Lessons We (Re) Learn in Ukraine
Cause and Effect Revealed
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The modern world is confusing because cause and effect is obscured. What exactly is the series of inventions, supply chains and business relationships that made the Apple computer I write this on come into existence? Connections are revealed when the normal flow is disrupted. You never noticed how much you rely on your thumb until you cut it. The war in Ukraine is just such a (tragic) disruption. Below are less lessons than reminders of forces that have always been there but are now made obvious.
Reminder #1 - Being apolitical is political.
As unpleasant as politics is and as awful as some politicians can be, we have no choice but to participate. If we don’t participate, bad politics comes back to destroy our lives. The tired, cynical indifference with which many Russians responded to the gradual denigration of post-Soviet politics carried a higher cost than it might have initially appeared to entail. What’s happened in Russia happened before in Germany and may yet happen in the US; Trump continues to both attract a following and praise Putin. Zelensky summed it up well in a Sunday interview. “In Russia … there is a large percentage of people who support the truth…I hope those people … will knock on the doors of all their friends and relatives to break through this information wall.”
Reminder #2 - Russia is tough to administer; if Putin is replaced, the successor will face the same thorny structural challenges as previous Russian leaders.
One of the reasons Putin was put into power was because the Yeltsin years were chaotic. Yeltsin was groping for a non-Soviet model but neither he nor the people around him had a clear enough idea what Democracy or rule of law looked and felt like. This lack of perspective contrasted with places like Poland or Czech Republic which had experienced rule of law between the first and second world wars and knew what to go back to. Note, for instance, how peacefully Czech and Slovakia divorced in 1993.
When the center—Moscow—is weak, the empire disintegrates. Russia’s population today is 148 million, half that of the Soviet Union. One of the first things Putin dealt with as a leader was preventing Chechnya from breaking away. Putin may not survive this war. But his replacement will be faced with the same challenge—how to administer the largest land mass in the world with a corrupt bureaucracy overseeing a population that, not surprisingly, doesn’t trust each other or the government?
Putin’s technique is a modern, refined version of Stalin’s approach, which was to rule through fear and force. The news report that negotiators at a March 3 session were poisoned fits in with this approach.1 Do not expect Putin to negotiate in good faith, he wants to destroy Zelensky and has sent in numerous kill squads to do so.
Reminder #3 - A weak economy threatens political stability.
There are competing theories about why the Soviet Union collapsed. Based on my time living there in the final year (1990) of its existence, I have a simple explanation: lack of toilet paper. That sounds crude, but it is true. Russia has some of the biggest forests in the world but the economic system was so broken that in the last year of the Soviet Union’s existence very basic things were hard to come by. Based on Russian social media, shortages (sugar and tampons) are beginning to appear again. This could be hoarding essentials but it could also be the precursor to more substantial shortages. We don’t have enough short-term data to know for sure.
The longer the Russian economy is disrupted and cut off, the more obvious it will be to ordinary Russians, which so far largely support the war. Yes, it is easy for Putin to blame shortages on the West but for Putinism to continue it must demonstrate that the ideology can create economic growth. Just as high gas prices will be blamed on Biden in the mid-term elections, weak growth will be ultimately blamed on Putin, which means he will need be even more vicious to keep things in check, setting up a self-reinforcing negative cycle.
Reminder #4 - In the modern world, energy is almost as basic a need as food.
Much of the Ukraine news focuses on the military angle. However, to cut off Russia’s military machine, the most effective weapon is if Europe stops buying Russian energy. Just like a business or a household, Russia’s government has income, borrowing and expenses. The income is largely from selling commodities and taxes (which are a function of economic activity) and the borrowing is now, given sanctions, limited to its domestic population. Expenses are the same for any government—pensions (social security), roads and bridges, education, defense.
Since the war began, it appears volumes of Russian natural gas and oil have not substantially shifted (oil exports are down a bit) but prices are up.2 There are also reports of ports refusing to accept Russian tankers. Revenue = price times volume, so the Kremlin seems to be doing OK. However, Germany has said they want to get disentangled from Russian energy as soon as possible, which is probably around 4 years. Unplugging faster would create a nasty shock to European economic growth, meaning that despite good intentions energy reliance trumps moral outrage.
