France’s next revolution

The vote that could wreck the European Union

Why the French presidential election will have consequences far beyond its borders

IT HAS been many years since France last had a revolution, or even a serious attempt at reform. Stagnation, both political and economic, has been the hallmark of a country where little has changed for decades, even as power has rotated between the established parties of left and right.

Until now. This year’s presidential election, the most exciting in living memory, promises an upheaval. The Socialist and Republican parties, which have held power since the founding of the Fifth Republic in 1958, could be eliminated in the first round of a presidential ballot on April 23rd.

French voters may face a choice between two insurgent candidates: Marine Le Pen, the charismatic leader of the National Front, and Emmanuel Macron, the upstart leader of a liberal movement, En Marche! (On the Move!), which he founded only last year.
The implications of these insurgencies are hard to exaggerate. They are the clearest example yet of a global trend: that the old divide between left and right is growing less important than a new one between open and closed. The resulting realignment will have reverberations far beyond France’s borders. It could revitalise the European Union, or wreck it.

Les misérables
The revolution’s proximate cause is voters’ fury at the uselessness and self-dealing of their ruling class. The Socialist president, François Hollande, is so unpopular that he is not running for re-election. The established opposition, the centre-right Republican party, saw its chances sink on March 1st when its standard-bearer, François Fillon, revealed that he was being formally investigated for paying his wife and children nearly €1m ($1.05m) of public money for allegedly fake jobs. Mr Fillon did not withdraw from the race, despite having promised to do so. But his chances of winning are dramatically weakened.

Further fuelling voters’ anger is their anguish at the state of France. One poll last year found that French people are the most pessimistic on Earth, with 81% grumbling that the world is getting worse and only 3% saying that it is getting better. Much of that gloom is economic.

France’s economy has long been sluggish; its vast state, which absorbs 57% of GDP, has sapped the country’s vitality. A quarter of French youths are unemployed. Of those who have jobs, few can find permanent ones of the sort their parents enjoyed. In the face of high taxes and heavy regulation those with entrepreneurial vim have long headed abroad, often to London. But the malaise goes well beyond stagnant living standards. Repeated terrorist attacks have jangled nerves, forced citizens to live under a state of emergency and exposed deep cultural rifts in the country with Europe’s largest Muslim community.

Many of these problems have built up over decades, but neither the left nor the right has been able to get to grips with them. France’s last serious attempt at ambitious economic reform, an overhaul of pensions and social security, was in the mid-1990s under President Jacques Chirac.

It collapsed in the face of massive strikes. Since then, few have even tried. Nicolas Sarkozy talked a big game, but his reform agenda was felled by the financial crisis of 2007-08. Mr Hollande had a disastrous start, introducing a 75% top tax rate. He was then too unpopular to get much done. After decades of stasis, it is hardly surprising that French voters want to throw the bums out.
Both Mr Macron and Ms Le Pen tap into that frustration. But they offer radically different diagnoses of what ails France and radically different remedies. Ms Le Pen blames outside forces and promises to protect voters with a combination of more barriers and greater social welfare. She has effectively distanced herself from her party’s anti-Semitic past (even evicting her father from the party he founded), but she appeals to those who want to shut out the rest of the world. She decries globalisation as a threat to French jobs and Islamists as fomenters of terror who make it perilous to wear a short skirt in public. The EU is “an anti-democratic monster”. She vows to close radical mosques, stanch the flow of immigrants to a trickle, obstruct foreign trade, swap the euro for a resurrected French franc and call a referendum on leaving the EU.

Mr Macron’s instincts are the opposite. He thinks that more openness would make France stronger.

He is staunchly pro-trade, pro-competition, pro-immigration and pro-EU. He embraces cultural change and technological disruption. He thinks the way to get more French people working is to reduce cumbersome labour protections, not add to them. Though he has long been short on precise policies (he was due to publish a manifesto as The Economist went to press), Mr Macron is pitching himself as the pro-globalisation revolutionary.

Look carefully, and neither insurgent is a convincing outsider. Ms Le Pen has spent her life in politics; her success has been to make a hitherto extremist party socially acceptable. Mr Macron was Mr Hollande’s economy minister. His liberalising programme will probably be less bold than that of the beleaguered Mr Fillon, who has promised to trim the state payroll by 500,000 workers and slash the labour code. Both revolutionaries would have difficulty enacting their agendas. Even if she were to prevail, Ms Le Pen’s party would not win a majority in the national assembly. Mr Macron barely has a party.

