Crimea River

By Grant Williams

March 17, 2014

"Пожежа починається з іскри."
(Fire begins with sparks.)

"We all want to believe in impossible things, I suppose, to persuade ourselves that miracles can happen."

"He possessed the logic of all good intentions and a knowledge of all the tricks of his trade, and yet he never succeeded at anything, because he believed too much in the impossible.
Surprising? Why so? He was forever in the act of conceiving it!"

“Дай с ногото́к — попро́сит с локото́к.”
(Give him a fingernail — he will ask for a forearm.)

You drove me, nearly drove me, out of my head
While you never shed a tear
Remember, I remember, all that you said

Things That Make You Go Hmmm...

(Marina Lewycka): Public clashes between Ukrainians and Russians in the main square in Sevastopol. Ukrainians protesting at Russian interference; Crimean Russians demanding the return of Sevastopol to Russia, and that parliament recognise Russian as the state language. Ukrainian deputies barred from the government building; a Russian "information centre" opening in Sevastopol. 

Calls from the Ukrainian ministry of defence for an end to the agreement dividing the Black Sea fleet between the Russian and Ukrainian navies. The move is labelled a political provocation by Russian deputies. The presidium of the Crimean parliament announces a referendum on Crimean independence, and the Russian deputy says that Russia is ready to supervise it. A leader of the Russian Society of Crimea threatens armed mutiny and the establishment of a Russian administration in Sevastopol. A Russian navy chief accuses Ukraine of converting some of his Black Sea fleet, and conducting armed assault on his personnel. He threatens to place the fleet on alert. The conflict escalates into terrorism, arson attacks and murder.

Sound familiar? All this happened in 1993, and it has been happening, in some form or other, since at least the 14th century.

So begins an article in the UK Guardian this week, written by a British novelist of Ukrainian origin, Marina Lewycka; and amidst all the furore surrounding the events in Ukraine these past couple of weeks, it's important to gain a little perspective in order to understand the history surrounding the country's fractious relationship with Russia and its recent dalliance with European suitors.

Source: Wikipedia

The key to the stand-off over Ukraine is the Crimean Peninsulano stranger to conflict over the years and home to the infamous "Valley of Death" into which rode the 600 whom Tennyson commemorated in his epic poem recounting the ill-fated Charge of the Light Brigade. The order that sent those gallant young men to their inevitable doom is symptomatic of the kinds of catastrophic misjudgements that get made when emotions are running high.

At 10:45 a.m. on October 25th, 1854, the following order, signed by the Quartermaster General Richard Airey, was delivered to Field Marshall, Lord Lucan (no, not him. HE was the 7th Earl of Lucan. THIS was the 3rd Earl — his great, great grandfather):

Lord Raglan wishes the cavalry to advance rapidly to the frontfollow the enemy and try to prevent the enemy carrying away the gunsTroop Horse Artillery may accompanyFrench cavalry is on your left. R Airey. Immediate.

The vagueness of Raglan's order confused Lucan, as it made no mention of which guns the Light Brigade were being ordered to keep from leaving the battlefield; but when he questioned the order, Captain Louis Nolan of the 15th The King's Hussars damned his impudence:

"Attack, sir!"

"Attack what? What guns, sir?"

"There, my Lord, is your enemy!" said Nolan indignantly, vaguely waving his arm eastwards. "There are your guns!"

And with that, not daring to challenge a direct order further, Lucan ordered the Earl of Cardigan to lead the 600 men of the 13th Light Dragoons, the 17th Lancers, the 11th Hussars, the 4th Light Dragoons, and the 8th Hussars into the teeth of the Russian battery two kilometres distant, with further guns flanking their advance on either side.

Source: Wikipedia
Cannon to right of them,
Cannon to left of them,
Cannon in front of them
Volley'd and thunder'd;
Storm'd at with shot and shell,
Boldly they rode and well,
Into the jaws of Death,
Into the mouth of Hell
Rode the six hundred.

