Deutsche Bank knuckles down to close its credibility gap

Despite shares near record lows, the effects of Sewing’s turnround efforts are starting to show

Stephen Morris in London and Olaf Storbeck in Frankfurt


© FT montage / Bloomberg


When a delighted oenophile started praising the “excellent” choice of red wine at a shareholder dinner this month, Christian Sewing moved to dispel any notion that Deutsche Bank was back to its profligate ways.

“Enjoy it while it lasts,” the chief executive told a small group of the bank’s key investors who had gathered in the 34th-floor dining area of its Frankfurt headquarters, after a marathon five-hour strategy presentation.

He explained the two-decade-old bottles from a famous French vineyard were “leftover stock” acquired in more flamboyant times, and sought to reassure investors that such luxuries were now forbidden under his parsimonious regime.

Mr Sewing’s emphasis on austerity is understandable after a tumultuous 2019 for Germany’s largest lender, in which decades of accumulated problems came spectacularly to a head.

Deutsche’s shares plunged to a record low as it grappled with profit warnings, regulatory probes and a global economic slowdown. A merger with equally troubled domestic rival Commerzbank was abandoned in April after six weeks of fruitless talks. In a fresh push to convince investors that Deutsche has a viable future as a standalone business, in July Mr Sewing announced the bank’s most radical strategic overhaul in two decades. Deutsche is relinquishing its ambitions to be a global investment bank, cutting 18,000 jobs, closing equities trading and forming a roughly €280bn bad bank to run down unwanted assets.

Leading this turnround plan is Mr Sewing, a no-nonsense, down-to-earth leader, according to those who have worked with him. He began his career at Deutsche 30 years ago as an apprentice and, before joining the executive board in 2015, he worked in various risk-management and auditing roles on three continents.

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Ahead of Deutsche’s 150th anniversary in March, Mr Sewing claims he has broken with the mistakes of the past and is no longer “denying or turning a blind eye to our weaknesses — we are tackling them head on . . . we are in relentless execution mode,” he told analysts in July. Mr Sewing declined to be interviewed for this article.

Despite this, pessimism remains widespread about management’s ability to execute the latest restructuring, which marks the bank’s fifth strategic overhaul in seven years.

“Many people still think: ‘well, it is Deutsche Bank — they will find a way to disappoint’,” said one of the bank’s top-10 shareholders. “I disagree because this management team is different. Christian set a really good tone and there is no infighting between the investment bank and private bank [any more].”

A slowing German economy and the European Central Bank’s more aggressive negative interest rate policy have added to Deutsche’s woes since July as it increases the pressure on the lender’s interest income and pushes up the costs for parking cash at the ECB.

The bank’s shares, which dropped sharply in the first few weeks after the cuts were announced, have still not fully recovered those losses and languish near a record low.

The stock trades at an 80 per cent discount to the net value of its assets, the steepest of any major European bank.

Chief among investors’ concerns is Mr Sewing’s new-found optimism for the investment bank, which in July he described as a business where “we lost our compass in the last two decades”. He accused his predecessors of a “culture of poor capital allocation” and chasing revenue, without concern for sustainable profits.

Yet, this month, in a change of tone that surprised many, Mr Sewing revised upwards the 2022 targets, signalling that the investment bank will again become Deutsche’s fastest-growing business.

While the bank lowered its outlook for the private bank and asset management — two divisions previously praised for stable and predictable earnings — the investment bank is now expected to grow by an average of 2 per cent per year and generate a return on tangible shareholder equity of up to 8 per cent by 2022. Just five months earlier, the bank had said that the unit’s revenue would be flat over the coming three years, and deemed a 6 per cent return on equity realistic.

Line chart of Share price (€) showing Deutsche Bank in 2019


“Management expectations [are] still far too bullish,” warns KBW analyst Thomas Hallet, who sees tougher regulation, stiff competition and low interest rates undermining growth.

