Our continued addiction to fossil fuels is bolstering Vladimir Putin’s petrodictatorship and creating a situation where we in the West are — yes, say it with me now — funding both sides of the war. We fund our military aid to Ukraine with our tax dollars and some of America’s allies fund Putin’s military with purchases of his oil and gas exports.
~ Thomas L Friedman, NY Times, May 17, 2022
The Russian Federation has amassed a large army on the border of Ukraine and threatens to invade unless the US and NATO make concessions including the withdrawal of forces from Eastern Europe, securing Moscow a broad sphere of influence. There has been much hand-wringing in Western media: will Putin invade or is this just a ruse designed to extract concessions?
If we look past the uncertainty, it is clear that an increasingly over-confident Putin has entered a trap of his own making.
The West is faced with an ultimatum: either concede or Russian forces will invade Ukraine.
But every problem presents an opportunity.
The more aggressive Russia becomes, the stronger NATO gets.
Russian actions have united Western alliances, with even long-term neutrals Finland and Sweden, moving closer to NATO. Both Finnish and Swedish presidents reiterated their right to join NATO in response to the Russian ultimatum.
Germany has long obstructed a stiffening of NATO defenses, increasing its vulnerability to Russian energy blackmail by shuttering nuclear power plants and supporting the Nordstream 2 gas pipeline across the Baltic Sea. But opposition is growing. A recent poll shows that the percentage of Germans who trust Russia has fallen by 11% over the past two years:
Concessions are unlikely, simply because there is nothing to gain from them. Concessions by the US would weaken NATO and encourage the Kremlin to make even more outlandish demands in the future. Concessions by NATO without the US would produce a similar outcome.
Russian invasion of Ukraine would be a strategic mistake.
First, invasion would be a flagrant act of war, removing the cloak of deniability that has covered Russian operations in the Donbas region. A formal state of war would increase the flow of Western technology and weapons into Ukraine as Western leaders are required to openly acknowledge Russian aggression.
Land invasions are costly in terms of both blood and treasure. The Russian army may eventually overrun the Ukrainians through the weight of forces and technological advantages. But Ukrainian armed forces have been in a protracted war in the East and are well-trained and equipped with modern anti-tank weapons, artillery and unmanned drones. The costs would be high.
Turkey’s Bayraktar Unmanned Armed Combat Drone – Source: Ukrinform
Where the Ukrainians are at a disadvantage is in air defenses and vulnerability to long-range missile attacks. But that window is closing.
To stiffen Ukraine’s ability to resist, the United States and NATO have dispatched teams in recent weeks to survey air defenses, logistics, communications and other essentials. The United States likely has also bolstered Ukraine’s defenses against Russian cyberattacks and electronic warfare. (David Ignatius, Washington Post)
An air campaign would also achieve little without a follow-up land invasion.
Even if the Ukrainian forces are defeated, that is where the real problem starts. Occupation is a costly and morale-sapping exercise as the Soviets discovered in Afghanistan in the 1980s and the US discovered in Vietnam, Iraq and Afghanistan (they’re slow learners). An insurgency negates the occupiers’ advantages in air power and technology, leading to a drawn-out campaign with no outcome.
“You have the watches. We have the time.” ~ Taliban fighters in Afghanistan.
A Russian occupation force would require 20 combatants for every 1,000 Ukrainians, according to a formula devised by Rand Corp. analyst James Quinlivan in 1995. That would translate into an a required Russian force of almost 900,000, illustrating the impracticality.
We could expect a Russian occupation to be exceedingly brutal, along the lines of Syria, creating a humanitarian crisis and flooding the West with refugees. But that is only likely to harden resolve, marginalizing appeasers in the West, and increase support for the insurgents.
The cost of an extended Russian campaign would deplete the Russian Treasury, even without increased sanctions. It would also escalate opposition within Russia, spurred by the high cost in lives and deteriorating living conditions. The result would threaten collapse of the Russian state in much the same way as the campaign in Afghanistan led to the eventual disintegration of the Soviet Union.
The threat of armed invasion of Ukraine is a mistake. It is likely to strengthen resolve in the West and, if the threat is carried out, result in a long, protracted war in Ukraine. The cost in both blood and treasure would threaten to topple the Russian state.
Russian overconfidence has led them into a trap. Thinly spread across a number of conflict zones, they are vulnerable to an escalation in insurgencies wherever they have “peace-keeping” occupation forces: Syria, Belarus, Ukraine, Moldova, Georgia, and now Kazakhstan. The cost to the West would be low but would exact a huge toll on the Kremlin, depleting their military and already-vulnerable financial resources.
“Moderation in the pursuit of liberty is no virtue.”
