Streetwise Professor

May 20, 2012

Holy Makarov

Filed under: Economics,Energy,Financial Crisis II,Military,Politics,Russia — The Professor @ 7:42 am

Russia has been notably obstreperous on two foreign policy issues: American missile defense plans and Syria. In each instance, members of the leadership have threatened direct military confrontation if Russia’s will is thwarted.  Ironically, the more veiled of these threats-Medvedev’s with respect to Syria-led to a bigger blowback on Russia.

A little over two weeks ago, Chief of the General Staff of the Armed Forces of Russia and First Deputy Minister of Defense Nikolai Makarov stated that Russia might launch a preemptive attack against US antimissile systems based in Europe if “the situation worsened.” Makarov would not make such a statement unless it was approved at the highest levels-meaning Putin.

Makarov’s warning was paired with a presentation of a computer simulation in which a diabolical US system shot down a barrage of Soviet I mean Russian ICBMs headed for the US.

It is flattering, I guess, that the Russians believe that US ABM systems are so capable, or will be in less than a decade’s time.  But if they actually believe this, they are delusional.  The particular installations in Europe against which Makarov vented, and threatened to attack, are of no use whatsoever against a Russian ICBM launch against the US.  They are not on the path of outgoing land based Russian missiles (which would take a polar trajectory), of no use whatsoever against SLBMs, and are laughably few in number.  US systems based in North America are also very limited in number and coverage.

Indeed, even the Russians themselves can’t tell a consistent story. They tout the evasive capabilities of their new ICBMs and the difficulty of ABM systems in dealing with large numbers of decoys.  Rogozin the Ridiculous tweeted:

If someone tried 2 build MD system right under our noses, it’d only give’m illusion of defense. We’ll pierce that fence

The mixed messages, and the underlying unreality of the characterization of the threat, make it rather difficult to interpret exactly what Putin et al are thinking.  Any reasonable interpretation does not give comfort.  Paranoid and panicky vs. using missile defense as a pretext to attempt to cow the Europeans and split them from the US.  Or both.  Oh joy.

An even higher authority-at least de jure-uttered the other apocalyptic threat.  Dmitri Medvedev obliquely raised the threat of nuclear war in remarks on Syria:

In his comments at a conference for lawyers in St. Petersburg, Mr. Medvedev started out by ruminating on the unintended outcomes of military campaigns. That is a theme often taken up by Russian officials as a line of criticism for what they see as America’s interventionist policies in the Middle East.

“The recent, hasty military operations inside foreign states usually end with the arrival of radicals in power,” Mr. Medvedev said shortly before 1 p.m. on Thursday.

He went on to add that: “At some moment, such actions, which undermine sovereignty, can end with a full-fledged regional war, or even, and I don’t want to scare anybody, the use of nuclear weapons.”

Russia has been shrill in its defense of its client and big arms buyer, the murderous Assad regime, and was outraged at the demise of another client (and big arms customer), the Khaddafy regime.  It has made it clear that it will not abide a repeat of what transpired in Tripoli and Benghazi in Damascus and Homs.  In this context, raising the possibility of the use of nuclear weapons can only be interpreted as a threat by Medvedev (which again would not be made without Putin’s approval) to employ nuclear weapons in response to NATO/US efforts to overthrow Assad.

Is the threat credible? Unlikely, but who is taking chances? Certainly not the markets:

An unusually candid reference to nuclear war by Russia’s prime minister prompted a sell-off in the nation’s stock market this week, underscoring how nervous traders here have become about worsening relations with the West, a street protest movement in Moscow and an overall slump in emerging markets.

. . . .

The Russian Micex index, a gauge of large blue chips traded on the domestic market, fell sharply. By the market closing, the index had lost 3.5 percent and ended the day at its lowest level in seven months. Some large Russian companies tumbled even further. Sberbank, the country’s largest lender, dropped 7 percent.

Yes, there were other bearish developments, notably a drop in oil prices, but the market drop appears to large to be explained by these other developments alone.

Why the reaction? One explanation is that they highlight the political risk of investing in Russia. They emphasize the importance of geopolitical objectives to the Russian leadership, and that they are not all that interested about comity with the west.  Such a confrontational posture will almost certainly create risks for foreign investments in Russia, and the Russian economy generally.

