Russian President Vladimir
Putin has gone on record stating that the breakup of the Soviet Union was one
of the worst catastrophes of the 20th century.
Putin’s statement—which is
ominous in its own right—takes on an even more menacing tone in light of recent
events in the nations of the former Soviet Union. The most obvious example is
Ukraine’s conflict with Russia, which perhaps more than any other recent event
in the region, has seized the attention of the West.
During the last year, the
conflict in Ukraine has come perilously close to a state of full-blown though
undeclared war.
Looking back over the past 12
months, we’ve seen a seismic shift in the political makeup of the region.
Russia has effectively annexed the Crimean Peninsula, which includes the city
of Sevastopol, home of the Russian Black Sea Fleet—and critically, the Russian
Navy’s only warm-water port. In the political sphere, Ukraine’s unpopular
president, Viktor Yanukovych, abandoned his vast estate along the Dnieper
River, fled into exile in Russia, and was soon after impeached by the Ukrainian
parliament.
Despite these momentous
events, the conflict, which began on November 21, 2013 in Kiev’s Independence
Square, grinds on. In Eastern Ukraine, Russian separatists—some wearing what
appear to be Russian military uniforms—continue to battle the Ukrainian Army,
with both sides suffering casualties despite several cease-fire agreements.
But in a larger sense, the
crisis in Ukraine represents a metaphor for Putin’s increasingly imperial
ambition. While the situation in Ukraine is grave and could escalate into an
even more dangerous crisis, it’s still just one piece of a much broader puzzle.
Unlocking that puzzle begins
with Vladimir Putin—and what are, by all appearances, his plans for
reconstituting the Russian Empire.
Moscow’s Long Arm—A
Firsthand Experience
I personally experienced the
long arm of Vladimir Putin’s political machine two years ago, just as I was
preparing for a trip to Moscow.
In May of 2012, the Financial Times
published an op-ed piece I had written with my good friend, the political
scientist Ian Bremmer. In the article, Ian and I said we believed that Russia
was on the wrong path.
We listed many reasons why:
Russia’s intervention in state capitalism; a pervasive sense of
authoritarianism; and a population in demographic decline, as well as rampant
socially driven diseases like alcoholism. We recognized early on some of the
problems—economic, political, and social—that Russia might face.
A few days after the FT ran our op-ed piece,
Ian and I were going to meet with senior policymakers in Moscow. When I
arrived, half of the people I was scheduled to meet with suddenly decided to
cancel.
I suppose there could have
been a nasty spring flu going around the United Russia party that May; but more
likely, people who hold dissenting views from Russia’s party in power will
suddenly have their meetings politely canceled.
This isn’t surprising:
corruption in Russia has become endemic to the political system.
Transparency International’s
Corruption Perceptions Index, which measures the way public-sector institutions
are perceived, ranks the Russian government 127th out of a total of
177 countries rated—which is hardly an endorsement of Mr. Putin’s style of
governance.
Empire Building, 21st-Century
Style
Russia has always considered
itself an empire—even before the Bolshevik Revolution.
In Tsarist days, Imperial
Russia was a great power that believed buffer states were necessary to maintain
its security and its place in the world. After the Bolshevik Revolution, during
the era of the Soviet Union, Russia maintained client states in Eastern and
Central Europe to control a sphere of influence far larger than its own
national territory.
During the time of the tsars,
Ivan the Terrible expanded the Russian Empire by enlisting the support of the
Cossacks. Now the organizational complexity of the 21st century has
given empire builders a new tool to consolidate their power: the supranational
union.
The
Creation of the European Union
On January 1, 1999, 11 democratic European countries,
including the most economically powerful nations in Western Europe,
officially united to create a common currency—the euro.
The eurozone, along with its free-trade counterpart, the
European Union, represents a culmination of work toward a united Europe that
had begun decades earlier.
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Perhaps it isn’t surprising
that Putin’s latest attempt at empire building has taken on this distinctly
modern form, using the European Union and the eurozone as templates for
consolidating power.
The Eurasian Economic Union
(EEU), which will formally go into effect on January 1, 2015, is Putin’s latest
bid to unite the territories of the former Soviet Union. The original
territories to be included in the union were Russia, Belarus, and
Kazakhstan—but the treaty was amended in October to include Armenia. The nation
of Kyrgyzstan may soon follow suit.
Click to Enlarge
The Eurasian Economic
Union: A Rival EU?
The Eurasian Economic Union
is something economists refer to as a “customs union”—a free-trade zone with a
common tariff applied to foreign goods.
But the EEU is still in a
gestational phase. The history of the European Union suggests that over time,
the integration of a free-trade area expands—which may well be Putin’s goal.
Putin doesn’t want to simply
create another North American Free Trade Agreement (NAFTA). His aim is to
create another EU—a rival EU—with the Kremlin exercising the real power behind
the scenes.
To understand the
empire-building project that Putin has embarked upon, it makes sense to think
of the EEU as a political union first. Putin’s ability to consolidate power
politically was a necessary first step, leading to progressively greater
economic integration.