The result of one of the most famous military blunders of all time, the destruction of the Light Brigade at the Battle of Balaclava, demonstrated the dangers of military miscalculation in the Crimea; and 160 years later the possibility of another such misjudgment on the part of a commander looms heavily over the region.

However, rather than tracing every twist and turn in the Crimea between 1854 and today, we shall focus on the more recent history of the isolated and vulnerable peninsula that juts out into the Black Sea from Ukraine's southern coastline; and, with a little help from the NY Times, we'll begin with a look at how things stood after the first week of the crisis:

Source: NY Times

As you can see from the map, there were two major Russian military installations in Crimea prior to tensions getting a little elevated in Ukraine: the airbase at Gvardeyskoye and, far more importantly, the home of Russia's Black Sea Fleet at Sevastopol. These are marked by the blue dots. The red dots? We'll get to them shortly — but first, a little more history.

The Black Sea Fleet, founded in 1783 by Prince Potemkin, has enormous historical and political importance to Russia.

The revolt by the crew of the battleship Potemkin in 1905 is widely accepted as being the catalyst for the Russian Revolution (Lenin himself wrote that the uprising sowed the seeds of the Revolutionary Army), and so the history of activities in Sevastopol being somewhat disruptive goes back a long, long way — and forward just as far:

(Taras Kuzio, "The Crimea: Europe's Next Flashpoint," November 2010): [P]resident Viktor Yushchenko had repeatedly pointed out that the Black Sea Fleet (BSF) is an agent of instability in Crimea, Ukraine that facilitates separatism. In a letter to Russian president Medvedev, Yushchenko stated that "Throughout the period of the BSF’s base on Ukrainian territory, its commanding structures had systematically permitted a great number of infringements of bilateral agreements and Ukrainian legislation, which the Ukrainian side had regularly informed the Russian side."

That paper was written somewhat presciently after the Ukraine government had announced that the leases on Russia's naval bases in Crimea would not be extended beyond 2017 (the existing agreement provided that, as long as mutual consent was reached, Russia would pay $98 million per year in rent for her bases (or roughly the same price as a four bedroom apartment here in Singapore).


Somewhat miraculously (and, I'd like to stress, after NO money WHATSOEVER found its way into any presidential pockets), in April 2010, newly installed pro-Russian stooge President Yanukovych and then-Russian President Medvedev reached an agreement whereby the Russian lease on naval facilities in Crimea would be extended beyond 2017 — by 25 years, with an additional 5-year renewal option (2042–47) in exchange for a multi-year discounted contract to provide Ukraine with Russian natural gas.

Which was nice.

(Incidentally, for those of you who have been asking after his health, Yuschenko has made a complete recovery from the freak and unexplained accidental dioxin poisoning which occurred in late 2004 during a bitterly fought election campaign in which he defeated pro-Russian stooge his main rival, Yanukovych. I will pass along your good wishes.)

Anyway, within a few days of the closing ceremonies of the Sochi Winter Olympics, as the world turned its eyes away from Russia for the first time in several weeks, all hell let loose as Russian mysterious, unidentified troops coincidentally seized key locations across the peninsula in a series of coordinated completely random operations.

Remember those red dots we were going to get back to? Well, they represent the targets seized during the completely random operations carried out by the mysterious, unidentified troops; and they included air bases, naval bases, border crossings, and the parliament building.

What are the odds?

A look at another map, this time showing military installations on the Crimean Peninsula and beyond into Ukraine, paints something of a misleading picture:

Source: NY Times

(NY Times): Russia's military abilities dwarf those of Ukraine’s, which is underfunded and poorly positioned to counter an attack from the east. According to a recent report by the International Institute for Strategic Studies, Ukraine’s armed forces use mainly Soviet-era equipment, much of which needs to be upgraded or replaced. Ukrainian air defenses are considered weak and its naval fleet is far inferior to Russia’s.

