War in Europe
Some brief perspectives on this week's events
I want to start this post with an admission. As I had written in my last post, I expected things in Ukraine to cool down - I was wrong. My thought was, a war would be very unpopular in Russia and it would cause huge economic damage. But much more so, the idea of sending young men and innocent civilians into death for old men’s nostalgic desires to put their flag onto someone else’s soil just seemed entirely anachronistic and out of this world
Yet under the thin veneer of civilization the old reflexes are there, always have been. I was born only 36 years after the end of the Second World War, but it seemed centuries ago, looking at the world around me growing up. The horror of war and ideas-of-nationhood gone rogue was all but reflected in stories at the kitchen table. My father was 17 when the war ended, as he stumbled through a Munich in rubbles, looking for food and work
This attack is shocking and upsetting. Even before, Putin’s moves were very aggressive. How did he get so emboldened? The reasons are economic. This posts briefly summarises the chain of events that lead to today
Putin always had his eye on re-establishing the borders of the Soviet Union
Until recently however, Russia was both too weak and the Western alliance too strong for him to take action
Now, the balance of power has shifted on both ends
How did that happen?
First, we have to go back a few steps, to the 1990s. We find a period were dozens of trade deals globalised the world economy, culminating in 2001 with the accession of China to the WTO, championed by Bill Clinton at the time:
As discussed before, many deals turned out to be onesided, or non-compliant (cf. China’s state owned enterprises or foreign JV-rules)
While this expansion brought much wealth to emerging markets, it slowed growth in the Western world, especially for its lower/middle class
To counter that lack of growth, governments and central banks intervened
The US, with its strong primate on commerce, put emphasis on interventions around low rates, bailouts and asset price inflation. Europe followed
While these measures boosted corporate earnings and margins, they did little to bolster wage growth. The result was increased inequality and broad discontent, which gave rise to populism and swept Donald Trump into office
Trump followed unorthodox policies to address these issues, which he summarised as “America-First”
“America-First” destabilised the existing US alliances, especially with Europe and NATO
It also fractured the relationship with China. Trump’s broad trade war was, figuratively speaking, an aggressive punch in the face for China
Whether China deserved it or not is a different debate. Either way, China did not turn the other cheek to de-escalate. They fought back
Two dynamics resulted from this. (1) Today, China is significantly more anti-American and (2) it started to look for alliances elsewhere
Into this context, COVID-19 happened, and with it the overdoing of monetary and fiscal stimulus. It completed the economic regime change to an inflationary world
Inflation is a deeply de-stabilising dynamic
Citizens’ perception of economic order is shaken. How does it feel to pay 20% more than a year ago for an everyday good? Consumer confidence and government support polls translate this feeling into measurable data, they’re both near decade lows
It also limits the room for maneuver. If governments turned on the monetary firehose to stabilise a crisis, they would create more inflation
Much has been said about President Biden’s weakness and how inflation was his fault. I would just like to recall that both Biden and Trump, aggressively so, campaigned for more stimulus cheques in 2020, and 70% of the population were in favor at the time. The actual underlying issues go decades back
Now, let’s go back to Putin. Since the Ukraine crisis of 2014, he had waited for an opening to make his move
To prepare for international backlash, Putin expanded and reshuffled Russia’s FX reserves. He sold USD and US bonds, bought gold and other currencies, notably Chinese Yuan
He increased trade with China, a commodity-hungry nation eager to source additional supplies
He watched the monetary excess in the West, which many Russians and Chinese see as a sign of decay1. (To draw parallels to this to some degree justified view, it’s an ironic historic coincidence that the sale of 30 cryptopunk NFTs at Sotheby’s got pulled just a few days before the Ukraine attack, over fears the $30m lot price wouldn’t be achieved)
Now the stars aligned for him
With inflation rampant in the West, not only is the US’ and Europe’s ability to react severely hamstrung
More so, Russia with its commodity-centric economy has been a huge beneficiary of this new economic regime. Even now, despite the war, every 24h Europe buys $700m worth commodities from Russia. That number was less than half a few years ago
Further, with China disgruntled by the US and its eye on Taiwan, he’s found a natural strategic and economic ally
On Feb 4th, China’s President Xi visited Russia, and this headline below is hindsight ominous
Since the breakout of hostilities, China has increased its commodity imports from Russia, assured financial support for Russia’s banking system and issued statements that bewilder the Western reader, such as:
So here we are, looking at a shifting world order and grim news reports that we thought belonged to another time
What’s next for the Ukraine? While a Russian army that is 10x the size of its opponent seems to prescribe an obvious outcome, I think it’s important to keep the following in mind:
The Russian soldiers are fighting a war they don’t want and risk their lifes for something they have no interest in. In the age of TikTok and Instagram, promises of Walhalla for attacking your neighbor ring very hollow
The Ukrainians are defending their homes, their families, their liberty against an authoritarian aggressor. Their resolve is urgent and deep, much different to their Russian counterparts2:
While Russia has quickly achieved full control of the skies, control of the cities is much more difficult. The US estimates taking control of a hotel-sized block takes 700 soldiers and many casualties - how drawn out could this battle be before Russian moral is gone, if it’s already so low to begin with?
