When ordering the Russian Army to take control of key points of Ukraine’s Crimean Peninsula on the first weekend of March, it is highly unlikely that Vladimir Putin had appropriately contemplated the full financial and economic implications of such a decision.
Unsurprisingly, on Monday March 3, the global financial markets (currency, bonds, and stocks) reacted as expected and took a toll on the Russian market. That day, Russia’s main stock index, the MICEX, plunged 11% (wiping off an estimated US $58 billion of its market cap), the Ruble and the bond and money markets also experienced strong deterioration, forcing the Russian Central Bank to increase short-term interest rates (from 5.5% to 7%) and spending with about US $12 billion of its reserves in an effort to stop the drastic drop of the Ruble and counterbalance capital flight (currently, the market’s penalization has dipped even further). The European bourses also felt the pinch, given their proximity to both Ukraine and Russia, albeit to a substantially lower degree, with Germany’s DAX tumbling 3.4% and France’s CAC 40 dropping 2.7%. In the US the reaction was rather muted, with no major index dropping over 1%.
As previously stated, it is very likely that Putin did not have any idea of the adverse financial reaction that his belligerent political decision would cause. Why so? Two reasons:
- First, Putin’s professional training was in the security and intelligence forces, serving as a Lieutenant Colonel in the KGB before joining politics in 1991. By the end of 1999 he became Russia’s PM. Since becoming the strong man of Russia, his actions have consistently denoted a mentality far apart from knowing the intricacies of the global society. Putin is anything, but an internationalist.
However painful it might be to him, Putin must realize that the ideological confrontation between communism (and essentially everything associated with it, like closed and rigid central planning with autocratic governments) and capitalism is over. Capitalism won. That outcome has been overwhelmingly clear since the late 80s.
- Second, Putin’s immediate damage control reaction on Tuesday March 4, notoriously softening his belligerent stance, de-escalating both the rhetoric, as well as the general movement of Russia’s troops in Crimea. Yes, it could have been a tactical, temporary retreat. But there is a high chance that Putin was caught off guard by the severe and immediate market penalization towards his hostility. If this was so, this factor by itself (plus future similar possibilities) might weigh heavily in his mind and make him seriously reconsider his whole strategy.
Regardless of future events in this affair, it seems that Vladimir Putin and his inner circle received an unexpected harsh and painful lesson from the global financial markets.
As previously mentioned, the immediate penalization to Russia’s economy by the severe setback of the financial markets on March 3 was in the tens of billions of USD. The devaluation of the Ruble was an immediate blow to Russian society’s purchasing power, particularly towards imported goods and services. Fortunately for Russia, the penalization damage can eventually dissipated. For this to happen though, the lesson has to be well learned. This means no further significant misbehavior from the Russian government elite in the coming weeks and months, as well as settling the Crimea-Ukraine-Russia dispute through diplomatic channels, with the mediation of the EU, the US, and possibly the UN’s International Court of Justice (ICJ) as well.
Russia, much like the world, has handsomely benefited from globalization. Namely, Russia has been an active actor in world trade (in both directions) and in the financial markets. Understandably, every business and financial transaction implies rights and obligations. To a very large degree, the whole world is ruled by financial markets. There is no single country that can subtract itself from that influence, more so when dealing with a country essentially open to the world, at least from the financial standpoint.
When the extinct USSR invaded Czechoslovakia in 1968, the Russian markets didn’t blink, because there were no open financial markets. The USSR was then a Communist country, an essentially closed society to the outside world. Russia in 2014 is very different from its predecessor in this regard.
No one can have it both ways. By opening up its financial markets (and to some degree its economy), Russia did agree to play according to the global rules of the game, which were already established. That inherent responsibility was perhaps not assumed with full awareness. Nonetheless, the cause/effect relationships in the financial markets are universal and permanent, with no exceptions allowed. The global financial system resembles a somewhat democratic society where the voice of a very powerful and representative segment of society is manifested not by vote, but by instant and unambiguous money flows.
Russia is a newcomer to the financial markets. The Moscow Exchange was established on December 19, 2011, by the merger of the Moscow Interbank Currency Exchange and the Russian Trading System. The Moscow Exchange operates all financial assets across the board: equities, bonds, derivatives, currencies, money markets, and precious metals; in addition, the Moscow Exchange also operates Russia’s Central Securities Depositary and the country’s largest clearing service provider.
To a great degree, the financial markets achieved (very quickly and effectively) what diplomatic and political pressure couldn’t; it remains to be seen if the financial pressure will be sufficient. At the very least, some of the potential losses and costs for Russia derived from its actions were rapidly visible to Putin. That’s why, in most likelihood, he was forced to step back and resort to damage control techniques right away.
