This piece, musing about the financial implications of a confrontation in the Ukraine, I started two weeks ago. Since then I have had to rewrite it on a daily basis, as I have misjudged events gravely.
As at today, it seems almost irrelevant how much we retail investors are going to suffer financially when we witness a country going under, shredded by the violence of war. Rockets and tanks are destroying cities and livelihoods. Putin is waging a war fit for the cruelties of 1956 and 1968, which crushed Czechoslovakia’s and Hungary’s hopes for communism with a friendly face.
I had a lot of understanding for the ignominies of the post-Cold War humiliations of Russia, which suffered a systemic collapse, ill-drafted privatisations, robber capitalism and the crushing advance of the anti-Russian military alliance of NATO. Yet I have always thought that Putin and his cronies are driven by financial calculus, rather than ideological grandstanding. Irrationality had no place in my own thinking.
After having watched Putin’s TV-staged session of the Security Council of Russia, where he angrily made public his intentions to crush the Ukraine, I understood that we saw a dictator, paranoid and revengeful like Stalin. He did not countenance counselling, independent thinking or dissent. The poor three blokes hesitating to agree were reprimanded like schoolboys and may end up in a GULAG any time soon. Putin today is impervious to diplomacy, compromise and rational assessment. He is visibly anchorless and has lost his marbles.
As a direct military involvement in the Ukraine is off the table, we threaten embargoes. “We are going to stop them trading in pounds and dollars,” UK Prime Minister Boris Johnson promised, following US President Joe Biden’s threat to impose a “heavy price” on Russia.
Well, we have levied painful embargoes on Russia before, after their annexation of the Crimea. Yet through a combination of import substitution, sound monetary and fiscal policies, negligible foreign debt and resourceful embargo dodging, Russia has adapted well.
This is why even more painful embargo measures had to be imposed now. Russia’s central bank is embargoed, with its hard currency reserves frozen; the country is locked out of all dollar and euro debt markets; Russian financial institutions cannot use the international payment communication system SWIFT anymore.
Politicians, civil servants and the oligarchs are personae non grata, with their foreign assets frozen and visas revoked. Even Putin himself and his wealth is in the crosshairs now, which makes one wonder how little money laundering rules have achieved so far, considering his estimated fortune of a few hundred billion US dollars held by proxies and shell companies in the West.
I do not wish to diminish Putin’s act as a super villain. Yet I never quite understood the West’s involvement in the Ukraine over the last 30 years. We supported the Orange Revolution in 2004, hinted at EU membership and adoption by NATO, which we always knew to be insincere. We promised financial aid, but provided ordnance and military training instead. We tenaciously continued our Cold War strategies fighting the ghosts of the Soviet Union.
On the face of it, there was no difference between Russia and the Ukraine. Both countries were and are corrupt, exploited by self-enriching elites and have little regard for the rule of law. Both countries suffer the Soviet legacy of outdated industrial structures which passed for free into private hands.
We will see corporate upheaval, ruinous stagnation and rampant inflation- Andreas Weitzer
The only difference was that Russia was increasingly governed by the security forces, and the Ukraine ‒ particularly after the ousting of the Russian-friendly, kleptocratic president Victor Yanukovich in 2014 ‒ by demagogues who bet on the Ukrainian-speaking majority, denying Russian speakers their own language and their affiliation with Russia.
The often mentioned and now defunct Minsk II Agreement, which aimed to pacify the war-scarred Donbas region and to reintegrate them into Ukrainian territory, is a case in point. This ceasefire agreement, hammered out by France, Germany, the Ukraine and Russia in haste, was admittedly a vague document, open to interpretation. Yet Russia could rightly claim that the Ukraine, which soon started to regret what it had signed away, had no intention to ever permit its Russian-speaking provinces autonomy or equal treatment.
How this ever more dangerous standoff between Russia and the West over Ukraine will play out we do not know. We are witnesses of a merciless conquest, which we will try to match with yet more US weapons, military consultants, intelligence and aerial surveillance for the nationalists, which have a legitimate right to stand up to aggression. Russia’s nuclear drill in February is a symbol for the risks of dealing with Mad Dog Putin.
With Russia whacked to pariah-status akin to Iran and North Korea, we have to expect Russian counter-measures, which will range from a stop of Russian natural gas supplies to Europe and far-reaching import bans to the expropriation of Western industrial assets in the RF. Think of BP’s 20 per cent ownership of Rosneft, western retail banking of Raiffeisen or UniCredit in Russia, or Renault’s manufacturing sites in the Russian Federation.
The crux for us retail investors are not only the primary effects of each measure, which are damaging enough, but the hard-to-gauge secondary effects, which we tend to ignore.
I have never owned Russian shares, with the short-term exception of Gazprom, which I held for a while when its stock was ridiculously cheap and I still misjudged how Gazprom was anything but a commercial enterprise. I always believed that retail shareholders in Russia, like in China, were not investors but gamblers, riding a rigged market. Russian corporations, aided by crisis exchange rates, could again become luring investments now, with P/Es in the lower single digits. But embargo acts will make sure that we’ll have to give it a pass.
I have always invested in RF corporate bonds, as Russian issuers were paying slightly higher coupons despite their moderate leverage and low credit risk. With hindsight I am lucky to have given Russian sovereign debt a pass. But even corporate bonds, from Lukoil to Norilsk Nickel, are now valued as if they had defaulted already. This will be tough for pension funds and insurers which in their search for yield had shared my thinking.
It is the secondary effects though, which will be unexpected and painful. Manufacturers in Europe, and in consequence globally, will suffer a crushing supply shock. Commodity prices, from fertilisers to metals, from fuels to chemicals will skyrocket. Inflation, already let lose by the distortions of the pandemic, will resemble the deficit situation of a war economy, with prices becoming totally unhinged. The trust in our financial architecture will be shattered.
Disturbing in all this is the asymmetry of our embargoes. While “fortress” Russia, the world’s biggest repository of raw materials, will export all it has to offer to China, shrinking to the size of a junior partner, we will see corporate upheaval, ruinous stagnation and rampant inflation.
The Russian public, admittedly, will not be pleased to see their vacations to Europe curtailed, their shelves emptied, their savings worthless and their economy crippled. And they will be saddened to see themselves at war with a nation so close to their heart. But then, Putin and his cronies had never much empathy for their own people, and they know how to control them by force. A fortress, we may recall, can easily double as a prison.
The purpose of this column is to broaden readers’ general financial knowledge and it should not be interpreted as presenting investment advice, or advice on the buying and selling of financial products.
andreas.weitzer@timesofmalta.com