Russia/Ukraine Tensions

Here we are, already in February of 2022. Markets have been volatile this entire year and much of that has to do with the pandemic, inflation and how the Federal Reserve (Fed) will handle inflation. But I think some of the volatility has to do with the recent buildup of Russian troops (and possible war) on the border of Ukraine. The troop buildup has not progressed to outward violence with Ukranian troops, but the concern is that it will. Investment markets are genuinely concerned about what could become a significant military standoff, or worse, a war. In today’s Financially Speaking I want to take a closer look at the Russian aggression, try to understand it better and offer my sense of where it might be headed. I’ve written on this subject previously in client letters, but today’s article will be a deeper dive. As always, the team at Barron Financial Group are only a phone call or email away if you have further questions or prefer a personal discussion.

Russian Aggression and History

Russia started its troop buildup on the Ukraine border in November of 2021. The total number of Russian troops is now estimated near 130,000. Although that might not be enough to take over the entire country of Ukraine, depending on Ukrainian resistance, it is enough to move toward, if not overtake the Ukrainian capital of Kiev. But why do this? Why would Russia’s President, Vladimir Putin, take on the burden of moving the troops, handling the necessary troop support logistics and absorb the cost to do it all? These are good questions and I think one of the best ways to try to answer them is to look at history. Specifically, how Russia has addressed other territorial concerns. Let’s start by going back to 2008. George W. Bush was the U.S. President at the time and somewhat serious conversations were being engaged with the country of Georgia joining NATO. Georgia is a country south of Russia and part of a region referred to as the Caucasus. The country was once part of the greater Soviet Union and went independent after the Soviet breakup in 1991. Georgia, and the Caucasus region are often referred to as a Russian “buffer zone” because it is an area where potential threats are on Russia’s doorstep. The Caucasus separates Russia from Turkey, Iran and other Middle East nations that could present a threat to Russia either militarily, or via the more common political or ethnic conflict spillover into Russia. Georgia is about 1,200 miles from Moscow, so the idea of it becoming a NATO member presented a legitimate security concern for Russia. Thus, in August 2008 Russia sent troops into Georgia to, allegedly, help simmer internal conflicts there. The result was a 5-day war that ended with Russia taking over the Georgian areas of Abkhazia and South Ossetia. This created an internal struggle in Georgia that essentially ended the NATO membership discussions. Russia continues to occupy those territories with a military presence to this day. Western nations were not happy about this war, but Georgia didn’t matter enough to any of them to do more than impose sanctions on Russia. In the end, this resolved two Russian problems; 1) it ended the NATO threat; and 2) it placed Russian troops on the doorstep of an area with chronic spillover potential. A case-study of Russian aggression that resolved apparent threats with limited global repercussions.

Russian Aggression and Ukraine

Let’s start with some important basics.  First, like Georgia, Ukraine was part of the Soviet Union and was an integral component of Russian defense until the Soviet Union collapse.  Second, Ukraine’s eastern border with Russia is only 300 miles from Moscow.  Much closer and potentially more threatening than Georgia.  Third, this region occupies part of what is known as the Northern European Plain.  An area of fertile, relatively flat terrain that is conducive to troop movements and potential military threat.  Unlike the Caucasus, which has never presented Russia with a military invasion, the Northern European Plain has been a pathway for five Russian invasions in the last 500 years.  Invaded by military forces from Poland, Sweden, France, and Germany, twice.  Hence the reason Ukraine is seen as an existential buffer zone.  Granted, the likelihood of an invasion into Russia in today’s world seems a stretch, but for someone like Vladimir Putin, the future is unknown and unpredictable.  Case in point – the 1991 collapse of the Soviet Union.  Thus, I think we can mostly agree, if not understand, that Ukraine becoming a NATO member would be an extreme security threat to Russia.  Now, for a bit more history, let’s go back to 2014 when a Ukrainian revolution removed the pro-Russia President and pushed the government, and population, closer to Western nations.  Russia moved in very quickly to do two things; 1) annex Crimea, which is the home to Sevastopol (an extremely important port city with critical military and economic access to the Black Sea); and 2) to occupy the eastern Ukrainian regions of Donetsk and Luhansk as a minimal buffer zone between Ukraine and Moscow.  Russia maintains troops in these areas as a continued challenge to Ukrainian sovereignty.  But those forces would be entirely outmatched in the event Ukraine joins NATO.  And Russia knows this.