Now, in order to fast forward to the key points here, some background and a couple more maps will be useful, as they explain very clearly the ethnic and political divide that splits Ukraine. Ready? OK, here we go.

Ukraine sits between Europe and Russia, bordering Belarus, Poland, Slovakia, Hungary, Romania, Moldova, and, of course, Russia herself. A former Soviet Republic, Ukraine was granted independence in August of 1991, and its eastern border marks the farthest reaches of Europe.

At 603,628 sq km, Ukraine is the largest country in Europe and is home to some 44 million people.

Those 44 million people are split in their allegiance between Europe and Mother Russia, and that split has been growing since the very first independent presidential elections were held in the country in December of 1991.

In those elections, Leonard Kravchuk was voted the country's first president; and just twenty days after his victory, he joined the leaders of Russia and Belarus in signing the declaration which formally dissolved the Soviet Union and established the Commonwealth of Independent States.

The joy of independence was short-lived, however, as the country plunged into a recession which stripped away 60% of its GDP and led to record hyperinflation:


(Wikipedia): Ukraine experienced its worst inflation between 1992 and 1994. In 1992, the Ukrainian karbovanets was introduced, which was exchanged with the defunct Soviet ruble at a rate of 1 UAK = 1 SUR. Before 1993, the highest denomination was 1,000 karbovantsiv. By 1995, it was 1,000,000 karbovantsiv. In 1996, during the transition to the Hryvnya and the subsequent phase-out of the karbovanets, the exchange rate was 100,000 UAK = 1 UAH. By some estimates, inflation for the entire calendar year of 1993 was 10,000% or higher, with retail prices reaching over 100 times their pre-1993 level by the end of the year.

In 1996, it was taken out of circulation, and was replaced by the Hryvnya at an exchange rate of 100,000 karbovantsi = 1 Hryvnya (approx. USD 0.50 at that time, about USD 0.20 as of 2007).

Start and End Date: Jan. 1992 — Nov. 1994

Peak Month and Rate of Inflation: Jan. 1992 — 285%

The recession lasted eight years, devastating the country's economy; and despite many initiatives launched to stabilize the country, the enormous corruption and graft which riddled the ruling political class made real progress largely impossible.

In 2004, in some of the most blatantly rigged elections of modern times, our friend Viktor Yanukovych first muscled his way to power, but — almost by way of testament to just HOW severely rigged the results wereYanukovych was cast into opposition by the peaceful Orange Revolution. By promising the people of Ukraine far less obvious and slightly more palatable corruption, Viktor Yuschenko and Yulia Tymoshenko (a highly-corrupt successful businessswoman who once placed third on Forbes Magazine's list of the world's most powerful women, on the back of her extremely sketchy highly successful gas company which was wrapped up in a number of money-laundering and conspiracy cases high-profile dealings with the likes of Russia's Gazprom) assumed power.

Yanukovych would return to power in yet more clearly rigged elections in 2010, and this time his first order of business was to lay corruption charges at the feet of Tymoshenko who, after a not in the least bit surprisingly short trial, was convicted of embezzlement and abuse of power, sentenced to seven years in prison, and ordered to pay the state $188 million.

At least nobody could say Yanukovych doesn't learn his lessons.

But it was in January 2008, during negotiations between Ukraine's leaders and NATO about the country's potential membership in the NATO Member Action Plan (MAP), that the seeds of the reaction to recent events were sown.

Russia was not too keen on having NATO missile "defence" systems on her borders and made her objections clear in no uncertain terms, while the West seemed perplexed that the Russians would have a problem with such a move. After all, why should Russia object to having such weapons in close proximity to her borders? It's not as though the West would kick up a fuss if the tables were turned.

(Oh, while I think of it, on a completely unrelated topic, I recently read Thirteen Days: A Memoir of the Cuban Missile Crisis, by Robert F. Kennedy and found it to be an excellent readjust in case anybody is looking for book suggestions.)

