by Ivan Martchev
February 23, 2022
Neither Treasuries, nor oil, nor the Russian stock market believed the Sunday evening headline – that a summit between President Joe Biden and President Vladimir Putin had been agreed in principle, brokered by French President Emanuel Macron. As more negative headlines rolled in Monday morning, the Russian stock market fell 10.5% in a single session, while oil and Treasuries kept rallying.
On Monday, Bloomberg TV ran a headline that Vladimir Putin will sign a decree recognizing the “independence” of Donetsk and Luhansk, two territories in Eastern Ukraine, which would clearly escalate the present tensions, even though it is not yet an invasion, with boots on the ground.
My gut feeling is that some kind of retest of the January lows for U.S. stocks is coming, which should hold if the Ukrainian situation does not turn into cutting the Russian banks off SWIFT, and the Russians shutting off the natural gas pipelines because they are not being paid. The Russians can cause a recession in the EU with a super-spike in natural gas prices, which are already significantly higher than U.S. prices due to the botched de-carbonization policies in Europe. I am all for de-carbonization, but the fact that there wasn’t enough wind for electricity wind farms last year cannot be the reason why European natural gas got to a $250/bbl. crude oil equivalent price last fall. Unfortunately, this is precisely what happened.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
European natural gas is now trading 50% below its highs from last fall and has very different price dynamics than U.S. natural gas. America has as much known natural gas reserves as Saudi Arabia has oil, but it is much more costly to liquify and ship (involving terminals, specialized tankers, and then de-liquefaction so that it can travel over existing pipelines when it reaches its destination).
The Russians now have the advantage, and I think they will use it.
Vladimir Putin does not believe in written agreements. From his perspective, the only way he will assure the long-term security of the Russian Federation and prevent further tightening of the noose around it (via NATO, the EU, and other alliances) is to neutralize Ukraine. Later on, he may build a Eurasian Economic Community (EEU), possibly extending to regional military alliances and closer alignment with China.
In other words, I think he will be going into Ukraine. He is taking advantage of the fact that nearly half of Ukraine – predominantly in the south and east – does not speak the Ukrainian language but only Russian and they do not consider themselves to be ethnically Ukrainian but Russian. I am only saying this to weigh the investment implications for stocks, bonds, and currencies. I don’t know how far the West is willing to go to stop any invasion, but my guess is that Europe is not willing to go into a recession with all its complications, just as the Omicron wave is fading and the global economy is getting better.
The History of Russian Buffer Zone Strategies
To understand Putin’s mindset better, take a look at Russian history. After the Molotov-Ribbentrop pact green-lighted Hitler’s 1939 invasion of Poland, Hitler then attacked Russia in 1941, but as a victor in 1945, the Soviet Union ended up getting most of what that original treaty outlined. They got 10% of Finnish territory, roughly 25% of Poland (most of the territory outlined in the 1939 pact) and folded it into Belarus and Ukraine. They ended up folding Latvia, Lithuania, and Estonia into the Soviet Union.
According to encyclopedia Britannica:
“To this public pact of nonaggression was appended a secret protocol, also reached on August 23, 1939, which divided the whole of eastern Europe into German and Soviet spheres of influence. Poland east of the line formed by the Narew, Vistula, and San rivers would fall under the Soviet sphere of influence. The protocol also assigned Lithuania, Latvia, Estonia, and Finland to the Soviet sphere of influence and, further, broached the subject of the separation of Bessarabia from Romania. A secret supplementary protocol (signed September 28, 1939) clarified the Lithuanian borders. The Polish-German border was also determined, and Bessarabia was assigned to the Soviet sphere of influence. In a third secret protocol (signed January 10, 1941, by Count Friedrich Werner von Schulenberg and Molotov), Germany renounced its claims to portions of Lithuania in return for Soviet payment of a sum agreed upon by the two countries.”
For the Russian Federation, Ukraine remains unfinished business, and my guess is that Russia has been plotting how to bring Ukraine back into the fold ever since the Soviet Union fell apart in 1991.
A successful Ukrainian campaign, from the Russian perspective, dramatically increases the odds that China will move on Taiwan before President Biden is out of office, as the world cannot operate without Taiwanese semiconductor foundries, and the Chinese will be in a position of power with the chip supply, similar to the way Vladimir Putin holds the key to the European natural gas markets. If China wanted to use the smokescreen of the Ukrainian invasion, they may even choose to attack Taiwan later this year.
In other words, 2022 promises to be an eventful year, and the Fed may not have to do as much tightening if the dominoes fall in the afore-mentioned fashion. Two invasions in one year is a lot to deal with. Still, from China’s perspective, they aren’t invading anything. They are just taking back a renegade province.
Russia’s long game with Ukraine is similar to how China has been plotting to take back Taiwan since Chiang Kai-shek declared martial law there in May 1949. My guess is that a Ukrainian invasion is imminent, while a Chinese invasion and takeover of Taiwan is at most a year or two away.