Geopolitics

It’s bad, but could be a lot worse

Geopolitics - bad, but could be a lot worse

It is almost impossible to open a news site these days without being greeted by headlines warning of impending geopolitical crisis, or more like crises. Whether this is the war in Ukraine, Gaza, China, Taiwan and the South China Sea.

It’s tempting to come to the conclusion that we are doomed, and head to the hills, or the bunker, stocking up on baked beans.

But geopolitical risk has been around for thousands of years, essentially in old money its foreign affairs.

It’s hard to gauge whether geopolitical risks are higher now than during the two world wars, the Korean and Vietnam wars, the Cuban missiles crisis, and the list goes on.

Everything in life is relative.

Geopolitical risks probably feel more pressing, worrying and risky today as we live in a much more connected world, with globalisation, integrated global supply chains, social media and the 24/7 news cycle. A diplomatic crisis in a particular region, can disrupt a global supply chain with knock on effects throughout the global economy and with the impact multiplied almost instantaneously by the news channels, rumour, false facts disseminated through social media.

Figuring out geopolitical risks is also perhaps more difficult as countries have more tools at their disposal to deliver on their geopolitical objectives and, in an increasingly multipolar world, there are more players, or powers, to figure out.

Things were a little more simple in the unipolar world which followed the collapse of the USSR, and where the USA was left as the last superpower left standing. But since then we have seen the US star (and stripes) fade with disastrous foreign adventures in Afghanistan and Iraq, and the rise of China as a hegemonic rival, Russia as a revanchist wannabe (but arguably failing and hence declining) power, nuclear armed Iran, North Korea, India and Pakistan, Israel, the Gulf states, Turkey, the BRICs, the EU, and then even non state actors like ISIS and global crime syndicates even. Figuring out what makes each of these players tick is difficult enough, but then understanding their interplay, often in crisis situations where a multitude of players are acting is difficult, nigh on impossible with much accuracy.

If we think of the tools of geopolitics, in the old days there was diplomacy - one might withdraw your ambassador to the court of St James. You might actually wage war, and then true calculus was military/security. In the unipolar world in the early 1990s, the US was so supremely dominant that it was relatively easy to figure out the endgame from say the first or even second Gulf wars, or then NATO’s intervention in Kosovo in 1999. There was only ever going to be one winner. Things got complicated though after the US failed to plan for peace after the second Gulf war. And as we have seen with the West’s reaction to crises involving nuclear powers like Iran, North Korea,and lately Russia over Ukraine, there is a reluctance to go to conventional war. This has seen the rise of new levers of geopolitical power or influence - economic statecraft, or sanctions, have been increasingly popular, but add in cyber warfare, election interference, use of social media, manipulating migrant flows (as Russia did in Syria and then Belarus), disruption to critical infrastructure (NS2 attacks) and even state terrorism/hybrid warfare, even note Russia’s recent efforts to challenge border and maritime boundaries in the Baltics. The imposition of sanctions on Russia after its annexation of Crimea in 2014, then full scale invasion of Ukraine in 2022 are much criticised but the question is what were the alternatives? Was the West willing to go to war with Russia, a nuclear armed power, or was there an option to do nothing. Sanctions filled the void.

Suffice to say that the geopolitical space is increasingly complicated, with many players and many moving parts.

When it comes to sanctions specifically, globalisation creates both opportunity to impose pain on a geopolitical rival but also vulnerability and risk of backdraft and damage to the sanctioning state’s own economy. A good case here would be Russia where it’s integration into global financial markets left its banks vulnerable to being kicked out of SWIFT or having assets frozen. But these same banks very often transact for a broad range of critical markets, particularly commodities. Hence figuring out the consequences of sanctions on Russian bank x, for commodity market Y can be very challenging.

Geopolitics is now multidisciplinary and needs a different skill set to the diplomats or military types who might have covered the turf 20 years back. It requires all those same skills, but add in economics, finance, cyber, social media, logistics, et al.