Now, where was I? Oh yes, Russia's baffling opposition to NATO missiles a handful of miles from her borders... Well, the Russians hated the idea, whilst NATO thought it was in everybody's best interests. From that moment on, Ukraine has been "in play."

I promised you maps, and right about now things are gonna get all cartographical up in here.

First up, a look at Ukraine split along political and ethnic divides. As you can clearly see, this is a country very much of West and East — of pro-Europe and pro-Russia:

Source: BBC

Taking that map one step further we get this:

Source: Washington Post

As you can see, the divide is very clear indeed. Thank God for maps. That's a lot of "splainin" saved.

So... that's how things stack up ethnically, politically, and militarily; but this next map, which has suddenly entered the collective conscious of the wider world, likely holds the key to how this situation plays out. It's a map of Ukraine and the gas pipes that crisscross the country:

Source: Zerohedge

There, in one simple map, is the crux of the struggle over Ukraine.

Russian gas enters Europe largely through Ukraine's pipelines; and, as you can see in yet another map (this time courtesy of the Wall Street Journal), most of Europe is somewhat reliant upon its continuing to do so, and some of Europe is totally dependent upon its doing so. Score a point for Vlad:

Source: WSJ

The Russians have the vital flow of gas into Europe as their primary leverage in this power struggle, and they have shown in quarrels past that they are not afraid to turn the taps off if they feel it is in their best interests to do so.

Based upon the stand-off in Crimea and the tension it is steadily elevating, the questions that need to be answered are these:

    • What happens next?

    • Does Putin once again run rings around the West, or is he forced to back down?

    • Will somebody, somewhere miscalculate and overplay their hand?

    • Is this just a flashpoint for trouble that's been brewing for a while?

    • Is there a wider picture here that Ukraine is just a small part of?

Well, as week one turned into week two, Putin's plans became clearer. While the West was running around trying to get consensus, Vlad the Impatient continued doing what those not hamstrung by such things as due process do: he fortified his position by adding a couple more air bases, another navy base, a few missiles, and an airport (see map below) — and all of this ahead of the one event which might be the basis for a possible miscalculation or overreaction.

As we've seen in recent years in Europe, the idea of a referendum which gives people the right to have their say in how they're governed is an extremely unpopular one amongst the political class, and the one called in Crimea for March 16th is even more unpopular than most. Granted, in Russia and its former republics and current satellites, the chances of such referenda being interference-free are roughly the same as those of Justin Bieber writing a bestseller on humility, but still...

Source: NY Times

It's the path to this referendum that is the main cause for concern.

Immediately following the ousting of Yanukovych from Ukraine, Crimea's parliament "elected" a staunchly pro-Russian PM whose first act of business was to call a referendum to decide whether Crimea would break away from Ukraine and join Russia.


No fuss. No prevaricating. Day one, job one: referendum.

Now, there is an old adage which applies more in politics than in almost any other field, and it goes like this:

"Never ask a question to which you don't already know the answer."

I am writing this on Saturday, the day before the Crimea referendum, but I am willing to go out on a limb and predict a handy victory for the pro-Russian faction, and that is when things may get nasty.


Is it such a completely bizarre idea for a power to hold a territorial stake in a very hostile foreign landparticularly when that piece of territory is an important naval base? Well, maybe not.

On the left is an aerial map of Sevastopol, the Russian naval base. The image has been rotated roughly 90°to make alignment easier. On the right? Well that would be Guantanamo Bay, the US naval base on the southeastern tip of that most anti-American of environments, Cuba. The US has leased the base since 1903 — and against strenuous Cuban opposition since 1959.

Source: Google Maps/TTMYGH

Just sayin'...

Folks, the "Yes" vote is a foregone conclusion, hence the build-up of tanks on the Russian/Ukrainian border in recent days; and the pantomime being played out amongst the likes of John Kerry, Sergei Lavrov (the Russian foreign minister), Putin himself, and various heads of state across Europe has the potential to be horribly misjudged in an environment where any number of presidents and prime ministers are desperate to look strong to their voting populaces.