La France ouverte ou la France forteresse?
Nonetheless, they represent a repudiation of the status quo. A victory for Mr Macron would be evidence that liberalism still appeals to Europeans. A victory for Ms Le Pen would make France poorer, more insular and nastier. If she pulls France out of the euro, it would trigger a financial crisis and doom a union that, for all its flaws, has promoted peace and prosperity in Europe for six decades.

Vladimir Putin would love that. It is perhaps no coincidence that Ms Le Pen’s party has received a hefty loan from a Russian bank and Mr Macron’s organisation has suffered more than 4,000 hacking attacks.

With just over two months to go, it seems Ms Le Pen is unlikely to clinch the presidency. Polls show her winning the first round but losing the run-off. But in this extraordinary election, anything could happen. France has shaken the world before. It could do so again.

The Financial Fire Next Time

Simon Johnson

Goldman Sachs Steven Mnuchin sworn in

WASHINGTON, DC – In early 2007, the worst financial crisis in almost 80 years began to unfold, coming to a head 18 months later with the collapse of Lehman Brothers and shock waves felt around the world. Desperate government measures saved us from Great Depression II, and officials vowed “never again” would we face the same risks. Politicians and central banks embarked on a broad process of national-level reform and international coordination – all intended to reduce the chance that very large banks could collapse.
A decade later, the global financial system has in some ways become safer as a result of these efforts. In other ways, however, the structure has not changed much – and may even have become more vulnerable. But, instead of completing the reform process, policymakers on both sides of the Atlantic seem determined to undo most of the measures underpinning what progress has been achieved.
The past decade has yielded three main accomplishments. First, some financial firms failed, and for good reason: their business models were bad, they were badly run, or both. At the same time, stronger financial firms expanded their market share.
Second, the funding of banks shifted away from debt and toward equity. More than one prominent bank before the crisis had less than 2% of its funding from equity – meaning that it was more than 98% financed by debt. That does not happen today.
Third, there are now restrictions on the activities of the largest banks. The so-called Volcker Rule prevents proprietary trading – a form of in-house speculation – by United States-based banks. In other countries, bank supervisors have become more skeptical about supposedly sophisticated risk-taking. Caution is in the air.
Unfortunately, all of these achievements may prove ephemeral. Powerful people want to remove restrictions on banks in the US and the United Kingdom. For example, the Volcker Rule can be expected to come under great pressure from Goldman Sachs and its many alumni now serving in senior US government posts.
Gary Cohn, a former Goldman Sachs president and chief operating officer who now heads President Donald Trump’s National Economic Council, says that we should reduce capital requirements (meaning allow more debt and less equity funding at banks) in order to boost the economy. This is exactly what happened in the early 2000s. If Cohn gets his way, the consequences will be similar: disaster.
Since 2008, the global financial system has become more concentrated in important ways. The biggest US banks did well relative to their competitors, including large European banks. As a result, in key markets – and throughout the world’s essential financial infrastructure – banks such as JPMorgan Chase remain far too big to be allowed to fail.
Finance sometimes seems complicated, but what is at stake is quite straightforward. US Senator Jack Reed recently summed it up well:
“My constituents don’t need fancy Wall Street calculators or formulas to understand that there is a value and a benefit to reforming Wall Street and keeping reckless greed in check. There is a value and a benefit to protecting consumers and their hard-earned wages. And there is a value and a benefit to keeping a family in their home and avoiding foreclosure.”
Government officials’ views on policy are shaped by how they see the world – and what they have experienced. If someone was dramatically hurt by a financial crisis, that person is less likely to want to go through the same thing again.
But if someone did really well – by buying assets on the cheap at the bottom of the cycle, for example, or expanding market share – it seems reasonable to suppose that they are less likely to favor caution. Reed made precisely this point in speaking to the suitability of Steve Mnuchin – a former Goldman Sachs executive vice president – as Treasury Secretary:
“[A]n individual who made his fortune aggressively foreclosing on his fellow Americans does not possess the right values, in my view, to be our Treasury Secretary. Based on his record, I am not convinced Mr. Mnuchin is capable of draining the swamp, and I fear he may end up further rigging the system in favor of the 1% at the expense of working-class Americans.”
But the Senate confirmed Mnuchin, which suggests that we are about to come full circle. As James Kwak and I documented in our book 13 Bankers, financial deregulation in the 1980s and 1990s led to a real-estate boom in the early 2000s; that set the stage for the 2008 financial bust, which in turn gave rise to a new wave of reform in 2010 and after. The reforms were serious; but they did not go far enough, and they can be rolled back without much difficulty. The Trump administration is poised to do exactly that.
The big banks will get bigger. Capital levels will fall. And reasonable risk-management practices will again become unfashionable. Powerful people do well from booms and busts. The rest of us can expect deeper inequality and more crisis-induced poverty.