The importance of getting the big geopolitical calls right has been laid bare by the war in Ukraine in that so many foreign direct and institutional investors got the call so wrong and have been left with assets stranded in Russia as a result.

One might ask here how they failed to read the glaring warning signals from their own Western governments in late 2021.

Various explanations can explain this failure to see the obvious.

Ignorance springs to mind and a failure to do one’s homework - a lack of investment in geopolitical risk assessment.

It is perhaps a little understandable that some failed to take the warnings of Western intelligence services after the failings in the lead up to the Iraq war. But then look at Putin’s long track record of malign action against the West, dating back to the invasion of Georgia in 2008, Transdniestr, use of WMD twice by Putin on the streets of a NATO member (the UK, and Salsbery/Litvinenko), Navalny, annexation of Crimea, first invasion of Donbas in 2014, Syria and election interference in U.S. elections in 2016 & 2020, Brexit, and an attempted coup in Montenegro. Why did business not see this and conclude that it’s not a great idea to be invested in Russia?

A Russian influence campaign was one factor - the warnings from Russian think tank staff, and diplomats in the months leading up the invasion that Putin would not be stupid enough to invade. Well he was.

Some Western business, particularly in Europe, were part of that Russian influence campaign having taken Putin’s forty pieces of silver. They were repeating the narrative that Russia would never invade, it was a peaceful country. Right.

Charitably for some, perhaps they were just too invested, and by the time the invasion was in motion, from 2021 it was too late to exit. By that time it was more a case of wishful thinking or living on hope.

But armed with the experience now of failures reading the Ukraine war, many Western banks and corporates are tooling up in geopolitical research capability - with a strong bid for ex Admirals, Four star generals and ex CIA directors.

But should the read from the war in Ukraine be that geopolitical risks are rising, extreme, and escalation across the board is inevitable? Or while individual crises in Gaza or Ukraine are imposing terrible costs on the direct protagonists and unfortunately many innocents there, there are still some guardrails in place which limits the global market contagion risk? I would tend to side with a more optimistic take - that things could be a whole lot worse, while there have even been some “winners” from some of the crises that are currently playing out globally.

Let’s take the war in Ukraine as a starting point.

First things first, the worst case scenario of a Russian victory in two weeks back in February 2022, which had been Putin’s assumption - and also the read of US intellligence, has not happened. That’s a huge geopolitical win, particularly for the West.

Just think thru what the consequences for Europe, and the Western alliance, of such a lightning Russian victory would have been.

Let me help you out here:

(-) Tens of millions of Ukrainian refugees would have fled West, straining the social, economic and political fabric of Europe. This would have further bolstered far right and far left populist movements imposing further centrifugal forces and straining European unity likely to breaking point;

(-) Russian tanks would be further West, on more of NATO’s borders, with concern that a emboldened, confident Russia would go further, thrusting into the Baltics states, into Moldova, securing at least a land corridor to Kaliningrad, and perhaps further to Poland, northern Kazakhstan, and elsewhere.

(-) Years of defence spending cuts, leaving NATO and European defences threadbare with troop numbers near 100 year lows, and kit decommissioned and in a generally poor state of repair, begs the question could NATO have defended itself at that point - and with few US defence assets still in Europe would the U.S. have been able or willing to ride to the rescue?  It is suffice to say, that Europe would need to massively and very quickly ramp up defence spending, by many billions of Euros a year.

(-) Could we be sure that Orban’s bromance with Putin is not part of a quid pro quo with Putin where Hungary secures Transcarpathia as part of a drive for a Greater Hungary which would risk a domino effect across the region, risking others to follow the same path, and risk of interstate wars in Central Europe?

(-) We could add in here, if Europe had been less fortunate with agroclimatic conditions, which eased energy demand in the winter of 2022, this could have seen massive energy supply shortages in Europe, production curbs in key industries and then global supply chain disruptions.

(-) Europe would be insecure, and think then of the impact on the euro and global financial markets.

