Hawks versus Doves on How to Beat Russia

Blain’s Morning Porridge March 9 2022 – Hawks versus Doves on How to Beat Russia

“Hiroshima, Nagasaki, Russian Roulette.”

This morning: We all want peace in Ukraine, but it’s critical that Russia is seen to lose, and lose badly – not only China, but India and the Gulf are watching. There are pros and cons to winning an economic war, and moral issues also, but the West can win – if it has the determination to do so.

But first… Who said Canada is boring? Some excellent advice from BC Alpha got the attention of the media earlier this week: “The risk of Armageddon has risen dramatically. Stay bullish on stocks over a 12-month time horizon…. If an ICBM is heading your way, the size and composition of your portfolio becomes irrelevant. From a purely financial perspective, you should ignore existential risk, even if you do care greatly from a purely personal perspective.”

Wise words indeed… and I guess it’s the answer to that age old question: Canadian.. (rather than dead). I love Canadians… like Americans but nicer, friendlier and almost European…

Back in the Real World:

The US has banned Russian oil and gas which it doesn’t need, while Europe – which very much needs both – announced plans to phase it out (Oil and Gas is 54% of Russia’s GDP) from its economy at enormous economic cost. These costs offer a neat illustration of how battle lines are being drawn in the West; between the Doves who favour an early negotiated peace in Ukraine, and the Hawks who advocate an all-out economic war to bring Russia to its knees.

As is the usually the case, the optimal course probably lies somewhere in the middle.

There is a bet to be made – fears of a massive energy price shock destabilising the West may be overblown, increased oil supplies will quickly replace Russia, OPEC will realise the politically astute trade is not to be seen actively supporting Russia while trying to balance China.. Would you take that bet? You might get an ear full of cider.. but.. its worth thinking about. What is clear, inflation, new geopolitical blocks, supply chains and the end of globalisation make for a very different market.

Much to my own surprise, Europe continues to impress. The European Union not only accepts its need to cut its reliance on Russian energy, but is going to issue bonds by the shedload to finance defence and energy reform to counter the effects. The cash will be spread across the Union to counter the effects of its previous energy-security miscalculations. It’s another step on the yellow-brick road to European financial mutualisation – which once I railed at, but would now welcome as a sign a new European power is emerging. (That will probably scare the b’Jesus out of Nigel Farage!)

If Europe has decided to futher mutualise debt 4 weeks ago I would be writing about “yet another nail in the EU’s coffin”, that Germany would never accept it, how the richer nations would decline to pay feckless southern nations’ pension costs, and surmise Europe was doomed to bicker as a collection of separate tribes each with their own personal agendas.

Well… Europe is coming together stronger. Will the new-found camaraderie last? It depends on how much pain there is to come.

The consequences of the Ukraine invasion are starting to bite and multiply – not just in agri-produce, commodity and energy spikes, but real economic damage is beginning to emerge across banking, insurance, aviation, autos, freight and a host of other sectors as the entire panoply of Western business close up shop across The Rodina. The knock-on micro damage to businesses and industry from the rising macro physical and political risks are going to be huge and consequential – with real effects on markets… but work-arounds will be found.

We knew the costs would be high when we gritted our teeth in anger at the Russian invasion. 2 angry weeks into what was supposed to be a Soviet Victory Parade our illusions about Spanking Putin are starting the fade. This is nasty. This is bloody. There is no glory. For the people of Ukraine there is mud, blood and death. President Zelensky tells us his people will bear the pain – they deserve our support.

Can the West bear the costs of a new Cold War?

Yes.

What the EU is doing in terms of monetary and fiscal policy to support the economy has risks and consequences – but the ECB has the experience gained over the last 10-years of monetary experimentation to manage the process. Other Western Central banks will equally be on the Front Line in this economic war.