As a customs union grows, it
establishes trade, financial, and investment links among its constituent
states. Then, as time goes on, member states may stabilize their currency
exchange rates, eventually becoming interconnected enough to develop a common currency.
The eurozone experiment
suggests that sustaining a monetary union requires banking, fiscal, and full
economic union. When you begin to trace the trajectory of the eurozone
experiment, the outlines of Mr. Putin’s plan begin to come into focus.
If Russia wants to establish
the Eurasian Economic Union as a rival to the EU, then it must include Ukraine,
Russia’s largest neighbor to the west.
As Jimmy Carter’s National
Security Advisor Zbigniew Brzezinski once wrote: “Without Ukraine, Russia
ceases to be an empire, but with Ukraine suborned and then subordinated, Russia
automatically becomes an empire.”
And indeed, what started as a
customs union is now becoming a broader economic union for the three members of
the EEU in 2015. Russia has already heavy-handedly suggested to Kazakhstan and
Belarus that they should start to stabilize their currencies and eventually
think about a common currency in the future. There are even proposals for the
beginning of a banking union, with joint regulation and supervision for banks
in the EEU. Kazakhstan has already balked at the idea of a common currency that
would be a stepping stone for a fuller banking, fiscal, economic and eventually
political union.
But Russia is pressing the
issue, and the delicate political transition in Kazakhstan may give Russia an
opportunity to “pull a Ukraine” in Kazakhstan, as we will discuss below.
Putin’s rhetoric is that
Russia should protect Russian ethnic minorities wherever they are in the former
Soviet Union—and about 25 million ethnic Russians live in those former Soviet
republics.
What a Sanctions War
Would Do
In the geostrategic sense,
Ukraine plays a key role in the development of the EEU, but there are
additional risks to an escalation of the conflict there.
The nightmare scenario for
the West—and for investors—is an escalating sanctions war with Russia.
Thus far, Western sanctions
have targeted only key individuals and companies in Russia, and have been
limited mostly to specific organizations, such as the energy sector, the
military, and state banks. Essentially, the sanctions have tried to encourage
financial markets to price in a greater risk premium for Russian investments,
but have steered clear of broad trade restrictions.
Russia retaliated with
counter-sanctions, specifically a ban on food imports and restrictions on
imported clothing, cars, and other products for government ministries. Coupled
with a much weaker Russian ruble, which reduces Russia’s purchasing power in
the world, Russian imports from Europe have collapsed. The Russian government
is now trying to replace these goods with domestic production.
But the real concern is
energy. Approximately one-third of Europe’s gas supply comes from Russia—and
about half of that gas is transported through Ukraine.
According to Eurostat, the
EU’s official statistics reporting agency, Germany gets about one-third and
Sweden almost one-half of their imported energy from Russia. Poland, Slovakia,
Bulgaria, and Lithuania depend on Russia for 90% or more of their imported
energy, excluding intra-EU trade.
Europe’s Energy Imports
Source: New
York Times
If the West were to impose
stricter sanctions against Russia, Russia might then retaliate with the supreme
sanction against the West—cutting off the supply of natural gas to Europe.
If the conflict between
Ukraine and Russia were to escalate into a full-blown war, which for the moment
at least does not seem likely, the risk of a disastrous energy embargo would
rise dramatically—though this would damage the Russian economy as much, perhaps
even more, than it would hurt Europe.
As recently as 2009, a
pricing quarrel arose between Russia and Ukraine when Gazprom, the Russian gas
giant, refused to renew a contract due to concerns over Ukraine’s outstanding
debt. The dispute was ultimately resolved by Vladimir Putin and then Ukrainian
Prime Minister Yulia Tymoshenko, but not before it threatened real catastrophe.
By the time the two leaders
had brokered an accord, gas pressure had already dropped in Poland and the
Czech Republic—sending ripples of fear about energy supply through Western
Europe that winter and causing waves of selling in European equities.
Russian gas lines crisscross Ukraine
Source: BBC
So in the event of a Russian
gas embargo of Western Europe, where would Russia sell its natural gas?
While Putin could attempt to
redirect sales of natural gas to his trading partner China, the infrastructure
required to transport that gas has not yet been completed, and the construction
required to make it operational will take years to complete.
Despite limitations in the
transportation infrastructure, the Russians already have a steady agreement in
place to sell gas to China—driven in some measure by Russia’s insecurity about
its relationship with the West.
On the other side of the
equation, tensions with Russia have already led some European countries to sign
contracts with the United States for future natural gas delivery. (At present,
US law does not allow for the export of meaningful amounts of liquefied natural
gas [LNG], but new LNG licenses are being issued.) The US is also increasingly
exporting its excess supply of coal to Europe, as the domestic shale gas and
oil boom reduce US coal consumption.
It’s Not Just Ukraine
I recently traveled to the
Central Asian nation of Kazakhstan, which is a former Soviet republic and
founding member of Putin’s Eurasian Economic Union. Russia has deep and
longstanding economic ties with Kazakhstan, especially in the trade of raw
materials and finished goods.