But all that did not happen because Ukrainian fought bravely. Europe owes Ukraine dearly.

Instead Europe has been bought time to rebuild its defences, it has had time to accelerate the energy transition, cut energy consumption and diversify away from reliance on Russia. This is not because of the skills or forethought of Europeans, but because of the bravery of Ukrainians.

And manna from heaven for NATO, Russia has been bogged down in a debilitating conflict for two and half years which has weakened its position relative to the West:

(+) Russia has lost hundreds of thousands of troops dead or injured and perhaps as much as half of its conventional military capability has been destroyed in Ukraine. That is kit that is no longer a threat to NATO;

(+) Russia has lost its ability to use Crimea as a secure naval base, and the Black Sea Fleet is no longer able to operate freely in the Black Sea. Ukraine, a non naval power, has defeated Russia, a naval power, in the Black Sea. Quite extraordinary.

(+) Sanctions might not have crippled the Russian economy but there has been a cost. Russia has to pay top dollar for imports and many of its export items are subject to discounts. Around $400 billion of Russian state assets are immobilised overseas. Capital flight out of Russia has likely amounted to over $200 billion. Lost GDP growth has cost perhaps $100 billion plus. And the cost of depleted Russian military kit is upwards of $100 billion. Russia has lost the European gas market permanently - an annual $50 billion business, which cannot be diverted east without expensive pipeline construction. All told the losses to the Russian economy are likely close to $1 trillion, which is more than half of annual GDP. A weaker, poorer Russia is less able to regenerate military capacity lost in Ukraine to threaten NATO. Now it can divert resources from consumption to defence, but this has long term social and political costs and risks internally in Russia, and ultimately could weaken that regime from within.

(+) Russian prestige has suffered as its claim to be a global superpower has faltered with its failure to secure a speedy win against a supposed third or fourth rate military power in Ukraine. Russian military technology has proven near obsolete and unable to compete with its Western counterparts - second generation NATO kit used by Ukrainians has generally beaten fourth generation Russian counterparts. This will result in lower military sales ($60 billion annually) for Russia and less diplomatic reach which often cmes with arms sales. Who wants to buy S400s now?

(+) Russian action has united NATO against a common foe, and given it new purpose. There is no debate now in Europe as to whether Russia is an existential threat to Europe. It is fact. And Europe is stepping up defence spending as a result, around $180 billion in new defence spending as a result of the invasion, and likely double that per year over the next decade. NATO members are now committed to the target of raising defence spending to 2% of GDP, many are at or above that level already and committed to increasing this even further.

(+) Whatever Trump might say, the US is the big winner from Russian actions. It’s allies are stepping up defence spending, shouldering more of the burden, and much of that extra defence spend will end up buying US weapons. Meanwhile, of the $75 billion U.S. spend to date (and the $61 billion additional support recently approved by Congress) supporting Ukraine, most has ended up staying in the US, being used to buy US military kit. And this kit is being used to degrade the military capacity of a geopolitical and military rival. It’s a no brainer win for the US, with no US troops out at risk. Putin’s invasion likely will bring hundreds of billions of extra defence spend to the US economy, multiples of the cost of supporting Ukraine, and much of this in red states.

(+) Russia has lost influence and leverage across the region, including in Central Asia and the South Caucasus. In no small part this contributed to Azerbaijan’s recent military victory in Nagorni Karabakh which has now opened the way to a lasting peace agreement between Armenia and Azerbaijan, and then on with Turkey. This should help enhance peace, security and prosperity in that region, whereas over thirty years of failed Russian intervention and duplicity had failed, even promoted conflict.

(+) Fears, meanwhile, of an escalation of the war to the point that Putin would used weapons of mass drestruction - for example tactical nuclear weapons - have come to nought. Likely China has acted to set limits herein on Putin - fearful there that any such impact would have damaging impacts on global markets: China does not want anything that rocks the global economy and slows its own accent to economic (then military) hegemony over the U.S.