~ Charlie Wilson’s War: The Extraordinary Story of How the Wildest Man in Congress and a Rogue CIA Agent Changed History
From Bob Doll at Nuveen:
“There have been several risk-off phases this decade, triggered by economic threats due to politically induced setbacks. However, the current sluggish global economy and weak trade, coupled with escalating trade tariffs and non-tariff barriers, is a worrisome combination. This is especially true because once protectionism has gained momentum, it may prove difficult to stop or reverse. While many risk asset prices are only off modestly from April highs, there’s an ominous undercurrent in global financial markets.
We have assumed that the pro-growth bias of both the U.S. and China would lead to a trade truce. That premise looks increasingly questionable, although a deal is always possible. Given that financial markets have not reacted more significantly, investors are still generally expecting the global economic expansion to persist.
Despite the longer-term power struggle, the constructive case for a trade deal between the U. S. and China was predicated on President Trump focusing on the short-term win, while the Chinese look to the longer-term. This difference in political time horizons made a deal possible. Now, the focus for both parties has shifted to long-term strategic objectives, resulting in a stalemate. A financial market downturn may be needed to break the impasse. An extended period of churning could develop if trade talks resume, but without signs of a resolution.
The current market weakness differs from prior periods of economic uncertainty during this decade. There has always been a path to a positive outcome for growth and risk assets, primarily via additional policy stimulus. However, the economic and market outcome this time has become more uncertain, and time will not work towards a positive outcome unless trade negotiations improve. Business sentiment will erode if mounting trade roadblocks and uncertainty do not diminish. Protectionism tops the list of recession catalysts, and a permanent deterioration in U.S./China trade relations could have adverse long-term revenue ramifications for global trade and growth.”
My thoughts:
” I am carrying so much cotton that I can’t sleep thinking about it. It is wearing me out. What can I do?”
“Sell down to the sleeping point,” answered the friend.~ Edwin Lefevre: Reminiscences of a Stock Operator (1923)
The media has been highly critical of Donald Trump’s threatened tariff war with China, suggesting that China has the stronger hand.
I disagree on two points:
The Bank for International Settlements says offshore dollar debt has ballooned to $US25 trillion in direct loans and equivalent derivatives. At least $US1.7 trillion is debt owed by Chinese companies, often circumventing credit curbs at home. Any serious stress in the world financial system quickly turns into a vast dollar “margin call”. Woe betide any debtor who had to roll over three-month funding.
Photo: Bloomberg
The financial “carry trade” would seize up across Asia, now the epicentre of global financial risk. Nomura said the region is a flashing map of red alerts under the bank’s predictive model of future financial blow-ups. East Asia is vulnerable to any external upset. The world biggest “credit gap” is in Hong Kong where the overshoot above trend is 45 per cent of GDP. It is an accident waiting to happen.
China is of course a command economy with a state-controlled banking system. It can bathe the economy with stimulus and order lenders to refinance bad debts. It has adequate foreign reserve cover to bail out its foreign currency debtors. But it is also dangerously stretched, with an “augmented fiscal deficit” above 12 per cent of GDP.
It is grappling with the aftermath of an immense credit bubble that has pushed its debt-to-GDP ratio from 130 per cent to 270 per cent in 11 years, and it has reached credit saturation. Each yuan of new debt creates barely 0.3 yuan of extra GDP. The model is exhausted.
China has little to gain and much to lose from irate and impulsive gestures. Its deep interests are better served by seeking out the high ground – hoping the world will quietly forgive two decades of technology piracy – and biding its time as Mr Trump destroys American credibility in Asia.
If we don’t learn from the mistakes of the past we will be destined to repeat them (George Santayana). Looking back over the last three decades gives an inkling as to what went wrong and to the level of economic mismanagement.
International trade is a zero sum game: what one country exports, another must import. Likewise, current accounts between nations are a zero-sum game: if one country runs a surplus, another will experience a deficit. Fortunately currency exchange rates act as an automatic stabilizer. If one country exports more than another, its currency will strengthen to the point that balance is restored in the level of trade between the two nations.
At least that is how it is supposed to work. Over the last three decades, Japan followed by China, has been rorting the system [translation: engage in a sharp practice (Australian/NZ)]. Accumulation of massive foreign reserves (e.g. by buying US Treasuries) prevented their currencies from appreciating and allowed them to maintain massive current account imbalances.
These beggar-thy-neighbor policies built up massive imbalances within the US economy.
Which led to the global financial crisis, the Great Recession, the sovereign debt crisis in Europe, the subsequent emerging markets crisis and extended slow recovery we are now experiencing.
The S&P 500 continues to test support at 2000. Failure would warn of another test of support at 1870, but respect is more likely and would indicate another test resistance at the high of 2130. Troughs above zero on 13-week Twiggs Money Flow indicate continued buying pressure. The overall trend remains bearish, however, having broken primary support at 2000. Respect of resistance at 2130 would warn of another test of support at 1870.
