The dive in the price of oil combined with economic sanctions has hit Russia’s economy very hard. The Russians have experienced massive inflation, as well as large outflow of capital from its borders. To combat this, the Russian Central Bank has raised interest rates to 17 percent, hoping to constrict the rampant inflation by attracting demand for the ruble, and restrict the money supply simultaneously.

Keep in mind that the 17 percent is a nominal figure, and if you adjust it for inflation, is much lower. For example, take a nominal interest rate of 10 percent, and then apply inflation at 12 percent, you’d have a negative interest rate of two percent. So as inflation runs high in Russia, the central bank will maintain or raise the real interest rate to combat inflation, even if that means raising the nominal rate to 25 percent. The downside for the Russian Central Bank to raising interest rates is the increased risk of default. This most likely would not transpire into a Russian sovereign debt crisis but a corporate debt crisis. If Russian companies began to go bankrupt and default on their debts it would increase pressure on the lending institutions that hold the paper.

In addition to the pressure applied to banks that have loaned money to Russian companies, which are mostly European banks, there is an even larger problem for US institutions. With a strengthening dollar and falling oil prices, emerging markets have taken a large hit. An emerging market country like Venezuela is very dependent on oil as a major source of revenue, and carries a heavy debt that is 57 percent of its GDP. It is comparable to a family where the father lost his job, and the family is already indebted. There is a good chance for default. Venezuela is not the only case of shaky emerging market debt. Brazil, South Africa, and Turkey all have high debt to GDP loads. In all, there are nine trillion dollars in dollar denominated emerging market debt. On top of that, there is an additional 5 trillion in energy related debt. So in total there is $14 trillion in unstable debt.

Say if 15 percent of the debt ends up in default. We would then be looking at $2.1 trillion in losses. That would be larger than the losses during the Dot-com bubble and the subprime mortgage bubble, which triggered the collapse of the housing market.

Exacerbating this already large problem could be the vast network of derivatives. These derivatives are used for several functions, to trade as financial instruments, to leverage banks’ positions, and to transfer risk.

In this scenario, pay attention to the last point, their ability to “transfer” risk. In 2008, AIG found themselves guaranteeing $61 billion in subprime mortgage derivatives, and could not provide the collateral to back it up. The US government ended up bailing out AIG and a number of other financial institutions. Without that there would have been a complete collapse of our banking system.

Today’s problem is potentially bigger. This is a terrible scenario, but could certainly become a real one if oil prices stay low and the dollar stays strong. Though if the Federal Reserve instead chooses to delay its rate hike, there will be a huge reversal in the dollar, and it will relieve this deflationary trajectory, for at least a little while longer.

Analysis by Andrew Gehrig