(+) Linked therein the West has learned to better read or call (out) Putin. It better understands that Putin is a bully, is frightened by the West’s power and is desperate not to get into a direct war with NATO, which Russia would loose in short shrift. It has learned that Russian red lines over the supply of progressively more advanced Western weapons means little, and they have hence been able to go through the gears in supplying Ukraine from T72s, MIG29s, to HIMARS, Leopard tanks now to long range missiles and F16s. Ultimately arming Ukraine is an investment in Europe’s security. Western leaders finally get the imperative. That should make Europe safer and at less geopolitical risk from Russia.

I guess to summarise, as a result of Russia’s invasion of Ukraine, Europe is now clear minded about the threat from Russia, building defences and durability against Russia, while Russia itself is much weaker as a result of Putin’s calamitous decision to invade. Putin is in a weaker position to threaten Europe going forward, assuming that is Western resolve holds to ensure a Ukrainian victory, which is still possible, albeit by no means assured especially given risks from a potential Trump second term.

And while we focus on the geopolitical risks from crises, like the war in Ukraine, we tend to ignore the fact that some countries have actually seen resulting benefits, albeit few want to admit it or write about it for fear of being labelled as war profiteers. Herein:

(+) Many global south countries have been able to buy energy and commodities cheaply because of sanctions lodged on Russia. India is, for example, estimated to have secured at the least a $40 billion discount on crude oil purchases. Exporters to Russia have also been able to charge Russia top dollar for exports, particularly those falling within the scope of sanctions. Herein China has been the big beneficiary, at Russia’s great expense.

(+) An estimated $300 billion or so in capital has flooded out of Russia, to countries in Central Asia, the South Caucasus, Turkey, the Gulf et al. This has generally buoyed these countries’ balance of payments, strengthened or stabilised their currencies, allowed their central banks to run looser monetary policies than would otherwise have been the case, and hence allowed them to benefit from higher real GDP growth.

(+) Repeating therein Turkey’s role in supporting Azerbaijan in its victory in Nagorny Karabakh, show casing its military technology, particularly drones (including in Ukraine) which has seen huge Gulf demand to buy this technology and perhaps this was behind the recent $51 billion UAE support package for Turkey.

Let’s not forget here that it is Ukranians making the ultimate sacrifice - but it is the West, and actually the Global South, reaping most of the benefits. We should do more to ensure a speedy end to the war which boils down to giving it the finance and tools to win the war as quickly as possible.

On the outlook for peace, I would perhaps venture to suggest that towards year end both sides might be more amenable to peace talks. For Russia, it’s hard to see its situation getting much better - it simply lacks the military and economic capacity to take and hold/subdue/conquer significantly more Ukrainian territory. And the longer the war goes on the larger the human, military and economic costs to Russia, and then the greater risk to Putin of another Prigozhin style incident. For Ukraine, the prospect of a Trump presidency and the risk then of a precipitous drop off in US support must be a concern. They must calculate as to the human cost of taking back Crimea, and DPR/LPR, against entrenched defences and now brainwashed inhabitants. Land for peace will not be considered but long term talks about future outcomes is a possibility. Such an outcome would scale back geopolitical risk in Europe at least. It is not out of the question but is probably not the current consensus.

China - how has the war in Ukraine impacted relations with the West, and risks therein?

I would argue, against the consensus, that relations between the West and China are in better place than they would hitherto have been had Russia not invaded Ukraine.

Remember the fear at the outset of the Russian invasion was that this was somehow coordinated with China and that Beijing would use Western preoccupation with Ukraine to attack Taiwan, and would meanwhile, go all in in support of Russia in Ukraine.