Here is another interpretation.  Yes, the remarks did coincide with a selloff in oil.  And that may be exactly why Medvedev uttered them.  The Russian economy and the Russian fisc are highly dependent on the price of oil.  Oil prices are currently below the level necessary to balance the Russian budget, which is not a good thing given the tumult in European capital markets. Brent is now trading at about $107/bbl.  Given current spending, Russia needs a price in the $115-$120/bbl range to balance the budget, and around $150/bbl to fund Putin’s elaborate election promises.

As my friend Sergei Guriev notes, Russia’s vulnerability is acute:

“It’s very hard to overestimate how vulnerable the Russian economy is to external pressures” from the oil price, Sergei Guriev, the rector of the New Economic School in Moscow, said in a telephone interview. “That vulnerability is huge, which is why Russia must be very vigilant. The spending is a risk.”

That vulnerability is huge.  No lie. That Sergei must be another one of those damned Russophobes.

Given this huge vulnerability, perhaps it is not surprising that Medvedev rattled the nuclear saber in the midst of a sharp selloff of oil: what better way to goose the price of oil than a threat of nuclear Armageddon in the Middle East?  Under that interpretation, his remarks would betray a certain, shall we say, anxiety about the current economic situation.  Which would help explain the sharp selloff in Russian stocks, or perhaps even suggest that the selloff was underdone.

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  1. Alas, Our good Professor, We recall many such articles published around a year ago, to the effect that Russia’s fiscal problems ensured a budget deficit for 2011. We were greatly pleased at the prospect of Russia entering financial bondage to Us, just like Latvia! We are greatly miffed that Russia pays Us a mere 3% of GNP for foreign debt service, and greatly desire that figure to rise!

    Alas, it was not to be. Russia had a 2011 budget surplus, shattering Our high hopes!

    We dare not raise Our hopes again.

    Comment by a — May 20, 2012 @ 2:20 pm

  2. a-You miss the point, as always. The point is that Russia’s budget is hostage to the price of oil. The price was high in 2011. The price now-falling. Get a clue.

    Take it up with Sergei Guriev, btw. But only if I can watch him kick your ass.

    The ProfessorComment by The Professor — May 20, 2012 @ 2:33 pm

  3. Our dear Professor,

    The price of oil will fluctuate.

    We recall very well Spring 2009, when many analysts saw Russia’s doom in the price of oil then. And the instant there was prospects of global recovery, the price rose.

    The only way to doom Putin is to doom the global economy.

    Which We are working on…

    Comment by a — May 20, 2012 @ 4:49 pm

  4. Damn!

    RSX up 4.3% today!!

    Comment by a — May 21, 2012 @ 4:47 pm

  5. @a-you really don’t get the whole high beta thing do you? Today Brent up by about 1 pct. US markets up well over 1 pct. Asia up by about 1 pct.

    The ProfessorComment by The Professor — May 21, 2012 @ 9:14 pm

  6. Our dear Professor,

    We do.

    Which is We do not read Russia’s doom in every little trough.

    Unlike you.

    Comment by a — May 22, 2012 @ 3:56 am

  7. I’m no S&D specialist, but it seems to me that the potential nail in Russia’s budgetary coffin this year is the Saudi/Gulf coast production reaction to slowing (EM) economies. The fact is most producers’ budget oil prices are well below Russia’s, and they have some incentive to prevent another 2+ year extended slump in consumption.

    That said, Americans can throw no stones. It’s interesting, and somewhat scary, how both the American and Russian fiscal dynamics rest on current risk premia.

    Comment by dh — May 23, 2012 @ 6:50 pm

  8. A: You don’t read Russia’s doom in every little trough, you read Russia’s glory in every little peak.

    The value of Russia’s stock market and currency depend UTTERLY on the price of oil, which is (a) set by foreigners and (b) based on a resource that will run out.

    The Russian economy is enslaved by foreign oil demand. No lie you tell can change that. And one day, when the oil runs out, Russia will finally disappear with it.

    Comment by La Russophobe — May 24, 2012 @ 1:58 am

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