(NY Times): With thousands of heavily-armed Russian troops occupying this perennially embattled peninsula, an overwhelming majority of Crimeans voted on Sunday to secede from Ukraine and join Russia, resolutely carrying out a public referendum that Western leaders had declared illegal and vowed to punish with economic sanctions.

The outcome, in a region that shares a language and centuries of history with Russia, was a foregone conclusion even before exit polls showed more than 93 percent of voters favoring secession.

Key European elections are a matter of weeks away, and all the incumbent parties are under intense pressure from previously harmless fringe elements. US midterm elections will be here before you know it, and this past week Barack Obama's approval ratings dipped to a new all-time low of 41%. Meanwhile, in Russia, Putin himself has been under considerable strain domestically as the Russian economy crumbles.

All these contributing factors, plus the fact that the global economy is still in critical condition (no... don't listen to THEM. It IS), make it ever more likely that (a) not being seen to back down to a Russian mobster/bunch of decadent Western imperialists is paramount to both sides and (b) a little armed conflict might be just the thing to rally the troops behind a leader or two.

It's happened before, many times. Just not recently (well, unless you include Afghanistan, Iraq, or Afghanistan again).

Source: Bloomberg

Sanctions have been threatened against Russia should Putin overstep the mark, and with the ruble in freefall lately, the weakness in the global economy hurting Russia's oil revenue, and the inevitable pressure being brought to bear on Russia's hard man ratcheting higher, the stakes grow bigger every day.

Draconian sanctions by the West would back Putin into a VERY tight corner indeed and would make a lot of very powerful allies reconsider their backing of the ex-KGB man.

A look at the damage already inflicted upon Russia Inc. is instructive, as can be seen from the charts above.

Now ordinarily I would bet the ranch on this spat being defused diplomatically and everybody leaving the negotiating table a little disgruntled (which would mean the outcome was just about perfect), BUT whilst on balance I still think that is the most likely outcome, I suspect that markets have become dangerously conditioned — by one perfectly executed landing after another in recent years — to expect (and position for) the best.

As I was mulling all this over today, a good friend emailed me and asked me my thoughts on exactly this topic.

The man in question is one of the very brightest minds it is my pleasure to be able to call on for advice and counsel, and so I thought, what better way to tidy up this week's many questions than by including the culmination of our email conversation (though with the odd expletive removed and certain names changed to protect the innocent):

On 15 Mar, 2014, at 12:10 pm, Mr. Big <> wrote:

apples to apples? ok, so why, how, what to do?

On Sat, Mar 15, 2014, at 12:26 AM, Grant Williams <> wrote:

My worry is this (I'm writing about it right now):

Markets have become conditioned to Goldilocks outcomes manufactured by CBs & govts over a period of three years when EVERYTHING should have gone wrong but nothing has.

The Taper hasn't mattered (yet) because everybody believes that, if the wheels come off, the Fed will blink and crank it up again.

China's problems are starting to become too difficult to ignore. (GDP 7.7% & PMI sub-50 for a manufacturing economy? Righto. Don't even get me started on the shadow banking system, which is straining at every seam right now.)

Abenomics is just beginning to be shown up for the farce it really is just in time for the consumption tax hike coming in a few weeks. Abe's fabled "three arrows" are not the ones everybody imagines but rather the kind of arrows with a sucker rather than a point on the end. Actually, in this case, on BOTH ends.

Putin is in a corner, and we KNOW he don't take to backin' down none.

Obama's approval is at all-time lows with midterms on the horizon, so he needs to look Presidential at home.

Draghi is trying to force the BuBa to BEG him for QE before turning the taps on, and it is crushing Europe, but he won't blink (I don't think).

The Fed meets next week and will taper another $10 bn.