No other European investment bank has boosted its forecast for investment banking and Deutsche is currently at the bottom of performance tables. During the first nine months of 2019, investment banking revenue fell by a tenth, pre-tax profit plunged by almost half, and it generated a return on equity of 1.8 per cent over that period, spending 88 cents of every euro earned.

Globally, Deutsche has slipped to 15th position for advising on mergers and acquisitions so far this year, down four positions from 2018; and for deals in its domestic market it has dropped two spots to seventh place, according to Dealogic.

“The higher growth target for the investment bank came as a surprise given Deutsche’s unimpressive track record and its inherent volatility,” said Alexandra Annecke of Union Investment, a German asset manager that owns 0.4 per cent of the lender. “This could weigh on its stock market valuation because investment banking is valued at lower multiples than [the] more stable businesses.”

Deutsche claims it has become more optimistic because fewer clients left the bank than expected when it closed the equities business — only 3 per cent, according to one executive — and transaction margins are improving as funding costs fall.

The price of the bank’s credit default swaps — derivatives that pay out if a company defaults on its bonds — demonstrate this improvement. They have fallen from a peak of around 180 basis points last year to around 66 basis points now, narrowing the funding-cost gap between Deutsche and rivals that was pricing it out of deals.

Deutsche has also made headway in getting rid of unwanted assets. By the end of this year, half of all those earmarked for disposal will have already left Deutsche’s balance sheet.

Regulators are pleased with progress, offering rare praise for Mr Sewing’s nascent transformation. Andrea Enria, the eurozone’s chief banking supervisor, said at a December conference that, while Deutsche “had clearly an issue with the viability of the business model” it is “well along in executing its new strategic plan” and “has made good progress in enhancing controls and reducing [its] risk profile”.

Reflecting this progress, this month supervisors lowered Deutsche’s minimum common equity tier one ratio (CET1) — a key indicator of balance sheet strength — by 25 basis points to 11.6 per cent. Deutsche has suspended its 2019 and 2020 dividends to help strengthen its balance sheet.

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Mr Sewing’s task has been complicated by a barrage of negative news over redundancies, management change and regulatory scandals that have rocked investors’ confidence and undermined the bank’s assurances that it had addressed past misconduct and improved its control functions.

In July, senior bankers caused a PR crisis when they invited tailors to Deutsche’s London headquarters to have made-to-measure suits fitted. Their timing was inauspicious: it was the day the lender announced 18,000 job cuts. Mr Sewing personally called them to tell them off.

“This behaviour is in no way consistent with our values,” he later said.

This month Frankfurt prosecutors forced Deutsche to pay out €15m for shortcomings in money-laundering controls. While they dropped a more substantial criminal investigation into suspected tax evasion, Mr Sewing has several other serious regulatory issues to tackle in 2020.

In early December Deutsche was ordered by a federal appeals court in New York to disclose Donald Trump’s financial records — which the bank has so far refused to hand over — part of an investigation into the US president’s tax returns.

There are also several international investigations into Deutsche Bank’s role in the €200bn Danske Bank money-laundering scandal. Until 2015, the German lender acted as a correspondent bank for Danske’s Estonian branch, clearing about €160bn of potentially suspicious transactions.

Pay and talent retention will be another challenge for Deutsche’s investment bank. After more than a dozen top executives left in 2019, more could follow as the bank is set to cut its bonus pool again by as much as a fifth, the FT has reported.

Concrete actions such as the balance sheet and compensation cuts are welcomed by investors, but many still put question marks over the long-term rehabilitation of Deutsche. “For the market, seeing is believing,” said Union’s Ms Annecke.

Mr Sewing and his top team are acutely aware of this scepticism and the need to shake off the bad-will that has built up since its launched its disastrous attempt to be the “Goldman Sachs of Europe” 20 years ago.

“This bank has been great at designing powerpoints, promising a lot to regulators and investors, then we executed only 60 per cent [of our plans] and put the rest in the drawer,” says one top executive. “We are closing that credibility gap now.”

