undoubtedly already working 24/7 to get round the EU’s attempts to isolate Russian banks. (Read full article here).

The loopholes related to Russian banks need to be put into some historical context. Moreover, as I show before here, some of them parallel the loopholes in the sanctions against German banks that the British government imposed in 1914.

Broad sanctions raise deep philosophical questions about whether it is right to harm the economic interests of an entire country for the sake of punishing a few individuals in its political leadership. For much of human history, of course, collective punishment was the norm and was accepted as pretty much legitimate. If Prince A invaded the territories of Prince B, soldiers loyal to Prince B had the right to rape and pillage any peasants or merchants who owed allegiance to Prince A.  The same thing went on the high seas in wartime: commercial vessels belonging to private citizens in the enemy country were “fair game” for privateers, at least until the 1850s. The Old Testament, which our ancestors appear to have read a bit too frequently, seems to endorse this collective punishment approach. Indeed, parts of the Old Testament appear to condone genocide and sexual assault in war.

Anyway, the Enlightenment changed how people think about war. It did so by giving us the idea of individualism. Since then, the idea of collective punishment has been tempered by various attempts to distinguish states from citizens, innocents from policymakers, public from private property. Ever since the Enlightenment, this is an issue we’ve be wrestling with whenever a war is being fought.

Self-interest has also contributed to our increasing desire to distinguish ruler from ruled, enemy government from innocent civilian. The growth of an interconnected world economy over the last few centuries has made it difficult to wage economic warfare against a foreign nation without hurting one’s own economy.   This interconnectedness is most evident in the realm of finance, where there are long chains of financial obligations linking firms in belligerent and neutral countries..

There is a really interesting historical parallel with the First World War here. Of course, Russia and the West are not at war right now, unlike Germany and Britain in 1914. (The fighting is being done by proxy forces in eastern Ukraine). However, Western government are engaged in a form of economic warfare against Putin’s regime that has generated debates that are somewhat reminiscent of those that took place in Britain during the early phases of the First World War.

Following its declaration of war against Germany on 4 August 1914, the British government was confronted with the question of whether it was going to permit commerce with Germany to continue. This question had been discussed by policymakers since 1911. In that year, Britain and Germany had come to the brink of war and had then pulled backed and resolved their dispute, which is who was going to colonize the Moroccans, peacefully. Although war had been avoided, it got people in both the government and the private sector thinking about what war between two economies that were so closely interconnected would mean for banks. Many of the policymakers who thought about this issue had read the works of Norman Angell, who had argued that sustained warfare before major economies would be impossible in the modern world because their economies were so interconnected.

 

 

British government had two contradictory sets of precedents it could follow. (These precedents were discussed in a wonderfully detailed history that was produced in early 1912 and which I read in the National Archives in Kew).  Here’s what the official history said.

In the eighteenth century, Britain had banned virtually all commerce with citizens of enemy states during wartime.  During the Napoleonic Wars, Britain had fought a thorough going economic war against France and the other territories controlled by Napoleon. Call this the collective punishment or Old Testament approach to the global economy in wartime. This approach was advocated by Jackie Fisher, the First Lord of the Admiralty.

The other model considered by policymakers was that of the Crimean War of the 1850s, the last major European war. During this conflict, Britain opted not to interfere in trade with Russia or with merchant vessels that belonged to Russian private citizens. That war had been fought on the understanding that the West’s grievance was strictly with the Russian state, not individual Russian merchants. British firms had been allowed to trade with Russia, provided they did so through Baltic ports rather than those near the Crimea, where the fighting was.

In my view, and the view of Olive Anderson, the policy taken during the Crimean War reflected the dominance in the 1850s of classical liberal or individualist ideas about laissez-faire, free markets, and the need to distinguish individual citizens from states. The 1850s were the high-water mark for the worldview the great economist Joseph Schumpeter would later call Methodological Individualism. Later on, more collectivist ways of viewing the world (e.g., nationalism) came back into vogue.

As Nicholas Lambert has shown in a recent, brilliant, and comprehensive book, there was lots of bureaucratic infighting in the British government in 1914 over whether to wage a total economic war against the German private sector. In 1914, the British government opted for a policy that was, at least superficially, closer to the eighteenth-century practice of total prohibition than the liberal taken during the Crimean War. The Trading with the Enemy Act announced in September 1914 was part of the British government’s strategy for waging economic warfare against Germany, which involved a comprehensive blockade of Germany’s coastline. Any British subject who had any commercial dealings, however trifling, with enemy alien firms without the prior consent of the government risked penalties ranging from fines to prison sentences. Sending letters to Germany via neutral countries without authorization from the censors also became illegal. Germans resident in the United Kingdom were interned and their property was entrusted to a Custodian of Enemy Property (There’s a great new book on this rather illiberal episode in British history). (See here). Trade with neutral countries such as the Netherlands was subject to controls designed to prevent the transhipment of goods to customers in Germany. British corporations were prohibited from paying dividends to shareholders in Germany, although the British mail censors occasionally permitted needy British citizens to write to a German company with a view to having dividend remitted via the Netherlands.

 

 

The British government prosecuted a number of small firms and individuals for the offense of trading with the enemy in Britain. The goods mentioned in many of these indictments were of a non-military character, such as silk. Several owners of small factories in Britain were given prison sentences for trading with the enemy through the Netherlands and neutral countries. These were small-fry businessmen living in places like Manchester though—the politically-connected bankers in London were allowed to continuing dealing with big banks in Germany.

The Trading With The Enemy regulations of September 1914 contained a number of loopholes designed to minimize the impact on important British economic interests, particularly the cotton trade. It should be remembered that at the start of the war, the motto of the British government was “business as usual,” and that it was only halfway through that Britain developed a full-fledged command economy with conscription and food rationing and so forth. So the existence of loopholes permitting the continuation of some of the peacetime channels of trade isn’t totally surprising. The most visible of these loopholes related to banks.

 

In the early phases of the war, the London branches of five German banks were even permitted to continue to operate using German managers and clerks, albeit under the supervision of Sir William Plender, the senior partner of Deloitte, an accountancy firm with plenty of expertise in cross-border finance.

The slowness with which branches of German banks were liquidated was extremely controversial, especially after more and more British families received the dreaded telegram from the front announcing the death of one of their menfolk. The decision of the British government to allow the London branches of the German banks to continue operating was denounced in the newspapers owned by Lord Northcliffe, a specialist in vindictive yellow journalism. Northcliffe’s editors targeted Plender, presenting him as a traitor.

By 1916, the British public’s intensifying hatred of Germany forced the British government o accelerate the liquidation of the London branches of the German banks. However, as late as March 1918, British politicians were still complaining in parliament that the London branches of London branches of Deutsche Bank, the Dresdner Bank, and the Disconto-Gesellschaft were still operating in some fashion. In defending the policy, the Chancellor of the Exchequer, Bonar Law, explained that “these banks are kept going, not for the sake of the German shareholders, but for the sake of British and Allied creditors”. This explanation was cold comfort to the widows of British soldiers, so legislation to facilitate the termination of the London operations of these banks was passed in August 1918, when the war was almost over.

The sanctions the EU has imposed on Russia are nicely calibrated to minimize the damage done to political powerful interest groups such as the City of London. It remains to be seen whether public opinion will tolerate the current arrangement.

 

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