Only deep structural reforms can stave off defeat
When King Pyrrhus of Epirus stood on the Italian coast surveying the battlefield of Asculum where he had just defeated the Roman army in 279BC he famously said: “If I have another victory like that I will return to Epirus alone.”
Epirus is in the modern day Balkans and Pyrrhus was the first serious challenger faced by the growing Roman Empire, which very nearly lost to the Illyrian fighting forces.
The Romans won in the end thanks to their ability to simply out-resource all their opponents: if an army lost they simply drew on their massive and growing hinterland to raise another one. They wore their opponents down into eventual defeat – even if that took years to accomplish. The Romans were later challenged by Hannibal in the second Punic war and unable to defeat the wily general, but again they out-resourced him and Carthage was eventually raised to the ground.
The US is in a similar position today and that is what worries the emerging markets that are rapidly catching up with the western world.
Like the Romans, the US has built a military-industrial economy that can massively out-resource all its opponents’ and so is impossible to defeat – a legacy of the rapid militarisation during WWII when it simply out produced first the Nazis and then the Soviet Union, the only other country on the planet at the time with any chance of matching the US’s industrial might.
Like the Romans, the US will have its share of vain and incompetent leaders and US President Donald Trump has become an international laughing stock, with other politicians openly mocking his stupidity.
Rome screwed up regularly in its fights with Hannibal. The most famous was the battle by lake Trasimene, where Hannibal lured the Roman general Gaius Flaminius into a trap by playing on his arrogance and drove the Roman forces into the water where most of them drowned. Hannibal lost a handful of soldiers. The battle is still taught at West Point and acknowledged as one of the most stunning military victories of all time. But Hannibal lost in the end, defeated at the battle of Zama outside the Carthaginian gates.
The US imposed new sanctions on Russia on April 6 that have ended in a Pyrrhic victory as they seem to have done as much damage to US business interests as Russian.
The new US sanctions that singled out Oleg Deripaska and his Rusal and other companies in the Specially Designated Nationals And Blocked Persons List (SDN List) has been a “game changer”. Previous sanctions stopped those listed from issuing new shares and bonds, but the new sanctions forbid US investors from owning existing securities and gave them just 30 days to sell (the deadline is May 7).
The upshot as been chaos on the aluminium market where prices soared to record highs, and wails of pain from US pension funds, among others, that not only hold these securities, but following Russia’s upgrade to investment grade earlier this year, have to own some Russian assets.
It has taken two weeks, but the US Treasury Department (USTD) that oversees the sanctions regime was forced into an inglorious climbdown this week and has given investors five months to unwind their positions, which will still be hard as the problem remains: who are you going to sell them to?
But the sanctions seem to have worked if their goal was to change Russia’s behaviour. Russian President Vladimir Putin has ordered his media machine to tone down its anti-American rhetoric and the buzz of diplomatic activity suggests that both sides are looking to find a new deal. This was no Pyrrhic victory for the US after all, but has been an expensive one, so expensive that the USTD is unlikely to extend sanctions to more oligarchs for the time being.
How much have the sanctions cost Russia? It’s hard to say. Russia’s oligarchs immediately had $16bn wiped off their wealth as stocks fell in panic selling after the sanctions were announced, but the stocks have since recovered much of the ground lost.
This week the Central Bank of Russia (CBR) said that the banking sector will lose RUB100bn ($1.6bn) as a direct result of the sanctions, due to revaluations and currency effects. But if you start adding in the IPOs and SPOs that are already being delayed and the investment that won’t come the cost is a lot higher. bne IntelliNews totted up some obvious costs in an editorial recently and came up with the number: $150bn.
Russia can weather a blow like that. It has $450bn in gross international reserves (GIR) and with oil at about $75 per barrel, after the deleveraging and cost cutting of the last three years Russia Inc is back in profit; the country can live without international financing and as such is sanction-proof. Indeed the irony is thanks to the sanctions the value of Russian debt has plummeted so Russian companies have started to buy back their bonds at bargain bucket prices, which makes them even more resilient to sanctions than before. This week oil major Lukoil announced it was buying back $1.5bn worth of its own bonds.
