For those of you new to this publication, you can see what I am up to here. My readers grow by word-of-mouth, so please share. If someone forwarded this to you, you can sign up by clicking the button below. I’ll add the caveat I’ve used all week, I am writing faster and more frequently than normal, which means this is a bit more raw than typical. I hate typos and if you see one, alert me and I’ll update the post.
Ukraine fits so neatly into our story rubric that it is immediately recognizable. Zelensky is Harry Potter and Voldemort is you know who. It is also David and Goliath and The Hobbit and Smaug.
The potency of the story is such that it is easy to miss the broader meaning. Putin’s miscalculation about the vigor of Ukrainian resistance and the ability of the rest of the world to both quickly recognize the evil of what he is doing and mount an at times uncoordinated but so far effective counter-attack demonstrate the power of an open system and the brittleness of a closed one.
The stakes for Putin, who is unhinged and oversees a largely closed system, are extremely high. If this continues to go, from his perspective, badly, what does he do next? That’s a question for a military strategist not me, though his decision to put his nuclear forces on alert can’t be taken as bluff.
Open and Closed Systems
The debate about how to run an economy has largely been settled—free markets work better. That was the key message when the Soviet Union collapsed in 1991. The debate about how to administer a country has not been settled, however. Despite a few thousand years of data, today there exist variants of two models, open or closed. We are now getting a real-time lesson of the practical differences.
Under Putin, Russia has become increasingly closed—one leader, loyal (pliant) lieutenants, no meaningful opposition. Because there is no rule of law, both information and the economy are subservient to the leader’s need to exercise and maintain power. The underlying assumption is a complex country in complex times needs a steady, unfettered hand to lead it forward. That idea dates to Plato.
Most modern corporations work similarly, albeit on a much smaller, more benign scale. However, with a corporation there is a functioning feedback loop. If companies fail to adjust to new conditions, as they frequently do, they go out of business. (See this post, for more). After years of arresting and killing critics, Putin is now experiencing just this type of feedback loop.
Ukraine is trying to become more open. In an open system, everything is in flux. Who runs the country, the nature of information, coalitions and the economy constantly shift, what Joseph Schumpeter referred to as “creative destruction.” The assumption is that individuals will somehow sort it out even if certain choices—like voting on complex policies, adjusting to economic change, seeing through propaganda and navigating the health and financial system are extraordinarily complex.
The Value of Disruptive Truths
Zelensky never would rise to power in a closed system. His resume is wrong, a former comedian and actor versus Putin, a lawyer with years of government experience. Similarly, top chiefs in China are Party veterans and often engineers. Zelensky is also not on the list of people most would select to run a war, yet he has clearly risen to the occasion with astonishing bravery and aplomb.
Because the flaws of an open system are so obvious, there are regular bouts of doubt in its relative merits. When bridges collapse, knuckle heads are elected, ill-advised (Vietnam, Iraq 2) foreign ventures undertaken, citizens are exposed to this stupidity again and again by news outlets incentivized to shock. Today, amid tales of remarkable bravery, there are videos circulating (not verified) of Ukranian citizens given Kalashnikovs to defend instead using them to harass others. That’s painful transparency.
By contrast, the flaws of a closed system are obscured. As of yesterday, Russia’s state run TV hadn’t told their viewers Russians are attacking Kiev. When I spoke with my Moscow-based mother-in-law last night, she simply didn’t believe me when I told her there are thousands of Russian dead, though more sophisticated Russians can readily access that information.
Late Sunday, the Russian Ministry of Defense conceded losses, without offering a number. The Ukrainians say around 4000 Russian soldiers have lost their lives, roughly the amount of US soldiers who died in all of Iraq. In an interview, a Russian POW said he’d be shot if he retreated, which is what the Russian secret police did in WW2.
Incentives
In a closed system, the incentive is to find your place and fall into line. In an open system, the incentive is to take risks and initiative, thus the high pay for successful entrepreneurs. The difference is between being told what to do versus choosing what to do. Despondent Russian POWs (one a tank commander, another a sniper) seem to have no idea why they are in Ukraine and contrast sharply with Ukrainians lining up to give up their life to defend their land.
This incentive structure also in part explains why even Russians who loathe Putin are scared to fight him, though some are valiantly protesting. A closed system works via threat of violence, the type now being meted out on Ukraine. The list of those who have crossed Putin and been killed is long. Today, is the anniversary of the murder of Boris Nemtsov, a leading opposition politician. His own analysis of Putin was curt: Putin is a “pathological liar,” he said, which is worth bearing in mind as you read headlines about possible negotiation.
While closed systems give the appearance of order, they are in fact fragile, largely because most people don’t like living in them. It is in fact this reality that makes the many flaws of an open system become more attractive. By demonstrating the power of open systems, Zelensky and Ukraine are teaching all of us an invaluable, timeless lesson.
Economic Implications
Money management is full of people who made a lot of money and then lost it all. That’s what Putin looks like to me. Transcripts have emerged (I don’t know if they are accurate) of his deliberations and they suggest that he thought this would be over in 48 hours. Here are the market linkages I see at work:
Russian wealth will suffer enormously. When financial markets open in a few hours, the Russian ruble will likely fall sharply. Russia’s wealth still has not recovered from the 2014 Crimea invasion. While a lot of Putin-enablers will get justifiably crushed in this round of sanctions, millions of otherwise functional businesses will also get crushed. The brain drain out of Russia will accelerate.
Cutting Russia out of the global system is likely to further disrupt the global supply chain, though sanctions seem designed to keep oil and gas flowing. Russia is a significant exporter of other commodities, like palladium, which are critical for catalytic converters. Supply chain disruptions are inflationary.
Given high prices, whether the war is short or long, I suspect the Federal Reserves credibility fighting inflation is on the line and they will need to raise interest rates quite a bit. That’s bad for stocks and bonds, even though stock jumped last week.
Markets are incredibly volatile. As a portfolio manager, I take less risk when markets move this much. I do this by holding more cash. THIS IS NOT INVESTMENT ADVICE.
China has to be rethinking Taiwan and its embrace of Russia. Does this create room for a new approach with the US? That’s probably too optimistic.
Finally, this war is one more indication of how quickly media is changing (another example of creative destruction). The New York Times and The Wall Street Journal feel like they are about 20 hours behind Twitter and Telegram.
So far this year, I’ve lost a bit less than 1% (unaudited!).