Fast forward to today and Russia has amassed over 100,000 troops along the Ukrainian border, apparently as a threat to further NATO expansion.  The U.S. and other Western nations became quite concerned by December 2021 and diplomatic efforts to reduce tensions began.  By mid-December Russia had issued a “Draft Agreement” outlining its demands to the U.S. and NATO in exchange for reducing Ukrainian border tensions.  Although that draft agreement was a non-starter (at least in part because it demanded NATO permanently stop expanding eastward) it did open the door to further negotiations.  These negotiations continue to this day.  But, getting back to our original question, why?  Well, we’ve clearly established the security threat to Russia if NATO has a member state only 300 miles away from its capital on the easily crossed Northern European Plain.  For Vladimir Putin it may also be that he feels his options are growing more limited as time goes on.  Russia’s position is weaker today than it was in 2014.  The current Ukrainian President is clearly pro-western and very interested in becoming a NATO member and engaging more with the Eurozone.  Both of which would bring Ukraine further from the level of influence Russia desires.

And that leaves us with the question of where do we go from here?  There are really not many options as I see it.  One, for sure, is that Russia goes ahead with a full invasion and tries to takeover Ukraine.  I don’t feel this is likely because this path is loaded with problems.  First, it would be incredibly expensive to do this in terms of manpower, fuel, ammunition, and the supply chain needed to sustain them.  Next, the Russian economy isn’t exactly robust when it comes to this kind of disruption, and the sanctions imposed by Western nations will add, perhaps substantially, to the economic challenge.  Next, because Russia has been building its troops since November, it has completely lost any chance of surprise.  Ukraine has been beefing up its defenses, and getting foreign aid since January, which makes a potential confrontation that much bloodier.  This compared to the almost complete surprise Russia had when it went into Georgia in 2008.  And finally, the body count will be frightening.  Yes, Russia has excellent ground forces and equipment.  But, Ukraine has enough military power, and foreign aid, to cause real damage to the Russian military.  Would Russia win, probably, but Vladimir needs to be concerned with what could be thousands of dead Russian soldiers broadcast on TV and the reaction of his countrymen.  Next on my list is the polar opposite path for Russia of pulling back its troops and essentially, giving up.  I don’t see this as a real option.  The reason is that President Putin has backed himself into a corner of threatening aggression and demanding concessions.  If he pulls back without gaining those concessions, it will show utter weakness, something Putin has never done.  One midway idea is that Russia could engage in large cyber-attacks on Ukraine with the intent of disrupting the country to a point where Russian influence might be more welcomed.  We’ve already seen some evidence of alleged Russian cyber-attacks in Ukraine.  My issue here is that while cyber-attacks may very well be disrupting, the entire world will know who is behind the attacks and react accordingly.  The increased sanctions will come as will the possibility that the U.S. or the U.K. could launch their own counter cyber-attacks.  Something they are more than capable of doing.  Another midway idea, and my second most likely scenario, would be for Putin to move more troops and artillery into the Donetsk and Luhansk regions and essentially annex those areas.  It’s not ideal, but it does give some added buffer space to Moscow with Russian troops stationed there permanently.  It worked in Georgia.  It would also resolve the question of whether Putin is bluffing.  The challenge here (though minor in my view) is that some believe Ukraine has been itching to send troops into those regions and forcing Russia to fight.  That would be a backfire for Putin.  Lots of cost and dead bodies for only limited gain.  Last on my list, and most likely in my view, is the idea that the U.S., NATO and European nations offer Putin something in the way of assurances that they will back away from eastern expansion for some agreed upon period of time.  Along with other concessions such as the opening of the Nordstream 2 pipeline, an important economic win for Russia.  The details would not likely be made public, but they don’t need to be if war is avoided.  The challenge here is how will the U.S. and Russia back down using diplomacy and still walk away with something that looks like a diplomatic victory.  Bragging rights are important.  My guess is that some middle-ground can be found.

My final point to consider is that geopolitics is complicated.  A year ago, with the world fighting the COVID pandemic, no one would have even thought of a threat of war in Ukraine.  Nations do what they feel they must to best protect their citizens and key interests.  Understanding or explaining these tactics can be difficult, but it’s important to try to consider all the motivations involved.  Even if some of them seem far-fetched.  I for one, and I’m sure all of us, hope for a non-military solution to this crisis.