The reality is that China has pulled its punches in supporting Russia in Ukraine. China has not done what it could have done, which would have been to finance and arm Russia. Instead it has sought to navigate a delicate balance of keeping relations with Russia warm while not further inflaming relations with the West. Proof of the lack of significant Chinese military support for Russia is the fact that Moscow has had to resort to securing arms from Iran and North Korea.  Important to understand here that for Beijing the key relationship is with the US, not Russia. The US has the ability to hurt China’s economic development by further rolling back from globalisation with the use of tariffs et al. The Biden administration has I think recognised China’s cautious approach to the war in Ukraine and I think it has responded by pulling its own punches on key areas of interest to China, particularly around trade and tariffs.

I would also add herein that the US no doubt is understanding and appreciative of Chinese action to set bounds for Russian action in Ukraine, particularly in terms of setting clear red lines for Putin on the use of WMDs in Ukraine. I could well imagine that the US has sought direct representation to China to make sure that Russia knew the limits in this respect.

I would also argue that the war in Ukraine has reduced the risk of a Chinese attack on Taiwan. Indeed, therein, I would think the big lesson from past failed US military adventures in Iraq and Afghanistan and now Russia in Ukraine is don’t get pulled into wars you are not sure you can win. And with respect to the war in Ukraine, the massive underperformance of Russian military kit, which is often a derivative for Chinese military hardware, would likewise raise doubts as to whether China could speedily win any war over Taiwan. China likely would want to further study the lessons of the war in Ukraine, particularly in terms of the use of drones before risking any similar venture over Taiwan.

Hence the war in Ukraine has reduced geopolitical risks around the US - China relationship, and I think also over Taiwan.

Our tour de geopolitical force moves on to the Middle East and the human tragedy which is the war in Gaza - a tragedy for both communities.

Risks of an escalation to a broader regional conflict appear overblown though as I think regional and global powers are acting to put guardrails on the key belligerents. Importantly neither the US nor Iran want this to escalate into a war between Israel and Iran which would inevitably drag in the US on the side of Iran.

The Biden administration, for its part, faces difficult elections in November and a broader regional war would push up the price of gas at the pumps - likely terminal for Biden’s re-election. A war with Iran would, meanwhile, further stretch US military resources from their current focus on Ukraine, Taiwan and helping Israel secure victory against Hamas.

The Iranian regime, for the part, has just survived a wave of political demonstrations, and perhaps mindful of reforms ongoing in the Gulf is eager to refocus on improving the economic outlook - perhaps through greater cooperation with the Arab Gulf states. A war would derail any hope of an economic revival and would risk military defeat by the U.S.

The Arab Gulf states themselves are focused on their visions of economic revival based on promoting tourism, logistics and trade in particular. A broader regional war would be terminal for these visions as it would project insecurity for the region.

Highly populated Arab states like Egypt, Jordan, and Iraq, face weak political and social settings and the turmoil of war, disruption to economies and likely a rise in anti-Western sentiment on the Arab street would not auger well for domestic political stability.

China is now a regional player, having signed various trade and cooperation agreements with Gulf states. But it’s interest is ensuring stable global markets, keeping commodity prices low/stable and securing trade routes. All this to keep the globalisation trade alive. Through its own channels to Iran it will surely be calling for moderation.

So most of the key actors here: the US, Iran, the Gulf and Arab states, and China have an interest in keeping a lid in the current conflict. Only Israel might see some benefit from escalation to a wider war with Iran, as a) it would secure assistance from the US in downgrading the Iranian nuclear threat; b) an extension of the war, and escalation to Iran, might help PM Netanyahu deflect from his own particular domestic political problems. But the US has some leverage still on Israel through its military backstop. And therein I think the U.S. has exerted maximum leverage on Israel to limit risks of an escalation to conflict with Iran, albeit I sense the quid pro quo has been giving Israel more leeway in its actions in Gaza. The ultimate price here is being paid by the poor civilians in Gaza, and those Israelis in the line of fire of Hamas and Hezbollah rockets. A longer war in Gaza might be the price of keeping Israel from escalating to a direct war with Iran.

Heightened tensions in the Middle East have also though brought some benefits to some states:

Gulf states, and oil states generally, have seen oil prices buoyed which has supported balance of payments and further filled sovereign wealth fund coffers.