Wall Street's Best Minds

The Real Reasons Behind the ‘Trump Rally’

Zach Karabell argues that certain sectors seemed destined to climb regardless of who won the election.

By Zachary Karabell

We are now two months into the new year, a month or so into a new administration in Washington, and nearly four months removed from the fall presidential election. During that time, equities have risen steadily, and to a lesser extent, so have yields on U.S. government bonds. The strength of equities has been a source of puzzlement to many, and not a day goes by without major voices in markets and Wall Street questioning when the so-called “Trump rally” will run out of steam.

The widespread assumption is that the strength of markets—equities and yields both rising—is largely a byproduct of the election. Take this recent headline: “Investors may be banking too much on Trump lifting earnings.” One can find similar sentiments expressed daily. This framework, however, may be misleading. In fact, one can make a sound argument for equity strength based on solid fundamentals that are now more in focus with the noise and uncertainty of an election year that is in the rearview mirror. And one also could make a case that some rise in bond yields and a tapering of the bond bull market has been long overdue. It’s time to separate the markets from politics, which the markets themselves appear to have already done.

Fundamentals anyone?

Let’s say, for the sake of argument, that there are two possible reasons that stock and bond yields have been going up: expectations of gains for certain sectors because of new policies in Washington, and solid company fundamentals. The two, of course, are not mutually exclusive.

What if we remove Washington from the equation, what actually changes? Expected changes in infrastructure spending, or substantial financial industry deregulation, or reform of health care may amount to less than expected, or perhaps to nothing at all. With Washington out of the picture, we can even make a solid case for why stocks are doing well.

And they have done well, with the Standard & Poor’s 500 up more than 10% since Election Day Nov. 8, 2016. Small-caps stocks have been even stronger. Global equities have performed well too, with emerging markets showing double-digit gains. Sectors that are perceived to be tethered to Washington’s potential policies surged in November, such as Financials and Industrials, but recently Health Care, Information Technology, and Consumer Discretionary names have made up for their lag. The only sectors that have performed poorly are Energy and Utilities.

Financial stocks are widely assumed to be doing well, based on the presumption that Dodd-Frank regulations that had supposedly been stifling lending with higher capital requirements would be rolled back. Perhaps. But one can make a cogent case that financial services stocks in general, and bank stocks in particular, have been trading at a steep discount to the market based on years of low interest rates.

As the Federal Reserve signaled its intent to continue raising short-term rates after years of zero rates and quantitative easing, it makes sense that investors would take a renewed interest in inexpensive bank stocks that are poised to reap more profit from higher rates and less compressed yield spreads. In addition, after a long period of companies’ delayed capital spending and consumers’ purchases of bigger ticket items, some new spending was almost inevitable. And that means more credit creation and, presumably, more borrowing and lending—also good for banks.

In short, financial stocks may have been due for a rally no matter who won in November. The fact that it was Trump who won does not, therefore, imply a Trump rally any more than a similar rally after a Clinton victory should have been dubbed a “Clinton rally.”

Industrials clearly received a postelection bid based on the assumption of a coming infrastructure push from Washington. But even without that push, there have been signs of increased spending, both in the U.S. and abroad. Base metals and industrials commodities have been surging after a dismal few years—supplies of everything from copper to iron ore have decreased in the face of plummeting prices and weak demand. As is usually the case, supply tends to expand too much in up cycles and contract too much during down ones. U.S. economic activity is steady, global surveys (such as global purchasing managers indices) point to rising infrastructure spending, and new projects are being authorized. Equity prices naturally would be expected to reflect these events, regardless of who had won in November.