Russia’s might is essentially military, as well as cultural —within its immediate geographic circle— not economic. Russia is a middle-of-the-table country (see table below), with a current per capita GDP of around US $18,100, almost half of the EU’s $34,500, with rampant corruption and extreme income disparities between the haves and the have nots, abundant ethnic conflicts, with decreasing personal income (after several years of growth), with an economy that’s barely growing, way below the levels of affluence of the first world. Russia is extremely dependent on the export of raw materials, basically oil, gas and related products; in this respect, Russia has a third-world-country-like economic structure.
By far, Russia’s reliance on the EU and the world is much greater than viceversa.
Energy exports accounts for roughly 70% of Russian exports.
On the other hand, Putin has dreams of grandeur for his nation, however far Russia is from achieving them. Putin has openly stated that the greatest geopolitical catastrophe of the XXth Century was the collapse of the USSR. It appears like Putin’s golden dream is to recover Russia’s power and lost might (in his eyes, probably stolen). Evidently, Putin has been having a lot of difficulty in understanding the rules of the game of the global society, especially among the first world countries.
It must be very difficult for Putin to renounce to his aspiration of Russia one day becoming a first world nation. Russia became an odd member of the now G8 group in 1998. Because of Russia’s development afterwards, the decision to include Russia into the G7 and make it a G8 is increasingly looking like a weird geopolitical miscalculation of whoever sponsored the enlargement initiative among the G7 nations. In no way does Russia resemble any of the other seven members of the group: Canada, France, Germany, Italy, Japan, the UK, and the US, all of them developed countries and full-fledged democracies—Russia is in an entirely different playing field. It is obvious that the high level of affinity, and relative integration among the former G7 is not shared with Russia, and viceversa.
On a related topic, beyond the bravado attitudes of China towards Japan in regard to the disputed sovereignty over the Diaoyu-Senkaku islands, China has recently shown a great dose of prudence and wisdom when dealing with Taiwan. The multi-mentioned Russian/Ukrainian experience should serve as a very useful confirmation of China’s intelligent recent approach towards Taiwan, in great contrast with the attitude of Putin towards Ukraine.
The history of the world is full of plundering and invasion wars among nations. That is a horrible truth, yet an undisputed shameful historical precedent of mankind. Most fortunately, this abominable traditional behavior among nations seems to have been eradicated from the developed nations’ mentality since the end of WWII.
All developed nations, without exception, seem to have learned that most painful lesson: military territorial annexation is a thing of the past. Besides the overwhelming moral considerations against it, in today’s globalized world true leadership implies other attributes, more related with know-how, science, technology, brands, intellectual capital, and the population’s well-being. Large territorial extensions are not that closely associated with world leadership among nations any longer. Ironically, Russia is the best example of this. Russia is the country with the largest landmass in the world, it also boasts a sizable population (10th in the world), yet, it is very far from being a wealthy and prosperous nation.
The close, permanent, and irreversible interconnectedness among all different nations in the planet is unquestionable. It is all around us, omnipresent, permanent, and essentially irreversible (read more on What is Globalization?). World leaders need to learn how to adjust and reap the most benefits from globalization, as a myriad corporations from different corners in the world have already successfully done. There is no other way.
Russia is a very rigid, antiquated economy, in urgent need of modernization and virtuous structural change. Thus, Russia essentially is in a fragile and precarious economic condition, lacking the financial resources to effectively confront the EU and the US. Nonetheless, despite of how powerful this truth is, is not sufficient by itself to guarantee the success of the good cause. In addition, it is indispensable that both the US and the EU stand together in as much unity as possible in confronting and containing Russia, if the need arises.
If stability and reasonable normality is not quickly achieved in Ukraine after Russia’s meddling, the EU and the US should exert strong pressure (economic, political, and diplomatic) on Russia to do things right. There is a lot at stake for the world at large. China must be paying extremely close attention to how things unfold.
It would be a terrible mistake not to punish Russia’s belligerence and unlawfulness, if and when the time comes. The present world order will be severely damaged if the need arises and the duo EU/EU do not rise to the occasion.
If Putin persists in his primitive territorial ambitions and is not stopped on its tracks, an ominous precedent will be established, with potentially devastating consequences for the whole world. The wellbeing of the new world order is a constant work in progress, with the permanent need of leadership from the great powers, particularly at crucial historical junctures. If required, the right precedent has to be established, with the EU and the US punishing Russia financially, politically, and diplomatically, for the rest of the world to see and learn from it.