Even if that means replacing fine vintage wine with the supermarket variety.

Worth its weight

The killing of Qassem Suleimani sends gold to a seven-year high

But the precious metal had already been on a long rally



“Nobody really understands gold prices, and I don’t pretend to understand them either,” said Ben Bernanke, then chairman of the Federal Reserve, in 2013, after a turbulent few months in the market for the metal (it hit its all-time peak in 2011, at the height of the euro-zone crisis and following a downgrade of America’s credit rating). Yet it is not hard to see why the metal hit its highest level since early that year—$1,588 per ounce—on January 6th.

The jump followed the drone strike that killed Qassem Suleimani, leader of the Quds Force of Iran’s Islamic Revolutionary Guard Corps, three days earlier. The rise of 2.9% over two trading days is similar to those after other Middle Eastern flare-ups. (Oil prices also leapt: Brent crude rose by 5%, briefly topping $70 a barrel.)

Iran’s attack on the Al-Asad airbase on January 8th caused a further 2% jump, to $1,611 per ounce, before investors concluded that Iran was saving face, rather than escalating.




Investors typically rush into gold when geopolitical risk soars.

However, its price has been rising for a while, climbing by more than 25% since November 2018.

The reason is falling real (ie, inflation-adjusted) interest rates.

The most common measure is the yield on ten-year inflation-indexed American Treasury bonds (tips); after the Federal Reserve began cutting rates this slid from around 1.1% in November 2018 to near zero last August. That was the lowest since 2013, the last time gold was so dear.

Analysts at PIMCO, a fixed-income asset manager, think of gold as an asset with no default or inflation risk (in inflationary times, investors often regard it as a hedge against rising prices).

That makes it pretty similar to tips, except that gold never yields any interest.

If real rates rise, gold’s relative attractiveness falls; when they fall, it rises.

Gold is not for everyone.

Warren Buffett, probably America’s most celebrated investor, is certainly no fan. He once said that the metal “gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility.”

John Pierpont Morgan, eponymous founder of America’s biggest investment bank, held a different opinion, quipping that “gold is money, everything else is credit”.

And when the return for providing credit is close to zero, it is little surprise that investors want their money in gold.

The Markets That Never Emerge

Emerging-market stocks have had a miserable decade. The slowdown in Chinese growth suggests they won’t break out as the next one begins.

By Mike Bird


The outlook for emerging-market stocks is now clouded by the growth outlook in China. Photo: roman pilipey/Shutterstock


After 10 years of misery for emerging-market stocks, investors may want to think about another name for the asset class.

Equities from outside the world’s advanced economies haven’t emerged into anything, and the prospects heading into a new decade don’t look any better.

The benchmark MSCIEM Index has offered a total return of 47% in dollar terms since the end of 2009, compared with 159% for the MSCI World Index, which tracks developed-market stocks even if its name suggests otherwise.



That isn’t just because the U.S. has done so well.

The MSCI Japan index has returned 95%. Stocks in Europe were slammed by the sovereign debt crisis and a feeble economic expansion, but investors would still have been better off buying into the old world than emerging markets.

Telling investors at the beginning of 2010 that the market’s performance would be so miserable might have been a hard sell.

Supported by massive Chinese stimulus, the MSCI EM had just recovered the lion’s share of its financial-crisis losses and returned more than 150% for the first decade of the 21st century.

U.S. markets lost investors money over the same period.

The outlook for emerging-market stocks is now clouded for exactly the same reason that they rallied back from the financial crisis so quickly: Chinese stimulus and credit policies matter more than anything else to the index.

With the Chinese government now increasingly fretful about debt-driven growth, a prolonged slowdown seems all but inevitable.

What is more, the makeup of the index has changed considerably: China’s direct share in it has roughly doubled from one sixth to one third, and that now includes stocks listed in the mainland.

Even that understates the country’s weight in the asset class, since other Asian economies are far more heavily exposed to China than they were 10 years ago.