Then there is the evergreen concern about valuations. Yes, the multiple on equities in general has been higher than the 100+ year average of about 15 times forward earnings. At around 17.5 times, in fact, the S&P 500 is trading at a higher multiple than it has in more than a decade. But does that matter? Although valuation is a sacred cow that many believe should not be questioned, in investing, as in life, everything should be examined and probed periodically.

The multiple is high, but crafting a portfolio entails a series of relative choices among stocks, bonds, cash, real estate, alternatives, and a plethora of other investment options. For example, a “riskfree” U.S. government 10-year Treasury Note now yields, at most, 2.5% if bought on a peak day. And it’s only “risk-free” insofar as the yield is safe; the price could be quite volatile, as we saw in November and December. But the earnings yield on the S&P 500 is closer to 4%, with a dividend yield of about 2%. And stocks can generate price appreciation, which adds to the total return.

Fundamentals can certainly support modest price appreciation. According to data from FactSet, the S&P 500—which (again) we use simply as a proxy for equities in general—has had two quarters of revenue growth, with almost 5% growth in the fourth quarter of 2016, and more expected for the first quarter of 2017. Of course, earnings growth has been steady, but many have been legitimately skeptical of future valuations without revenue growth. Now we are seeing it.

Finally, growth stocks have been outperforming value stocks, small-cap has been outpacing large-cap, and international has been doing somewhat better than domestic U.S. This all signals modest confidence in both a U.S. and global economic expansion. Even with uncertainties surrounding America’s free trade and regulation, much of the world has seen increased trade and a pickup in economic activity after a rocky couple of years. The U.S. is important, but certainly not the only actor. China has slowed, but has failed to collapse; Europe has (so far) failed to implode; and Latin America is seeing a surge in competent governance and its middle class. That all spells a calmer picture than the popular image of a world in chaos – which it is, of course, in certain places, but those are the exception rather than the rule.

So what now?

Ascribing market strength to the election runs the risk of incorrectly identifying what is driving capital. We will never know what would have happened with a different outcome in the U.S. election—we don’t get to replay the historical tape to determine if another variable would have mattered more. But just as Brexit in Britain has not led to quite the dire effects feared (though to be fair, Brexit itself has yet to happen), the election may be less a factor in the markets than many think.

The Fed had begun a modest tightening cycle well before November, and equities have been chugging along nicely since the rather sharp and substantial pull-back at the beginning of 2016.

Although such pull-backs are always possible, and indeed likely from time to time, they don’t mean that the market is on fundamentally shaky ground. As long as the preponderance of economic indicators and company fundamentals remains positive (which they are), and as long as inflation remains tame (which it is), and as long as global and domestic crises remain more feared than actual, then equity markets can continue their modest run.

Karabell is head of Global Strategies at Envestnet, a leading provider of wealth management technology and services to investment advisors.

Doug Casey on How Fascism Comes to America

By Doug Casey

I think there are really only two good reasons for having a significant amount of money: To maintain a high standard of living and to ensure your personal freedom. There are other, lesser reasons, of course, including: to prove you can do it, to compensate for failings in other things, to impress others, to leave a legacy, to help perpetuate your genes, or maybe because you just can't think of something better to do with your time.

But I'll put aside those lesser motives, which I tend to view as psychological foibles. Basically, money gives you the freedom to do what you'd like – and when, how, and with whom you prefer to do it. Money allows you to have things and do things and can even assist you to be something you want to be. Unfortunately, money is a chimera in today's world and will wind up savaging billions in the years to come.

As you know, I believe we're well into what I call The Greater Depression. A lot of people believe we're in a recovery now; I think, from a long-term point of view, that is total nonsense. We're just in the eye of the hurricane and will soon be moving into the other side of the storm. But it will be far more severe than what we saw in 2008 and 2009 and will last quite a while – perhaps for many years, depending on how stupidly the government acts.

Real Reasons for Optimism

There are reasons for optimism, of course, and at least two of them make sense.

The first is that every individual wants to improve his economic status. Many (but by no means all) of them will intuit that the surest way to do so is to produce more than they consume and save the difference. That creates capital, which can be invested in or loaned to productive enterprises. But what if outside forces make that impossible, or at least much harder than it should be?