Reminder # 5 - In an authoritarian country, a mercurial leader is more important than thoughtful technocrats or economic self-interest.
As Putin began to tighten his grip on power in the early 2000s and China’s growth continued through a number of challenges (like the 2008 financial crisis), there gradually came to be a belief in the Singapore model as a way of framing both Putinism and later Xiism. For those of you less familiar with Singapore, an autocratic but visionary leader, Lee Kuan Yew, essentially carved the wealthy city-state out of a jungle nestled between Malaysia and Indonesia.
While Singapore was politically repressive, it was not extreme and managed to create a business hub and astounding increases in wealth. To this day, the government is incredibly efficient and clean and much less corrupt than the US, based on Transparency International ratings. Couldn’t this model work for Russia and China, many wondered? Maybe the Singapore system was even better than Democracy?
Now it is clear that in an authoritarian system, the whims of the leader are the most important factor. It looks like Singapore just got lucky with a thoughtful autocrat. Great technocrats matter, but not that much. Many of them in Russia were apparently against the invasion. Beyond westernized technocrats, deepening Russia’s capital markets and trade linkages was also supposed to reduce the risk of war.
Reminder #6 - Avoid concentrating your risk.
What is true in terms of Europe’s reliance on Russian energy is also true in terms of investments. Those who concentrated their risk in Russia have, in some cases, gone bust. I know a Russian businesses person who had nothing to do with the government or commodities but who has now lost virtually everything. I look at that businessman’s experience, eye the 2024 US elections and wonder about how much of my own wealth is concentrated in dollars.
Reminder #7 - We are tightly economically inter-connected.
That Ukraine’s wheat helps feed the Arab world was not obvious to many until Russia invaded. Now this linkage is clear. Wheat prices are up 30% plus because collecting the first harvest and planting the second is tough during a war. While this is merely an inconvenience for many, it is a matter of social stability (see reminder #3) for wheat importing countries like Turkey, Egypt and Algeria.
“Russia claims it is a friend of the Arab world,” said Zelensky.
In terms of the US, the war is boosting commodity prices, which boosts inflation, which forces the Fed to tighten even more than would normally, which typically drives down asset prices. The year-to-date return of both US stocks and bonds is negative and will, I suspect, get more negative.
Reminder #8 - Heed warnings signs.
Churchill famously predicted Hitler’s rise by tracking German steel consumption. This time, there were lots of warning signs Putin was dangerous. The murder of Russian journalists (among them Shchekochikhin in 2003, with whom I worked, and Politkovskaya in 2006), illegally seizing territory (Georgia 2008, Ukraine 2014), manipulating the constitution to allow himself to come back to power (2012) were all signs. The warning signs in both China (Xi breaking terms limits) and the US (Trump and his enablers like Ted Cruz) are there as well. In terms of investing, your money is never “safe.” Money is always unstable.
Reminder #9 - In a crisis, ancient social structures reassert.
In the last 100 or so years, laws have gradually been put in place that afforded women an unprecedented degree of legal protection. To take just the US example (which lagged the Soviet example), in 1920 women were legally allowed to vote, in 1947 to serve on juries, in 1963 to earn equal pay (enforcement is a different matter), in 1971 private companies were forbidden from not hiring women with young children, in 1973 Roe v Wade, etc. Against that backdrop, watching the war it is now clear what social structure those laws evolved from. In Ukraine, while there are of course exceptions, by and large the men picked up modern day clubs to kill lethal invaders and women fled to protect children. War is a regression to a more primitive part of the brain and the social structures follow.
Reminder #10 - Always have a margin of error.
This is along the lines of how Buffett supposedly picked stocks (at least early on his his career) where he could buy companies that were so cheap that even if the company suffered a rough patch the value of their assets was such that there was downside protection. Margin of error means assume things can get worse and plan accordingly. In many cases you won’t need the margin, but sometimes you really do.
Pricing
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Investment implications
The market is now pricing in a 50 bps hike at the next Fed meeting in May and then 25 bps of hiking at every meeting after that for the rest of the year.