If Russian President Vladimir Putin was worried over the weekend about Western-imposed sanctions, his worries probably doubled on Monday, the first day of trading after he received parliamentary approval to send his soldiers into Ukraine.
Russian markets were punished that day. The Micex index fell 11 per cent, the biggest fall since the Lehman Brothers collapse in 2008 almost shredded the global financial system. Russia's biggest stock market players, some controlled by the Kremlin, sank by the same amount or more in near panic selling. The ruble went to a record low against the U.S. dollar, sending the Russian central bank into damage-control mode by lifting rates by 1.5 percentage points.
On Tuesday, Mr. Putin gave his first press conference since Russian troops took control of Crimea five days ago. He sounded defiant, saying the use of military force remained an option if the security of the large Russian minority in Ukraine were to come under threat. At the same time, he seemed willing to vent some heat from the Ukraine hothouse; the tensions that could trigger the use of blunt force had "dissipated," he said.
Perhaps it was the markets that convinced him to ease his finger off the trigger. The selloff on Monday was punishing even though sanctions had yet to be launched. And on Tuesday when Mr. Putin ended military exercises in Western Russia, stock markets in Europe and Russia rallied.
When asked about the threat of sanctions, Mr. Putin said "the damages would be multilateral," suggesting that the Group of Seven countries that would impose them, including Canada, would suffer as much as Russia.
While the G7 would suffer some collateral damage, the Russian market plunge shows that Russia would suffer even more. Russia is not the Russia it was 25 years ago, when the Soviet Union was still intact and largely shut off from world markets. Today, it is the world's eighth-largest economy and is even bigger when measured by purchasing power.
It is a new member of the World Trade Organization and has a functioning stock market with more than a few players, such as natural gas giant OAO Gazprom, that are followed closely by Western investors. It exports enormous amounts of natural gas and oil to the European Union and its companies and oligarchs have been enthusiastic buyers of European and North American businesses.
Russia is approaching full integration into the European economy, less so the North American one. If Mr. Putin does not "de-escalate," as U.S. Secretary of State John Kerry has asked him to do repeatedly in recent days, and punitive sanctions are launched, the Russian markets and the companies that operate within it will take a beating. If a shooting war breaks out in Ukraine, all bets are off for the Russian economy.
While Russia is not struggling like some euro zone countries, its growth rates are slowing quickly and a big fall in oil and gas prices would damage its fiscal health. Energy exports are both its saviour and potential Achilles heel.
In other words, the economic risks of a military confrontation is much higher for Russia today than it was a decade or two ago. One wayward bullet could turn Mr. Putin's dream of empire into an economic nightmare.
To be sure, the big companies in the G7 countries are in no mood either to see sanctions, which are very much on the table. Speaking in Kiev on Tuesday, Mr. Kerry said the United States would do everything in its power "to isolate Russia politically, diplomatically and economically" unless it withdraws the forces that took control of Crimea over the past five days.
The big-name Western companies that have substantial investments in Russia include Kinross Gold of Canada; British oil giant BP; car maker Renault-Nissan; Carlsberg, the Danish beer maker that counts Russia as one of its biggest markets; Exxon Mobil; and Austria's Raiffeisen Bank, whose shares took a beating in Monday's selloff. Any escalation by either side – the G7 on the sanctions front, Russia on the use of force in Ukraine – would see investors in these companies flee.
If the Ukraine crisis does de-escalate, the markets will be able to take at least some of the credit. Countries whose economies are linked have less incentive to get violent with one another. That's the founding principle behind the European Union, where it is impossible to imagine any one of its 28 members invading the country next door.