The second reason for optimism is the development of technology – which is the ability to manipulate the material world to suit our desires. Scientists and engineers develop technology, and that also adds to the supply of capital. The more complex technology becomes, the more outside capital is required. But what if sufficient capital isn't generated by individuals and businesses to fund further technological advances?

There are no guarantees in life. Throughout the first several hundred thousand years of human existence, very little capital was accumulated – perhaps a few skins or arrowheads passed on to the next generation. And there was very little improvement in technology – it was many millennia between the taming of fire and, say, the invention of the bow. Things very gradually accelerated and improved, in a start-stop-start kind of way – the classical world, followed by the Dark Ages, followed by the medieval world. Finally, as we entered the industrial world 200 years ago, it looked like we were on an accelerating path to the stars. All of a sudden, life was no longer necessarily so solitary, poor, nasty, brutish, or short. I'm reasonably confident things will continue improving, possibly at an accelerating rate. But only if individuals create more capital than they consume and if enough of that capital is directed towards productive technology.

Real Reasons for Pessimism

Those are the two mainsprings of human progress: capital accumulation and technology.

Unfortunately, however, that reality has become obscured by a morass of false and destructive theories, abetted by a world that's become so complex that it's too difficult for most people to sort out cause and effect. Furthermore, most people in the OECD world have become so accustomed to good times, since the end of WW2, that they think prosperity is automatic and a permanent feature of the cosmic firmament. So although I'm very optimistic, progress – certainly over the near term – isn't guaranteed.

These are the main reasons why the standard of living has been artificially high in the advanced world, but don't confuse them with the two reasons for long-term prosperity.

The first is debt. There's nothing wrong with debt in itself; lending is one way for the owner of capital to deploy it. But if a society is going to advance, debt should be largely for productive purposes, so that it's self-liquidating; and most of it would necessarily be short term.

But most of the scores of trillions of debt in the world today are for consumption, not production. And the debt is not only not self-liquidating, it's compounding. And most of it is long term, with no relation to any specific asset. A lender can reasonably predict the value of a short-term loan, but debt payable in 30 years is impossible to value realistically. All government debt, mortgage debt, consumer debt, and almost all student loan debt does nothing but allow borrowers to live off the capital others have accumulated. It turns the debtors into indentured servants for the indefinite future.

The entire world has basically overlooked this, along with most other tenets of sound economics.

The second is inflation. Like debt, inflation induces people to live above their means, but its consequences are even worse, because they're indirect and delayed. If the central bank deposited $10,000 in everyone's bank account next Monday, everyone would think they were wealthier and start consuming more. This would start a business cycle. The business cycle is always the result of currency inflation, no matter how subtle or mild. And it always results in a depression. The longer an inflation goes on, the more ingrained the distortions and misallocations of capital become, and the worse the resulting depression. We've had a number of inflationary cycles since the end of the last depression in 1948. I believe we're now at the end of what might be called a super-cycle, resulting in a super-depression.

The third is the export of dollars. This is unique to the U.S. and is the reason the depression in the U.S. will in some ways be worse than most other places. Since the early '70s, the dollar has been used the way gold once was – it's the world's currency. The problem is that the U.S. has exported perhaps $10 trillion – but nobody knows – in exchange for good things from around the world. It was a great trade for a while. The foreigners get paper created at essentially zero cost, while Americans live high on the hog with the goodies those dollars buy.

But at some point quite soon, dollars won't be readily accepted, and smart foreigners will start dumping their dollars, passing the Old Maid card. Ultimately, most of the dollars will come back to the U.S., to be traded for titles to land and businesses. Americans will find that they traded their birthright for a storage unit full of TVs and assorted tchotchkes. But many foreigners will also be stuck with dollars and suffer a huge loss. It's actually a game with no winner.

What's Next

These last three factors have enabled essentially the whole world to live above its means for decades. The process has been actively facilitated by governments everywhere. People like living above their means, and governments prefer to see the masses sated.

The debt and inflation have also financed the growth of the welfare state, making a large percentage of the masses dependent, even while they've also resulted in an immense expansion in the size and power of the state over the last 60-odd years. The masses have come to think government is a magical entity that can do almost anything, including kiss the economy and make it better when the going gets tough. The type of people who are drawn to the government are eager to make the state a panacea. So they'll redouble their efforts in the fiscal and monetary areas I've described above, albeit with increasingly disastrous results.

