Russian Roulette

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Would you buy a used country from this man?

In March, Russian President Vladimir Putin ordered Russian forces into Crimea and effectively annexed that strategic peninsula. Shortly thereafter, he found himself mired in a bloody civil war in neighboring Ukraine. By the end of June, he appeared powerful and confident. Despite western sanctions, the Russian economy was strong and the people were aglow with that special kind of Slavic nationalist fervor. Oil was $110 a barrel, the Ruble was trading at 33 to the dollar and interest rates were a stable 7%. Needless to say, things have changed substantially in the last two months. The price of oil has cratered, settling (at least for now) in the $57 range. The Russian currency has collapsed as the oligarchs have panicked, trading for more solid dollars, euros and yen at almost any price. As the Ruble fell to 70* to the dollar, the central bank panicked and doubled interest rates to 17%, in hopes of convincing Russians to keep their Rubles. As a tactic in a currency crisis, this has been tried before - it never works.

So now the future is dark for Russia, and there is much to be concerned about. There is some history here, but it's difficult see what it might tell us about today. In 1998, the Russian economy collapsed. But Russia was weak, Yeltsin had dismissed the cabinet in March and the IMF provided $22 Billion in support, and even so, by August his government was in default. But that was a safe, quiet, peaceful kind of economic crisis. Before that was the moment, in 1989, when the Soviet union found itself prostrate before the west, so desperate for hard currency that they had to agree not to crush the Solidarity union protests in Poland. A few weeks later, the Soviet Union no longer existed.

And that's the problem we're still dealing with. The one organizing principle of Vladimir Putin's Presidency is that moment when Gorbachev was willing to agree to any demands in exchange for money. It was the end of Soviet Marxism/Leninism, but more than that it was a purely Russian humiliation. A technological and military superpower laid low by the relentless logic of capitalist economics. Putin has worked tirelessly to restore some kind of national identity and Russian pride. And perhaps some of that is a worthwhile project. You want to build national pride. But an angry, pugilistic nationalism built on hatred of Muslims, hatred of Gays, and an overriding sense of victim-hood at the hands of Western Powers doesn't leave Putin with a lot of places to go.

So trying to predict the future is hard. But the worst case scenario has the Russian economy continuing to implode under collapsing oil prices, Western sanctions, a worthless currency and bonds that demand a risk premium, leading to another sovereign default. History teaches us that a timely war can be effective in distracting a cold, hungry and frightened populace. If the Russian economic collapse continues - and with the terrible economic conditions in the EU and no indication that the price of oil will recover any time soon, there's no reason to think it won't - there may come a time when Putin decides that for domestic and economic reasons a war would be just what the doctor ordered. And he's got a number of places to turn - Ukraine, certainly, with the causus belli already established and the killing ongoing, but also Georgia and Azerbaijan. And making matters worse, Putin has already established and confirmed the West's profound unwillingness to actually respond to Russian provocations with military force, giving him much more of a free hand to take the actions necessary to get the shooting started.

So. Where does it all go? Well, any confrontation between Russia and the West can lead to the end of the world. Tens of thousands of nuclear weapons mean that nobody is willing to simply accept a loss in a conventional war. But it's much worse than that. The lesson we learned in Ukraine is that the US and Europe are unwilling to risk global annihilation over small chunks of Eastern Europe. Putin has a comfort zone, up to a point. The problem for the whole world is nobody knows where the threshold for Western military action is. If the Kremlin were to begin to see significant domestic unrest in the face of large scale economic problems, even as the Russian Central Bank was struggling with a massive decline in hard currency reserves, it would be easy to gin up an escalation in Ukraine. But how much of an escalation? Take Kiev? Moldova? Threaten Romania or Latvia? Romania, Hungary and Poland are NATO members and therefore the US and Europe would be theoretically obligated to defend them, but the likelihood that they would risk a disastrous European war or even a nuclear exchange over those Eastern European nations is small.

So, once again we have Russia as the heavily-armed, economically unstable rogue superpower with much more to lose than her peer competitors. And today we find them burning with a chest-thumping inferiority complex that will prevent them from coming back to the IMF for bridge loans. The one thing they have is military power, and an apparent willingness to use it for for the most banal domestic political purposes. The Ukrainian separatists and the Western Sanctions give them a cause and an enemy, and, like a high-stakes game of Tetris, all the pieces seem to be falling into place for a very bad outcome.

*With a Chinese currency swap deal, the Ruble has since risen to under 60 to the dollar. But there's nothing to change the longer term trends...
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