While the lower underlying profitability of listed companies in developed markets, as measured by their return on assets, has crept back up toward its level before the financial crisis, the metric has tumbled in emerging markets, closing the gap between the two considerably.

That means investors are no longer compensated for the sector’s higher volatility.

The cause of the decline is largely slowing growth, and with debt levels already elevated the companies cannot safely compensate by levering up.

As for valuation, earnings multiples suggest emerging-market stocks are cheap relative to their developed world peers, with a 12-month forward price-to-earnings ratio of around 12.3, compared with 16 for stocks globally.

But that sort of gap has existed for much of the index’s history.

It is hard to imagine any source of growth large enough to offset the slowdown in the world’s second-largest economy.

Emerging market stocks are set to start a new decade facing the same problems that plagued them in the last one.

Loser Teens

In keeping with the adage that history does not repeat but rhymes, the decade from 2010 to 2020 ushered in a new age of disorder and distrust, just as the 1810s and 1910s did. Each era shows how unmet promises and unrealized hopes inevitably lead to disillusion and cynicism.

Harold James

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PRINCETON – We are at the end of a decade that has no name. The 2010s cannot really talk about itself, and this confusion is only partly born of semantics.

While the term “noughties” was applied to the first decade of the twenty-first century, few would be comfortable calling this past decade the “teenies.”

A century ago, there was no need to worry about such categorization: the 1910s were simply the era of the Great War.

But our semantic uncertainty also reflects a deeper problem about analysis and truth. As human civilization seeks meaning in its decimally ordered notion of time, language offers labels to capture each generation’s mood. In retrospect, the “twenties,” “thirties,” “forties,” “fifties,” “sixties,” “seventies,” “eighties,” and “nineties” all evoke powerful associations.

The “sixties” immediately calls to mind optimism, youth revolt, the promise of an incipient globalization, and the idea of “one world.” One lesson, then, is that for a decade to have a distinct spirit, it must coincide with a reality that can be clearly and truthfully described.

Oddly, the 1960s strongly paralleled the 1860s. From Giuseppe Verdi and Richard Wagner to the Beatles and the Rolling Stones, each decade gave rise to transformational music. And the transoceanic steamship would prove to be as revolutionary as the passenger jet a century later.

In the case of the United States, each period had a bloody conflict – the Civil War and Vietnam – that would redefine the national ideal. Even the mundane history of monetary politics contains striking parallels.

Under Emperor Napoleon III and again under President Charles de Gaulle, France was pushing for the creation of a European currency to reorder monetary relations globally.

By contrast, a half-century departure from the sixties tends to be dismal. The 1810s and the 1910s were both eras of shattered hope and lost illusions. Grand transformative visions – whether of Napoleon I in France, Czar Alexander in Russia, or President Woodrow Wilson in the US – collided with the realities of national projects, social animosities, and economic shock (not least the post-war period of deflation).

Napoleon, Alexander, and Wilson each imagined a world governed and pacified by rational law. And each quickly became a figure of mockery and derision. While Napoleon was vilified as a bogeyman, and Alexander as a vicious reactionary, Wilson was ridiculed as a Presbyterian preacher who had been taken for a ride by sophisticated European practitioners of Realpolitik.

The 2010s also began with grand rhetorical promises and heroic political figures offering hope.

On June 4, 2009, US President Barack Obama delivered the finest of his many distinguished oratorical performances. In his “New Beginning” speech in Cairo, he insisted “that America and Islam are not exclusive and need not be in competition. Instead, they overlap, and share common principles – principles of justice and progress; tolerance and the dignity of all human beings.”

That argument led nowhere. Obama masterfully conjured the appearance of hope, but not its actualization. The Arab Spring ended in bitter disillusionment, via repression, civil war, misery, and death.

As is often the case, political disenchantment has had an economic counterpart.

But the stubborn disinflation of the 2010s was unlike the major deflationary episodes that followed the Napoleonic wars and World War I. The macroeconomic conditions of the 2010s were not the result of a deliberate attempt to replace wartime finance with fiscal stability.

