War of Civilizations

October 10, 2014

The influence of sanctions on the behavior of Vladimir Putin and the Russian economy are two entirely different processes. Therefore, I will start with the question that I asked myself right after the military annexation of the Crimea by Russia and the start of the bloody war in the eastern part of Ukraine: what for and why was war chosen? Why is there no diplomacy or finances involved?

Russia’s expenses on the capture and maintenance of the Crimea in 2014 will approximately equal 7-8 billion US dollars. In 2015 and beyond, the annual expenses will amount to 5-6 billion US dollars (without taking into account investments). Of course, we should add to this the drainage of capital and the fall of the GDP as a result of Western sanctions. In my estimate, the drainage of capital in 2014 was approximately 150 billion US dollars (i.e., there is nothing left to drain). The fall of the GDP in 2014 was -1%; and in 2015 it will be -2%. These estimates were made based on today’s level of sanctions from the US and the EU, without taking into account sanctions from Ukraine and those sanctions which Russia can attribute to itself (spontaneous and emotional errors).

Returning to the question that the President of Russia must always ask himself: is the Crimea worth 10-14 billion US dollars and is the conflict in Eastern Ukraine worth 200-250 billion US dollars? I am putting aside any risks to Russia’s reputation. How do you answer this question? I will provide the thought process of a rational, pragmatic President. The task is to make the Crimea our own and to subdue Ukraine. In response, the rational decision (behavior) of the President is as follows: one can purchase all of the real estate and half of the land in the Crimea for 10-15 billion US dollars, and for 200-250 billion dollars one can buy from all of the Ukrainian oligarchs and millionaires all of their property, banks and even half of the land of mainland Ukraine! The task is resolved – the Crimea is under ownership, I own Ukraine, and I win the laurels of the civilized investor! This is how a rational and civilized President would think. It would seem that the behavior of the President of Russia is irrational and, even more so, he is an uncivilized person! Not exactly, it seems, as the fact is that President Putin is from another civilization altogether – the Muscovite-Orthodox civilization.

A civilized choice is an extremely vital factor of the domestic and foreign policies of large countries, and especially Russia. In essence, President Putin is himself a prisoner of the Russian World as, for example, President Obama and Angela Merkel are prisoners of the Western World. The logic used above presumes that the President is from the Western Civilization. S. Huntington and other Western thinkers distinguish a separate orthodox civilization with a center in Russia, which differs from Western Christianity due to its byzantine roots, three hundred years of Mongol-Tartar Yoke, bureaucratic despotism, and limited influence on its Resurrection, Reformation and Enlightenment. Interestingly, these precise aspects also separate Ukraine from Russia.

For a long time Ukraine stood with one foot in the soil of the Russian world and the other foot on the tiles of the Western world. The choice has been made. Western logic also dominates us and, therefore, it is difficult for Ukrainians to understand Vladimir Putin and his loyal subjects. It is even more difficult to have an effect on Vladimir Putin by the imposition of rational, economic sanctions by the Western Civilization. I will not list these sanctions, but I will say that they are lenient and humane. The aim of sanctions is for all of the key sectors of the Russian economy (weapons, oil, gas, banks, etc.) to be able to function but not expand. Russia is already cut off from Western credit and technology. This is first and foremost. Secondly, sanctions lead to the substitution of Western credit and investment with the gold reserves of the Central Bank of Russia (and this is 468 billion dollars) and its sovereign wealth funds (the National Welfare Fund – 88.6 billion dollars – and the Russian Federation Reserve Fund – 87.4 billion dollars). By my calculations, at this rate of sanctions Russia will exhaust its gold reserves and move closer to default only at the end of 2016 or the beginning of 2017. Nevertheless, the actual income of Russian citizens will already begin to plunge in 2015 and we may see weak social protests.

Why will it all happen so quickly? The aggregate debt of Russian banks, companies and the government is approximately 715 billion dollars. Annual interest payments and credit principle are approximately 160-180 billion dollars (you need to take into account cross-defaults, which will inevitably occur in the near future). In addition, I expect a fall of currency inflows in Russia from the export of fuel (oil, petroleum products and gas) by 5-8%. In 2013 already the currency proceeds from fuel export did not increase, but were still significant (around 350 billion dollars). If you add capital flight to these trends, then my evaluation of the timeframe for Russia’s upcoming default becomes clear.