But monetary support will only achieve so much. We still need to be prepared to accept the costs of a severe attritional economic war with Russia. Europe is doing its best to embrace that – phasing out the bulk of Russian energy this year. The West won the last cold war, and we can win this one – if we have the will to do so – but the world has changed and the costs will be high. At the end… there will be a dividend; Europe can emerge much stronger, and more united.

To be frank; Europe and Russia are both in demographic decline and aging, thus the Ukraine conflict is something of a regional distraction from the Global perspective. But, whoever wins could emerge reinvigorated.

That is why it’s critical the West is clearly seen to win. China will be watching Western resolve carefully – which will likely trigger another consequence; a new cold-war tech race with China as the Middle Kingdom learns the lessons of Russia’s failure.

I’ve heard the current impasse described in game theory terms – there are outcomes where both parties are winners, and others where we all lose out… in a flash.

I guess I am a Hawk. I advocate an economic Sanctions Blitzkrieg against Russia. The aim should be to inflict so much economic damage it will force Russia to change, and perhaps trigger regime change in Russia. But, critically, it will achieve nothing immediately. It means Ukraine’s struggle and suffering continues.

The Hawks hope (and remember, Hope is never a Strategy) Russia will dispense with Putin when it’s seen he’s failed. Political hawks think this could be a 12 month process – maybe longer. No one realistically places much faith in a Kremlin coup – if the Red Army can’t conquer Ukraine, why would we think their Generals could construct a transfer of power scenario in Moscow?

The Dove alternative is a peace where Ukraine cedes the disputed territories in the East and Crimea to Putin, and agrees a constitutional assurance it won’t join NATO or the EU. It’s likely he will insist on regime change. In return Russia will cease the attack.

The danger is any capitulation makes Putin look a winner – he can hide the Russian’s dismal performance and losses. It will leave him free to continue testing the West. As secondary issue is Russia might agree a ceasefire, and not retreat but hold on to the Black Sea coast – 70% of Ukraine’s agri-exports are shipped from Oddessa, which is now under threat. That would be a play for time..

Time is the third factor at play. The West has limited time. At the moment Russia is dissuaded from further action expanding the war by the NATO tripewire. But if the US backs out – which is distinctly possible under a Trump 2.1 administration from 2025 (and Biden will likely be neutered by the mid-terms in November), then Russia may feel more impowered to rip up agreements made under financial duress.

Of course, we don’t really know what Putin is thinking. He may have calculated time is not on his side – that he had to play his energy security hand now before Germany woke up to Merkel’s chronic energy mismanagement (Russian Gas and shutting down Nuclear – almost treachery I hear you say…)

He knows it will take 2-3 years before Europe can effectively even begin to field new forces from its rearmament process. The Bundeswehr will be effectively starting from scratch needing everything from boots to hair clippers before they even think about new tanks, planes and ships..

Of course – defence spending will be a massive boost for all the major European economies: France, Spain, Italy and Germany.. Western defence spending creates profit and growth. Spending on tanks in Russia bankrupts the country! It happened in 1989 and it will happen again.

Putin will also be betting Western electorates will turn to populism as energy prices soar, inflation hits their wallets, and a mini-recession or stagflation follows.

Somewhere in the middle of all that is an optimal course for the West to steer. It’s in everyone’s interest to end the War in Ukraine as soon as possible – maybe putting the pro-Russian regions on the table.. Maybe we should all politely not mention Nato Membership.

But then, the Sanctions should continue, the West should rearm and we push Russia towards reform. And make it clear that ultimately Russia will be much better off as part of Europe rather a protectorate of an expanding China.

No porridge next couple of days – flying and lots of meetings..

 Five Things to Spice Up Your Morning:

BBerg – Europe is on a war-time mission to end its addiction to Russian Energy

BBerg – China stocks tumble on Norway Fund Snub and Inflation

FT – Russia’s techies flee country the fear is flying into abyss

WSJ – Russian oil embargo forces OPEC to take sides

Thunderer – Worst crisis in decades for metal traders

Out of time, and back to the day job

Bill Blain,

Strategist – Shard Capital