They'll also become quite aggressive with regulations (on what you can do and say, and where your money can go) and taxes (much higher existing taxes and lots of new ones, like a national VAT and a wealth tax). And since nobody wants to take the blame for problems, they'll blame things on foreigners. Fortunately (the U.S. will think) they have a huge military and will employ it promiscuously. So the already bankrupt nations of NATO will dig the hole deeper with some serious – but distracting – new wars.

It's most unfortunate, but the U.S. and its allies will turn into authoritarian police states. Even more than they are today. Much more, actually. They'll all be perfectly fascist – private ownership of both consumer goods and the means of production topped by state control of both. Fascism operates free of underlying principles or philosophy; it's totally the whim of the people in control, and they'll prove ever more ruthless.

So where does that leave us, as far as accumulating more wealth than the average guy is concerned?

I'd say it puts us in a rather troubling position. The general standard of living is going to collapse, as will your personal freedom. And if you're an upper-middle-class person (I suspect that includes most who are now reading this), you will be considered among the rich who are somehow (this is actually a complex subject worthy of discussion) responsible for the bad times and therefore liable to be eaten.

The bottom line is that if you value your money and your freedom, you'll take action.

There's much, much more to be said on all this. I've said a lot on the topic over the past few years, at some length. But I thought it best to be brief here, for the purpose of emphasis.

Essentially, act now, because the world's combined economic, financial, political, social, and military situation is as good as it will be for many years… and a lot better than it has any right to be.

What to Do?

No new advice here, at least as far as veteran readers are concerned. But my suspicion is that very few of you have acted, even if you understand why you should act. Peer pressure (I'm confident that you have few, if any, friends, relatives, or associates who think along these lines) and inertia are powerful forces.

That said, you should do the following:

1. Maintain significant bank and brokerage accounts outside your home country. Consider setting up an offshore asset protection trust. These things aren't as easy to do as they used to be. But they'll likely be much less easy in the future.

2. Make sure you have a significant portion of your wealth in precious metals and a significant part of that offshore.

3. Buy some nice foreign real estate, ideally in a place where you wouldn't mind spending some time.

4. Work on getting official residency in another country, as well as a second citizenship/passport. There's every advantage to doing so, and no disadvantages. That's true of all these things.

One more thing: Don't worry too much. All countries seem to go through nasty phases. Within the lifetime of most people today, we've seen it in big countries such as Russia, Germany, and China.

And in scores of smaller ones – the list is too long to recount here. The good news is that things almost always get better, eventually.

The Kuril Islands and Russia’s Pacific Interests

By Laurenz Gehrke and Allison Fedirka

Russia is weakening while Japan is rising.

Russian and Japanese officials are preparing for March 14 talks in Tokyo to discuss the economic development of the Kuril Islands. Territorial claims over the archipelago have been a subject of dispute between Russia and Japan since the 19th century. The islands have remained under Russia’s control since 1945, when the Soviet Union took them from Japan. In the lead-up to this month’s meeting, Russia again asserted its authority over the islands. On Feb. 22,

Russia’s defense minister said Moscow plans to deploy an army division this year to the islands.

However, the islands’ ownership should not be thought of in the context of a simple territorial claim, but rather as one component of Russia’s greater geopolitical interests in the Pacific.

Today, the Russian Federation is primarily portrayed in the media and international affairs as a European power. This is not entirely wrong given Moscow, the country’s geopolitical epicenter, is only a couple hundred miles from European borders. However, the double-headed eagle on its coat of arms reminds us that Moscow must constantly look both west and east to protect its national interests. Russian territory is expansive, and Moscow cannot neglect its eastern borders despite the challenges posed by vast distances and inhospitable terrain.

Russia’s strategic interests in the Far East include oil deposits, access to Asian markets and proximity to the United States and its naval forces. Russia historically has maintained an interest in accessing more southerly, warm-water ports in the peninsulas and points of power projection to protect its border.

Russian President Vladimir Putin, right, chats with Japanese Prime Minister Shinzo Abe, left, during a visit to the Kodokan judo hall in Tokyo, on Dec. 16, 2016.