Kazakhstan is the largest
landlocked nation in the world, and the ninth-largest country by overall
landmass. Its northern border with Russia is longer than 4,000 miles. Roughly
one-quarter of Kazakhstan’s population of 17 million is ethnic Russian—but in
the north and west of the country, ethnic Russians account for between 40-50%
of the population.
This August, in a disturbing
turn of events, President Putin remarked that Kazakhstan has never had
independent statehood and was historically “part of the large Russian world.”
He also said that Kazakhstan’s citizens of Russian descent needed to be
protected—and that they would insist on protection if tensions were rising.
The Kazakhstanis naturally
bristled at this rhetoric, made especially ominous by the fact that Putin had
made nearly identical remarks about the ethnic Russians in Ukraine. Putin also
made special mention of Kazakhstan’s current president, Nursultan Nazarbayev,
praising him for having “created a nation” where none had existed before.
This leaves many Kazakhstanis
concerned about what Putin’s plans for Kazakhstan may be after Nazarbayev
eventually disappears from the scene. Nazarbayev is now in his mid-70s and has
run the country since its independence without a clear plan of succession.
There are also additional concerns about whether the ethnic Russian population
of Kazakhstan will rise to the bait and begin to assert their “rights” with
force, as they already have in Ukraine. President Nazarbayev has already
responded to this perceived risk by appointing more Russian ministers to
participate in his government.
Kazakhstan has played a
fascinating balancing act between Russia, China, and to a lesser extent, the
West. Indeed, Kazakhstan now sells more than half of its resource exports to
China.
I don’t believe there is any
reason for great concern about Kazakhstan in the short term—but the uncertainty
about succession after Nazarbayev leaves the presidency could make Kazakhstan
vulnerable.
Unlike many other countries
in the region, Kazakhstan has some significant economic advantages—including
sizable resource exports and earnings, the fact that it has managed to save
some of its oil earnings in its sovereign wealth fund. All of this gives
Kazakhstan some bargaining power vis-Ć -vis
Russia—at least as much bargaining power as a country a tenth the size of Russia
can command.
Source: RT
Putin has also engaged in
similar bullying tactics in Armenia, Moldova, Kyrgyzstan, and Tajikistan—all of
which are relatively poor, landlocked nations, with few resources and limited
wealth, and which now seem likely to join the EEU at some point in the future.
While these territorial
conflicts may seem distant from Western investors, taken as a whole, they
amount to a pattern of behavior in a potentially volatile region of the world
that investors should not ignore.
Challenging Global
Infrastructure
Also on the geopolitical
front, Russia and its BRICS partners—Brazil, India, China, and South Africa—are
working on creating a development bank that will serve as a BRICS alternative
to the Western-controlled International Monetary Fund (IMF) and the World Bank.
This is yet another troubling example of Russia’s apparent desire to turn its
back on the West.
In another example, there has
been speculation that Russia and China are planning to create an international
payment system to replace the SWIFT system in order to limit the capacity of
the US and Europe to impose financial sanctions against them. Support for some
of these ideas has cooled in China, though, where the notion of replacing the
SWIFT system has been rejected, while many analysts in the West think the idea
is nothing but a pipe-dream.
In addition, recent
revelations of electronic surveillance by the US may lead Russia and other
illiberal states to restrict Internet access and create their own nationally
controlled data networks.
Creating a full Eurasian
Economic Union that is less tied to the West through trade, financial
integration, electronic payment, and communication may be a romantic fantasy
for Russia given the fiscal costs the project would entail—costs that Russia
cannot afford.
Moreover, the recent fall in
oil prices—which is perhaps driven in part by Saudi Arabia’s goal of punishing
Russia for its role in Syria and the Middle East, as well as the sanctions
against Russia by the West—have led to a free-fall of the Russian ruble and a
near-recession in Russia this year and possibly next year as well.
Despite these headwinds,
Putin is still very popular at home where a controlled media has spun a tale of
a strong Russia helping its ethnic cousins in Ukraine. But as the economy
falters, the neoimperial goals of Putin will be increasingly challenged.
Nevertheless, for now the
Eurasian Economic Union dream is a dream to which Putin dearly clings—and he is
nothing if not tenacious.
Final Thoughts
Taken as a whole, Vladimir
Putin’s behavior suggests that his endgame is to keep the former member states
of the Soviet Union unstable enough to give up on closer ties with the West.
His plan is multifaceted—part political, part military, part geostrategic—and
focused on maximizing Russia’s influence in the region as well as increasing
the power of the fledgling Eurasian Economic Union.
Counterbalancing those risks
in the region are the central banks of the G4—the Fed in the United States, the
European Central Bank, the Bank of England, and the Bank of Japan—which have
kept interest rates low enough to suppress market volatility.
So far, that support from
central banks has served as an effective counterweight to the perception of
geopolitical risk in places like Ukraine. With a few short-term exceptions,
stock market prices have remained relatively stable since the crisis in Ukraine
began almost a year ago.
There’s still plenty of risk
in the world today. As an investor, you should pay attention to those events,
but don’t automatically assume that geopolitical risk will translate into a
massive correction in asset prices.
Vigilance and careful
observation are a must—panic is not required.
Cordially,
Nouriel Roubini
Chairman
Roubini's Edge
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