Rather, disinflationary pressure was driven by a combination of globalization and technological change.

Moreover, in the eyes of the public, economic underperformance was interpreted as a symptom of policy mistakes and mismanagement during and after the 2008 financial crisis.

Historically, periods of steady inflation have tended to augur a realization of promises, whereas disinflation and deflation make everything look simultaneously cheaper and unobtainable.

When inflation comes to an end, society is left like Tantalus, grasping desperately at something that is just out of reach (for central banks, that “something” has been inflation itself).

Nonetheless, in a 2013 commencement speech, Obama clung to hope: “the cynics may be the loudest voices – but I promise you they will accomplish the least.” Sadly, he was wrong again.

Cynicism is the inevitable response to a period of over-promising and under-realizing. As it takes hold, it creates the conditions for “post-truth” politics.

Simply because they did not have Twitter or anything like it, no nineteenth-century US politician could match President Donald Trump’s litany of lies.

By the Washington Post’s count, Obama’s successor has issued more than 15,000 “false or misleading claims” since taking office.

America’s promise is that it is a land of equal opportunity. But it now lags behind most other advanced economies in terms of socioeconomic mobility.

Europe’s promise is that it is a domain of toleration and shared values. But those sentiments have been overwhelmed by waves of migration and other forces of globalization.

More to the point, in the 2010s, the promise of a global rules-based order was broken. The post-1945 settlement is now the subject of a tug of war between countries that see themselves as old-fashioned great powers. Each is equipped with not only military might, but also a specific set of ideas.

For centuries, the “teens” have been the antithesis of the “sixties.” They have been times when the audacity of hope is replaced with despair, disillusionment, and falsehood.

As such, they have been profoundly disruptive and destructive. It will take a long time to recover, and only some of us will have the privilege of witnessing the 2060s.


Harold James is Professor of History and International Affairs at Princeton University and a senior fellow at the Center for International Governance Innovation. A specialist on German economic history and on globalization, he is a co-author of the new book The Euro and The Battle of Ideas, and the author of The Creation and Destruction of Value: The Globalization Cycle, Krupp: A History of the Legendary German Firm, and Making the European Monetary Union.

The Russian Military: By the Numbers

By: Jacek Bartosiak


After the collapse of the Soviet Union, Russia transformed its military from a sluggish, archaic institution to a fighting force better able to wage modern warfare, an essential function of which is to serve as a foreign policy tool for the government in Moscow. This is perhaps best illustrated by the composition of the armed forces itself.

The Pride of Russia

The great pride of Russia, and the basis of its regional power projection, is its soldiers. They are divided into four divisions (98 and 106 Guardian descent, 7th Guards), four brigades (11, 31, 56 and 83) and one Spetsnaz brigade (45), though, notably, Spetsnaz is supported by 20,000-30,000 personnel. Thereare also airborne troops capable of rapid invasion or quick response, albeit intended to operate in post-Soviet areas.

Unlike in Western armies, including the U.S. Army, Russian units are very “heavy,” supported by tanks, heavy infantry fighting vehicles and tracked vehicles required in the Baltic-Black Sea Intermarium.

The Russians do not have a modern air force by Western standards, but it is good enough to defeat opponents on the periphery. Russia’s integrated air defense system, on the other hand, is very modern – it was one of the few things Moscow never stopped developing, even after the Soviet Union collapsed.

The Russian navy, which is headquartered in St. Petersburg, boasts four regional fleets: the Northern Fleet, the Pacific Fleet, the Baltic Fleet and the Black SeaFleet. Together they have between 15 percent and 25 percent of the number of ships they had during the Soviet era.

The average age of their ships is 20-25 years. (These numbers exclude the Caspian Flotilla, which operates in closed waters.)

Traditionally, submarines were the backbone of the Russian navy, but 75 percent of the 61 submarines in service are already over 20 years old.