And fears over wider social and political unrest across the Arab and Muslim street has seen economic bailouts for Egypt and Pakistan, and perhaps more generous financing for the likes of Tunisia and Jordan. Notable here that before October 7 the dominant market view was that Egypt’s finances were not sustainable, and a default or debt restructuring was likely and even imminent. With recent Gulf bailouts this talk has been put on the back burder and Egypt has seen the return of portfolio inflows.

It is worth perhaps here focusing on the new found importance and stabilising force of rich Gulf states and their deployment of sovereign wealth fund money as a source of stability, helping reduce geopolitical risk. Recent years have seen the rich Gulf states deploy financial support packages to Bahrain, Oman, Turkey, Tunisia, Pakistan and Egypt. A notable change in recent years has been that this financing has shifted from bilateral lending to meet geopolitical interests to financing to generate investment returns. From no real stings attached this funding now comes with conditionality - the introduction and maintenance of sound macro and structural reform policies. The Gulf states are reforming with their vision agendas, and they expect the recipients of their aid/financial support to do the same. The Gulf states expect to get their money back, with a financial return, which means they demand policy orthodoxy as a condition. This serves as a great stabilising factor - helping reduce geopolitical risk where applied. We can particularly see the positive impact of this in Turkey after the provision of a $51 billion financing facility from the UAE in the summer of 2023 which was in support of the orthodox economic policies rolled out by finance minister Mehmet Simsek.

In conclusion I have argued that when it comes to global geopolitical escalation some of the very worst case outcomes in the war in Ukraine have not transpired and some guard rails have been put around the conflict. Arguably European security has been helped by the conflict albeit at the price of Ukrainian blood but blame there the lies squarely with Russia. The conflict has also actually helped reduce tensions between the US and China, and reduced the near term risk of a Chinese invasion of Taiwan. The war in Gaza is a tragedy, meanwhile, but similar guardrails are in place which reduces escalation risks. I noted the stabilising role now played by Gulf states and, in particular, the conditionality they now attach to rolling out financial assistance to friends.

I am perhaps presenting a glass half full case, but I am acutely aware of the risks. In particular:

* A Trump second term would challenge many of those guardrails. While Trump espouses a policy of US disengagement and isolationism, many in the GOP are hawks on China and Iran. I worry that Trump would not be able to hold back those arguing to support Israel in a defining war with Iran which could undermine the delicate balance in the region. And on Iran I think there is currently a window for engagement with the Gulf states, centred on economic cooperation - perhaps best for the US to leave Gulf politics to those in the region who know it best. Western double standards on Israel and the Palestinian cause also risk a backlash and a risk of a new wave of radicalisation across the Muslim world and even into Western economies, giving new life to entities like ISIS.

* And on Ukraine I worry that Trump’s fawning admiration for Putin will see Ukraine sold short on financing and munitions. This could see Ukrainian military setbacks and perhaps we would need to revisit the risks to Europe in my scenario of what would have happened if Putin had succeeded in taking Ukraine at the outset of the invasion.

* I guess linked to the Trump presidency is concern over wider polarisation in Western societies, but particularly in the US, the US political dysfunction, risks around acceptance of the US election results, and a repeat of the insurrection that we saw in the Capitol Hill riots. The US is globally systemic, it is perhaps now the biggest global geopolitical risk factor. Is it possible that the US political system unwinds, with state on state actions/disputes?

* And on China I worry that the overconcentration of power around Xi, and the lack of checks and balances sees economic policy mistakes, perhaps combined with risks of an escalation of trade wars with the US under Trump, sees the Chinese economy underperforming and then Xi playing the nationalist card over Taiwan as a distraction for his economic travails at home. As with the US, China is now systemic to the global economy. If the US is going to aim to head off Chinese economic development to prevent it securing economic hegemony it needs to let the Chinese economy down slowly, or risk another gobal financial crisis which could make 2008 look like a kindergarten party.