Currently Russia’s southernmost point to project power in East Asia is Vladivostok, home to its Pacific fleet. From there it can access the Sea of Japan. To reach the rest of Asia, Russia must go around Japan or face a potential choke point by passing through the waters bordered by Japan and South Korea. Free access to maritime routes through the East and South China seas is limited. Under the backdrop of the Cold War, in 1979, the Soviet Union and Vietnam signed a 25-year contract for the former to have a military base in Cam Ranh, Vietnam. This base gave Russia a southern point in the seas to help project power north. The contract expired in 2004, but in 2014, Russia resumed aircraft operations out of Cam Ranh and has been rumored to be exploring building on this access with Vietnam officials.

In recent years, Russia has put resources toward building up its Pacific fleet, and with good reason. Russia has sought to create a buffer zone along its southern Pacific border, particularly in the present-day Primorsky and Khabarovsk regions, whose land borders are shared with China and North Korea.

The greater Manchuria region (including outer and inner) and particularly the Liaodong and Korean peninsulas have historically been a flashpoint in East Asia. This flashpoint is marked by the convergence of competing interests from China, Russia and Japan. These competing desires to form and control a buffer region that would help marginalize rival powers have sparked multiple military conflicts in the region over the last 130 years, with control changing hands multiple times. The Korean Peninsula sits between China and Japan and served as a buffer between the two countries. As a result, both Tokyo and Beijing have sought to maintain influence on the peninsula as a means of protecting their national interests. The First Sino-Japanese War (1894-95) was fought over this issue and saw Japanese forces overpower Chinese forces on the Korean Peninsula and in Manchuria.

The result of the Sino-Japanese War ultimately led to the ensuing Russo-Japanese War (1904-05). Immediately after the First Sino-Japanese War, Japan received control over the Liaodong Peninsula by treaty. This did not sit well with the Russians. Japanese control of the area could rival Russian power in its domestic territory and pose a risk to railway construction that would connect the east with Moscow and warm-water ports. Instead of being across the sea, Japan was on Russia’s doorstep in a land-based stronghold from which to project power on mainland East Asia.

Russia successfully garnered support from France and Germany to pressure Japan into giving Russia control over a large part of Manchuria, which included the Liaodong Peninsula. Once again, in 1904, Japan engaged in war, this time with Russia over influence and control over greater Manchuria. Japan obliterated Russia’s navy and decisively defeated Russia, which was a surprise for Moscow. Russia’s fears of a powerful eastern neighbor in Japan were confirmed.

In the following years, Russia’s preoccupation with the Bolshevik Revolution and World War I opened space for Japan to invade Manchuria in 1931 and engage China in a second war. This conflict eventually merged into World War II. After Germany’s surrender in 1945, Soviet forces were free to engage on the Pacific front. The Soviet Union ousted Japan from parts of Mongolia and North Korea.

For much of the remainder of the 20th century, Russia remained the dominant power in this region.

However, the fall of the Soviet Union in 1991 resulted in a restructuring of the world’s geopolitical system in which the U.S. emerged as a global hegemon. China has returned to its historical status as a strong regional power, particularly in economic terms. That said, its export-oriented model is no longer sustainable and has laid the groundwork for domestic conflict in the country. China also has ambitious plans to develop a stronger military, but nothing that could compete with the United States.

This, however, does not stop Beijing from pushing its territorial envelope as far as it can.

The U.S. maintains its post-World War II role of protecting free passage among Pacific trade routes as world commerce in the Pacific continues to grow. Japan has recovered from World War II and has started laying the groundwork for building its own military and defense force. This budding ability to protect its national security, provide high levels of wealth with relatively small gaps and use technology to overcome its demographics problem will enable Japan to emerge as the premier regional power in Asia in approximately the next two decades.

What emerges from all of this is an image of Russia as both eager and weak. Russia cannot afford to ignore these developments especially given its history with Japan. It needs to protect its Pacific interests by building its fleet and developing its Far East economy. However, Russia is in the midst of a political and economic crisis. The future of Ukraine, whose existence as a buffer state is essential to Russia’s survival, is in flux. Severe economic problems have started breeding civil unrest in various regions. So while not heralding a return to former glory, Russia’s engagement in the Pacific is an attempt to follow its geopolitical imperative in the region within the confines of more pressing geopolitical constraints.