That's the broad backdrop. Now, let me ask you this:

What if this next $10 bn taper is the "bang" moment when markets suddenly realize that the Fed ARE serious about continuing to wind it down?

What if the latent fear over all of the above issues, combined with that next $10 bn and the words of smart guys like Seth Klarman ringing in their ears, tells managers it's "safety time"?

At some point the market factors QE at $0 if the Taper continues — and that time ISN'T after they withdraw the last $10 bn.

Above all, what if (and the marginal signs have been nagging away at me the last ten days or so) everything goes back to trading how it SHOULD, based on everything we know about markets and economics, instead of lingering in the Magical Fairydust World created by central banks since 2009?

Markets have been reacting correctly and beginning to decorrelate over the past several sessions.

Where does everything trade if a stimulus level of zero suddenly gets discounted?

I don't know EXACTLY, but I'll hazard a guess at "a ****-load lower" to kick things off.

Gold is talking loudly, so is copper.

JGBs and equities are mumbling, so are bonds.

Something is happening, right now, in all the dark corners of the dance hall, and whatever that "something" is, it will NOT lead to an extension of the bull market.

Do we "crash"? I think that's the wrong question.

The right questions (I think) are these:

If a major correction begins, at what stage do they turn on the printing presses again? 10% lower? 15%? 20%?

When they DO (and it is WHEN, not IF), what happens now that the last vestige of their credibility has evaporated? A quick spike then a crash, or does the patient flatline on the bed no matter how much juice they pump into it?

I'm nervous as hell and feel a sharp disturbance in The Force. We've been here before and pulled back from the brink every time, but this time that outcome is expected again by most, and that is extremely dangerous.

Markets are most assuredly NOT ready for reality.

What say you, Wise Man?

On Sat, Mar 15, 2014, at 12:33 AM, Mr. Big <> wrote:

EVERY new Fed chief gets a serious test. Every one. I have been trying to figure Yellen's. I know this:

A weakened/prone US, scared Russia, and nervous China is not good and not priced in.

On 15 Mar, 2014, at 12:42 pm, Grant Williams <> wrote:

Agreed 100%.

I've been saying for two years that nothing matters to anybody until it matters to everybody, and I have a nasty feeling that the test is this:

Suddenly, in one moment, EVERYTHING matters to everybody.

That's something even central banks won't be able to stop.

Every new Fed chair gets a test.

Burns had the run on gold that led to Nixon's closing of the window; Miller had the Oil Shock; Volcker had the inflation tiger to wrestle; Greenspan had the '87 crash; and Bernanke had the subprime crisis followed by the 2008 crash.

Now it's Yellen's turn.

After fifteen months of steady and predictable (thanks largely to the Fed's largesse and Draghi's promise to do "whatever it takes"), we are about to enter a period of extreme unpredictability right at the moment when the Fed is about to demonstrate to the markets that, yes, they really ARE serious about continuing to taper $10 bn every month.

This past week we have seen markets wobble in many unexpected ways as Ukraine has provided the background noise, Japan's JGB market has been weak, US equities acted very poorly and failed to shrug off bad news as they have been doing for as long as many can recall, and Asia, taking its cue from China, was very weak indeed — particularly Japan.

Commodities were battered (copper and iron ore particularly); bond markets didn't see the flight-to-safety rally we have become used to; and gold blasted through resistance to new six-month highs and did what it is SUPPOSED to do in periods of geopolitical uncertainty something we haven't seen for almost two years.

Ukraine's referendum may well herald a return to Cold War conditions or, perish the thought, to an armed confrontation between East and West on European soil, but Ukraine is merely the current flashpoint.

The troubles facing the world are far, far broader than just the messy politics of Ukraine; and there is a very real chance that those troubles coalesce into one giant ball of concern that is big enough to shatter the fake sense of calm we've all been lulled into by the passage of time between crises.
If they do coalesce, I can't think of a single asset anywhere in the world that is priced correctly for such a situation.
THAT is something worth thinking about.