It’s worth noting that several reports of Ukrainian bravery (here, here or here) - for now - paint a picture of a slower than expected Russian advance
Don’t write the Ukraine off too soon. Putin has entered a huge gamble. If he fails, he’s likely done
What are the consequences from all this?
Russia is one of the world’s most important commodity producers. It provides 55% of German gas, 10% of world seaborne oil, 12% of world fertilizer, 10% of US aluminium etc. It’s no surprise commodities were excluded from the sanctions package. Either way, this conflict increases the strain on commodity supplies, which means higher inflation for Europe and the US, and in turn a more urgent need for central banks to fight it. It accelerates all the existing dynamics I described in previous posts
There is even more pressure to reduce dependency on carbon-based fuels. Natural resources are a geopolitical weapon, Renewables aren’t. Maybe this dynamic helps re-focus current ESG-policies to something more constructive (see last post, e.g. increase CO2 certificate costs to reach breakeven earlier with hydrogen gas or carbon-air capture)
Further, a short-term extension of Germany’s remaining nuclear power plants could also be back on the table. Please keep in mind, nuclear is not the simple panacea many think. There is no long-term solution for expired fuel rods, and the costs to clean up old sites are exorbitant
Long-term, expect more de-globalisation. Home-shoring of supply chains, move from just-in-time to higher inventories etc. These dynamics contribute to inflation, all else being equal
Defence expenditure will increase. This is a sad but necessary fact. German chancellors Schmidt (SPD) and Kohl (CDU) come to mind, who argued during the debate about US-Pershing II nuclear warheads on German soil in the early 1980s that negotiations always take precedence, but you have to be so strong militarily that non-negotiation cannot be an option for the other side. On a side note, this debate also gave birth to Germany’s Green Party, which today provides foreign minister Annalena Baerbock
Even if Russia wins, this will likely, eventually destabilise Putin. Historically, all nationalist expansion dreams ended in tears, from NS-Germany to Argentina or Serbia. And the fabricated pre-text of Donbass-Russians calling for help has eerie similarity with “Sender Gleiwitz”
Taking all this into account, it is unsurprising, as mentioned before, that Russian assets (ETF: RSX) are exceptionally cheap right now. If things go differently than expected (e.g. Putin fails, whatever), they may recover much of their losses, while most bad news are priced in. Given the context, I refrain from recommending anything here, it’s for each oneself to decide
Finally, the re-emergence of war on Europe’s continent serves as a stark reminder of the benefits of the EU, whatever many big flaws it may have. European nations had been at war for literally thousands of years. Now they live peacefully with each other, the borders between them gone. The sad events in Ukraine show that what we thought a thing of the past is in fact just a few wrong turns away
ADDENDUM:
For those who would like to track the events in Ukraine more closely, I can recommend the following sources which I found helpful. Please keep in mind I haven’t verified them beyond reasonable common sense:
Illia Ponomarenko, Kyiv Independent
Jack Losh, Photographer, for impressions from Kharkiv
I wanted to link a commentary on Russia Today as example for this Russian point of view, but the site is down :)
Please note that I did or could not verify the authenticity of this tweet. War is always propaganda and it may be false. Given multiple credible, similar reports, I’ve decided to include it