* Target calculation: 2000 + ( 2000 – 1870 ) = 2130
The CBOE Volatility Index (VIX) has declined to below 20. A peak below this level (20) would confirm that market risk is easing.
NYSE short sales remain subdued.
Dow Jones Industrial Average is similarly testing support at 17000, with 13-week Twiggs Money Flow holding above zero.
Canada’s TSX 60 is testing support at 800. Breach would warn of another decline, while follow-through below 775 would confirm. Weak 13-week Twiggs Momentum, below zero, indicates the market remains bearish.
* Target calculation: 775 – ( 825 – 775 ) = 725
Germany’s DAX respected support at 10000 and 13-week Twiggs Money Flow recovered above zero. Recovery above 10500 is likely and would indicate a bear rally to 11000.
The Footsie continues to test support at 6250. Respect is more likely and recovery above the descending trendline and resistance at 6500 would suggest another test of 7000. 13-Week Twiggs Money Flow holding above zero indicates long-term buying pressure. Reversal below 6000 is unlikely, but would confirm the primary down-trend.
The Shanghai Composite Index respected resistance at 3500 and is likely to re-test government-backed support at 3000.
Hong Kong’s Hang Seng Index is expected to retrace to test support at 22500 after a similar bear rally. Rising 13-week Twiggs Money Flow indicates medium-term buying pressure. Respect of 22500 would indicate another test of 24000, but breach of support is as likely and would warn of another test of primary support at 21000.
Japan’s Nikkei 225 also signals medium-term buying pressure on 13-week Twiggs Money Flow. Breakout above resistance at 18500 would suggest an advance to 21000; follow-through above 19000 would confirm.
* Target calculation: 19000 + ( 19000 – 17000 ) = 21000
India’s Sensex displays the strongest buying pressure, with rising 13-week Twiggs Money Flow troughs above zero. Respect of support at 26500 indicates continuation of the rally. Penetration of the descending trendline would suggest an advance to 30000; follow-through above 28500 would confirm. Reversal below 26000 remains unlikely, but would confirm a primary down-trend.
The ASX 200 threatens to break resistance at 5300, with rising 13-week Twiggs Money Flow indicating medium-term buying pressure. Breakout above 5300 would signal a test of the descending trendline. The bear market, however, continues despite recent support and breach of 5000 would confirm a primary down-trend.
* Target calculation: 5000 – ( 5400 – 5000 ) = 4600
The biggest mistake in investing is believing the last three years is representative of what the next three years is going to be like.
~ Ray Dalio, Bridgewater Associates
Further to last week’s post on the US-Asia trade imbalance, here is the impact on the US current account (seasonally adjusted annual rate) over the last two decades. The last quarter shows reversal to an annual deficit greater than $500 billion.
The deficit remains at 3 percent of nominal GDP. This is clearly unsustainable.
Expect a continued arm wrestle between Russia and the West over influence in the Ukraine. Russians obviously view their shrinking sphere of influence as a threat to future security. But Vladimir Putin’s actions in Georgia, Moldova, Crimea and the Ukraine — straight from the KGB playbook — are the biggest threat to their security.
A war-weary US and pacifist Europe may be slow to react, but their capacity when provoked to subdue any threat from the East, through their combined economic might, is immense. One should not be fooled by Putin’s macho posturing. He is playing a very weak hand.
From a paper by Samuel Kapon and Joseph Tracy at the Federal Reserve Bank of New York:
As the economy recovered and growth resumed, the unemployment rate has fallen to 6.7 percent. …..The employment-population (E/P) ratio frequently is used as an additional labor market measure. The E/P ratio is defined as the number of employed divided by the size of the working-age, noninstitutionalized population. An advantage of the E/P ratio over the unemployment rate is that it is not impacted by discouraged workers who stop looking for employment.
Since the end of the recession, the E/P ratio has largely remained constant—that is, virtually none of the decline in the E/P ratio from the Great Recession has been recovered to date. An implication is that the 7.6 million jobs added since the trough of employment in February 2010 has essentially just kept pace with growth in the working-age population. In its failure to recover, the E/P ratio would seem to depict a much weaker labor market than indicated by the unemployment rate. An important question is whether this is a correct or a misleading characterization of the degree of the labor market recovery…….
Read more at A Mis-Leading Labor Market Indicator – Liberty Street Economics.
Hat tip to Barry Ritholz.
Doug Bandow suggests:
Washington should begin contemplating, within earshot of Beijing, getting out of the way of its allies if the North continues to develop nuclear weapons. The message to China should be: if your client state continues its present course, you may face a nuclear-armed Japan. If that happens, blame your buddies in Pyongyang.
Read more at Time for U.S. to Disengage from North Korea Crisis | Doug Bandow | Cato Institute.
Highlight of the Olympics so far is France’s performance in the Mens 4x100m freestyle relay:
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