Russian Naval Bases and Assets 
Russian Naval Bases and Assets

(click to enlarge)


The base of the most powerful Russian fleet – the Northern Fleet – is located in Severomorskin Kola Bay, the only ice-free place with access from the Atlantic.
 
It consists of seven or eight nuclear submarine carriers armed with intercontinental ballistic missiles (depending on your source), Russia’s only atomic cruiser and its only Russian aircraft carrier. Nuclear ballistic missile carriers can reach targets in the U.S., theoretically even from their own wharf.

They are protected by submarine-hunting impact vessels and submarines with maneuvering rockets, of which there are 16 in the Northern Fleet, and by conventional submarines, of which there are six in the Northern Fleet.

The Pacific Fleet, with its bases in Vladivostok and Petropavlovsk-Kamchatsky, includesnuclear submarines carrying intercontinental ballistic missiles and conventional diesel-powered submarines (nine pieces) intended for the coastal waters of the North Pacific.
 
A new class of Kalina conventional submarines with air-independent propulsion, which allows for a long-lasting immersion of quieter and smaller conventional ships, is expected to enter service after 2020. The Pacific Fleet also has a large number of Udaloy-class destroyers sailing on patrols throughout theWestern Pacific.
 
The Baltic Fleet has degraded since the end of the Soviet Union, which lost several ports when the Baltic states regained independence. The largest war port is now Baltiysk in Kaliningrad region. It controls the actions of the Polish navy right at its main approach to the Gulf of Gdansk, and the port ofSt. Petersburg.
 
The Black Sea Fleet is similarly afflicted, having lost its ports in Ukraine and Crimea after1991. But now that Crimea has been annexed and restrictions have beenplaced on Ukraine’s sea access, Moscow is implementing plans to strengthennaval forces in this basin.
 
The Caspian Flotilla completely dominates the drainage basin, equipped as it is with modern Kalibr long-range maneuvering rockets with striking capabilities against all of Central Asia, the Middle East and Eastern Europe. (It demonstratedas much in October 2015 by striking Syria.)

The value of the Kalibr system is that it can be fired from relatively small mobile platforms such as corvettes and that it has a range of 2,500 kilometers (1,500miles) – with relatively low rocket detection to boot. Most of theCaspian Flotilla is stationed at the base in Makhachkala, which has better access to water than Astrakhan, its traditional port.

Nuclear Weapons and Deterrence

The Soviet Union became a nuclear power in 1949. The Cold War arms race with the U.S. resulted in high numbers of warheads and their means of delivery, the number of warheads in the rockets, the direction of possible attacks, and homing locations – especially land-based near the enemy's borders (Cuba,West Germany and Turkey).

Russia’s comparative weakness after the fall of the Soviet Union, and the United States’ comparative strength, made nuclear weapons all the more valuable to Moscow. They allowed Russia to maintain its status as a superpower and gave the Kremlin a ton of leverage as it pursued its interests.
 
In 2010, the “NEWSTART” treaty curbed the number of nuclear warheads to 1,735, but in practice, it applied only to strategic warheads, not tactical warheads. Russia now has somewhere between 2,000 and 2,700 tactical nuclear warheads, depending on which source you use.
 
NEW START allows Russia to modernize and expand its nuclear arsenal and in fact has almost completely replaced its Soviet-era arsenal. By 2021, Soviet-era munitions are expected to constitute only 2 percent of Russia’s total nuclear forcé.

Of the three means of strategic nuclear delivery – intercontinental missiles, submarines and strategic bombers – ballistic ground-to-ground missiles from the Sovietera make up only half of the current number and are to leave service in2022.

They have largely been replaced by SS-27 Topol-M missiles, with thenew RS-24 Yars and RS-26 Rubezh also joining the line. The SS-28 missiles with maneuvering warheads that are currently under development are expected to be able to avoid U.S. missile defenses, according to Russia.      