What kind of logic is Vladimir Putin using? According to the doctrines of “Russkiy Mir” the departure of Ukraine, Georgia and Moldova to Western Civilization will strengthen Western Civilization and significantly weaken Muscovite-Orthodox civilization which, even without the departure of Ukraine, Georgia and Moldova, has been lately losing territory and people, including orthodox faithful and Russian language. Therefore, Putin’s task is to create economic, social and political problems in these countries in order to avoid the strengthening of Western Civilization after the joining of new countries. How many people will perish in a best-case scenario is not of interest to Putin. Instead, he is interested in a worst-case scenario, where the more people perish the better. This is the logic of “Russkiy Mir”. If Ukraine used such logic instead of Western logic, then prior to the surrender of the Crimea the Ukrainian military forces would have destroyed Crimea’s entire infrastructure, including all roads, buildings and enterprises, and would have fired amongst peaceful citizens.

It is clear to me why Vladimir Putin started this war of civilizations. Apparently, he believes, and he is probably correct, that his civilization is doomed. If Russia’s share in the global GDP prior to 2013 experienced growth, even at the expense of price increases on oil and gas (in 2000 – 0.8% and in 2013 – 2.8%), then according to the World Bank’s and the IMF’s forecast it will decrease to 2.5% within 5 years in 2019. At the same time, the US’s share in 2019 will basically remain the same at 21.8% and China’s share will grow to 14.7%! Importantly, these forecasts were published in April of 2014, and they do not take into account the EU’s and US’s sanctions against Russia. My assessment is that Russia’s share in the global GDP in 2019, taking into account sanctions, will be 1.8%. Russia is turning into an economic midget… No “reality” expressed and shown by Russian television, whether shown to Russians or viewers in the Eastern and Western worlds, will be able to help. And, Russia will not be able to spend 1.5 billion dollars from its state budget only on state-run television channels. For comparison’s sake, even China with all of its censorship spends a little more than 1 billion dollars on state-sponsored television.

It seems that we already understand the thinking and actions of Vladimir Putin. By all appearances, Vladimir Putin understands the logic of the actions and sanctions of Western Civilization and those who side with Ukraine. I would like to add that Vladimir Putin knows that one US decision to fully prohibit Russian banks and enterprises to accept dollars for settlements will lead Russia toward default and, within a month or a month and a half, toward a complete collapse of the Russian economy and even Russia’s demise. Understandably, this US decision will lead to the default of all Russian enterprises and banks which are tied to the dollar and euro. It is also understandable that these defaults will inflict damages on American and European banks. In such case, the West’s answer will be to freeze all sovereign assets of Russia in dollars and euros to compensate the losses from default. This would already be the end of not only Russia but of the entire “Russian World” (and in reality Belarus). The Russian economy will deflate twofold and the world will experience a decrease of GDP by 1% due to the deflation of the Russian economy. The effect of the crisis of 2008 on the compression of the GDP was much more extensive. Obviously this scenario is only possibly after a full-scale war against Ukraine.

Is there a solution and what is it? As of now, there are no solutions. This is at least exemplified by the discourse of Vladimir Zhirinovsky on a third world war and Vladimir Putin on a new super weapon. Although, it seemed in June that a life-saving idea emerged about how to dispose of the hegemony of the US and the EU in the global currency and financial system. I am talking about the 6th BRICS (Brazil, Russia, India, China and South Africa) Summit in Brazil, where an agreement was reached on the creation of a development bank (with a headquarters in Shanghai) with an authorized capital of 100 billion dollars and a currency reserve fund. We are actually talking about alternative structures to the IMF and the World Bank. In fact, Russia conceded that the role of the US in such structures will be played by China and the role of the EU by India. Russia will play a secondary role player (at least in an economic aspect).

As a specialist in international finances, I already stated that such structures can actually be created but, importantly, such creation would require at least two years (on the condition that the US and the EU will not interfere). However, this step will eventually lead to a collapse of not only Russia, but of India and China, without even mentioning Brazil. Alas, international trade with the US and the EU is the driving mechanism of the development of these countries. Moreover, you may as well forget about this project after the imposition of sanctions on Russia by the US and the EU. Russia does not have two years in reserve, but it definitely has one year. Therefore, one may expect new “unpleasant” surprises for both Ukraine and the West from Vladimir Putin.

I see a solution in compromise. Vladimir Putin should return the Crimea to Ukraine, but keep forever for himself the military base in Sevastopol (which will be surrounded by a Chinese Wall) and, of course, compensate losses from the war incurred by Ukraine from the aggression in the Donetsk and Lugansk regions and the annexation of the Crimea via a court decision or on a voluntary basis. Only a portion of the 50 billion dollars from the Yukos lawsuit would be sufficient for this compromise. Obviously, Vladimir Putin and our society are not presently ready for such a compromise. However, the task is to begin to search for a compromise from the correct position.

 

Of Counsel, Frishberg & Partners

Professor Alexander Savchenko

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