Europe’s Pyrrhic victory
Both Putin and Trump are willing to pick up these huge bills in their geopolitical standoff. The big loser in all this is Europe, which is facing a Pyrrhic victory in a war it didn't start.
The Russian-German Foreign Trade Chamber has just conducted a survey of 154 companies working in Russia and concluded sanctions could cost these leading companies €1.5bn.
"Short-term losses are estimated by the survey participants in the current fiscal year in the hundreds of millions of euros, and may amount to €377mn." The medium-term losses will amount to at least €820mn, according to conservative estimates. In the worst case scenario, it may total almost €1.5bn, the report said.
This is just the direct cost of sanctions. When you start counting in all the secondary affects, like the bne IntelliNews calculation, you quickly get to a figure that is ten times the size. Both the Kremlin and Brussels have estimated the cost of the retaliatory agro-sanctions imposed on Europe by Russia at some €100bn in lost revenues, jobs and the like – a number that is based on the fall by a third in Russian-EU trade since the crisis began with the annexation of Crimea in 2014.
Unlike the US, Europe doesn't have a military-industrial economy but is dependent on free trade and profits. It can’t and won’t weather protracted military standoffs. It wants a compromise so it can go back to business. This puts it at odds with the US policy, which will drive a wedge in between the allies – something that Putin is well aware of and will exploit.
But at the same time Europe has signed up to the Cold War security doctrine where it sits under the US security umbrella so that it doesn't have to invest in its own EU standing army or hugely expensive nuclear weapons research. All these relationships are now changing and something will have to give.
And Germany bears the lion’s share of these losses as Russia’s biggest European trading partner and the most heavily invested into the Russian economy.
German Chancellor Angela Merkel is due in Washington on April 27 to meet with Trump and is expected to argue strongly for scaling back or freezing the current sanctions war as, unlike the US, Germany is heavily exposed to the Russian economy.
In another parallel to the Roman analogy, the US is increasingly following a policy of “Carthago delenda est” – Carthage must be destroyed. Even after the Romans won the second Punic war and imposed crippling reparations on the city, the Romans became obsessed with it and were just looking for a chance to go to war again and finish the job. The same jingoistic attitudes were prevalent as those today towards Russia. The Roman’s thought of Carthaginians as venal and vain, made them the butt of jokes and derogatory attitudes were the norm.
This was despite the fact that Rome became heavily dependent on Carthaginian high quality goods and later its abundant supplies of grain. (History repeats itself: Russia is now the world’s biggest exporter of wheat and expects exports to double this year.) The city flourished under the Roman yoke and was able to pay off its fine very quickly. When the Romans did finally destroy the Carthaginian empire, historians took that as the beginning of the fall of the Roman empire as the removal of a serious rival lead to arrogance and decadence that rotted the empire away from the inside.
Russia is not in the same place as Carthage, which was a nation of entrepreneurs and artisans. But like Hannibal, Putin has shown himself to be a wily tactician and Russia has a few spectacular war-elephants like the Amator main battle tank, the S-400 surface-to-air anti-missile system and the SU-37 fifth generation fighter planes. If you attack Russian forces it is not going to go well for you, even if you are going to eventually win.
However, Scrpio Africanus defeated Hannibal by not engaging with him but harassing him and waiting for economic pressures at home to mount. Russia doesn't have the US resources and will sink into stagnation unless deep structural reforms are put in place. Putin has just announced a $162bn spending spree on the social sphere, but few Russian observers have much confidence that Russia will suddenly transform itself in such a way that this money is spent efficiently. Russia will defeat itself in the long run if Putin stays at the helm. The US just needs to bide its time (and perhaps wait for some better generals to come along).
SourcE: bne InteliNews