FR nuclear missiles are divided equally between above ground silos andrail launchers on land. In March 2018, President Vladimir Putin announced that Russia had new rockets with completely new capabilities, including allegedly nuclear-powered maneuvering rockets with virtually unlimited range, as well as a hypersonic missile, though it’s unclear if this is true.

The second means of delivery consists of 10 Dolgorukiy-class ballistic missile carrier submarines. Russia plans to complete the launch of new missiles for SS-N-32 Bulava submarines, each with six warheads separately maneuvering (reentry vehicles).
 
Moscow is also modernizing the third means of delivery: the strategic bomb fleet ofTu-160s and Tu-95MSs. The first bomber is to be reopened on the production line, and the second will introduce new versions to the line.Works on the new PAK DA bomber are also underway.

Given such a vastnuclear arsenal, and given the disproportionate value of the munitions that comprise it, Moscow abandoned the Soviet policy of no first use.      

Officially, Russia seems prepared to use nuclear weapons not just inresponse to a nuclear threat but in response to conventional threats as well, especially if it “threatens Russia's survival in a nuclear or conventional war.” The notion of “survival” in the context of Russia – with its geography, disintegrative tendencies and historically labile power systems – is dangerously fluid.
 
Strategic games and simulations suggest that if Russian forces face destruction in a theater or operational direction that endangers the state apparatus, then Moscow would use nuclear weapons under the so-called “escalate to deescalate theory.”
 
First floated in the1990s, the general idea behind the theory is that a low-power tactical warhead could, in fact, stabilize a potential conflict because itproduces the psychological effect of “escalating dominance” – that is, creating the impression of strength that confers to Russia the ability tocontrol the escalation process.
 
Russia can then count on achieving victory in the conflict by using low-power nuclear weapons on an operational scale, or to intimidate a state that has no nuclear weapons or is a member of a broader alliance.
 
The interests of the other countries of the alliance are then separated from the interests of the country against which nuclear weapons would be used. Most often, the remaining countries of the alliance then tend to sacrifice the interests of the member at risk in exchange for a promise to stop escalating, thereby resolving the conflict on terms favorable to Russia and altering thebalance of power in the region. In other words, Moscow escalates to deescalate.

By this logic, if conflict broke out between Russia and China or NATO, Moscow would opt fornuclear strikes to end a conventional war, assuming that the opponent would accept a loss or concession to Russia instead of risking furthernuclear escalation. However, the most recent versions of Russia’s defensedoctrines make no mention of deescalation through nuclear attack.

The National Security Strategy issued in December 2015 is especially antagonistic, in that it directly accuses the United States of “instigating instability” and threatening Russia's interests and mentions the never-ending role of force as a factor in international relations. But it elides nuclear deterrence. Some believe this is merely a feint to trick the U.S. into not modernizing its own nuclear arsenal.

Either way, it’s important to note that in Russian military parlance, the notion of “deterrence” differs fundamentally from the understanding in the West, which sees it as a steady state of affairs.

For Russia, it is dynamic, anactive action, which is in opposition to a fixed passive state, which isactive before the conflict, throughout the course of geopolitical rivalry, and even during open conflict. It is then expressed in a coordinated package of political, diplomatic, military, scientific, technological and all other undertakings aimed at ensuring the desired “stability” in competition.

Put differently, Russian deterrence is to provide strategic stability favorable to Russia and its geopolitical interests. It is when Russia’s opponent cannot gain an advantage that Moscow cannot contest.

These notions of deterrence and stability are expressed almost exclusively in the context of Russia’s rivalry with the U.S. – and specifically Washington’s ability to project power into Eurasia, including the Baltic-Black Sea Intermarium. This may change as China’s military power grows.

But even then, it’s unclear what action would trigger Russia’s use of nuclear weapons. The military holds nuclear strike drills, sure, but has never publicly defined its threshold. This is very likely a “calculated ambiguity” meant to throw off the planning of potential enemies. In this way, Russia creates a lot of room for political and military maneuvering, especially toward neighboring countries that do not have nuclear weapons.