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Stumbling Towards Apocalypse - Russia and The New World Disorder (Part 2)

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George Orwell – Call home

Like poison gas, propaganda is an exceedingly dangerous weapon to deploy – any shift in the wind blows it back onto its own side. Just as successful drug dealers never consume their own stash, governments must be exceedingly careful to ensure that their propaganda is treated as an export commodity – failing that, the narratives concocted for foreign markets and the local populace are consumed by policy-makers who then stumble into egregious political blunders: diplomats lie to journalists – then they believe what they read in the press, forget that it was they themselves who concocted the narratives.

History is replete with examples: the defense of the Czech working class against Western aggression, the Cuban populace awaiting the chance to rise up and overthrow Fidel, support for the Vietnamese Domino against Chinese expansionism, saving Germany’s vital Lebensraum from the Capitalist and the Jew – most recently, Russian expansionism and desire to reconstitute the USSR. All convenient myths – intended to justify an aggressive, militaristic policy and to drown out the few voices of reason.

<--pagebreak-->Declining empires are by far the most dangerous – sensing history snapping at their heels, they are apt to react impulsively, misjudging their own strengths and the relative threats represented by their rising adversaries. Following a triumphant end to the millennium just past, the American Empire is once again wounded in its pride – having failed to redeem Saakashvilli’s desperate gamble in Georgia, and with its Middle-Eastern policy an utter shambles, it now finds itself unable to reverse Russia’s reunification with Crimea.

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A match made in Washington

Though faced with a far more formidable adversary – a rising and revisionist China – any attempt to seriously confront China would be prohibitively expensive and almost certainly doomed to failure; thus, they ignore the Dragon to goad the Bear. Following the law of unintended consequences, what has actually been achieved is something which evaded policy makers in Moscow and Beijing for decades: an increasingly close alliance – economic, diplomatic and military – between these two highly-complimentary giants, a pole of attraction for numerous third countries seeking a viable alternative to domination by a wounded but still overweening Empire.

Sanction me – Again!

It has been said that insanity consists in doing the same thing over and over again in the hope of achieving a totally different outcome. Following this principal, despite the utter failure of the sanctions regime, Washington/Brussels can do no better than to threaten to increase them yet again.  

The dawning of the nuclear era has profoundly altered the nature of warfare – wars between major powers are now fought not with fighter planes and tanks, but with economic weapons – financial sanctions, investment flows, trade finance, loan syndication. Despite the overheated rhetoric the likelihood of a military intervention in support of Kiev is precisely nil. Devoid of any military option, and unable to sit quietly and do nothing, the Western powers must invent a publically saleable justification for their sanctions regime.

Sanctions hurt Europe more than Russia

The Washington narrative was always that, by causing enough pain to the oligarchs and/or the Russian people, they themselves would rise up to storm the Kremlin. Needless to say, this policy – based upon a comical misunderstanding of the Russian political dynamic – has proved a wretched failure. Mr Putin’s approval rating has soared into the high 80s, as the populace instinctively rallies around the flag, whilst not a peep of protest has been heard from the oligarchs who – perhaps mindful of the example of Khodorkovsky’s severed head impaled outside the Kremlin wall – are deeply disinclined to be seen siding with the foreign aggressor.

The sanctions have arguably caused more damage to Europe than to Russia – which runs a large current account surplus and has foreign reserves adequate to fund all debt redemptions for the foreseeable future (though capex will be at least temporarily impacted).

Following the counter-sanctions, Russia – previously the top growth market for European agricultural exports – has now totally replaced European food imports with a mix of domestic import substitution and new Latin American and Asian suppliers. The WSJ – not a source usually considered to be friendly to the Kremlin – cites estimates that the sanctions will cost Russia about $1bn, while Russian countersanctions will cost Europe some $10bn.

With the memory of the repeated disasters of the 1990s still relatively fresh in her peoples’ minds, Russia is deeply resilient – the current relative prosperity is a very recent phenomenon, whereas Europe’s ability to tolerate economic chaos while retaining social stability is, at best, untested.

Ukraine is a matter of existential importance to Russia and there is nothing the West can do to force a fundamental change in policy. All of the saber rattling achieves is to further entrench the split between Russia and the West to which it recently still aspired.

Russians are tougher than the West realizes


Despite the shrill headlines, there is no “New Cold War” – the Cold War was a war of ideologies. Instead, we are seeing a classical, 19th-Century struggle for imperial domination. We must hope that Kiev does not replace Sarajevo, for if it does, we shall indeed have attained “The End of History” – though not quite as intended.


How to trade it:  Back to the Future: Buy the bonds

The author is reminded of nothing so much as the situation in the aftermath of the 1998 Russian debt crisis, and again following the American subprime crisis of 2008. Prices and liquidity have collapsed in the Russian market, leaving some very good assets orphaned.

While the equities and the ruble are unarguably cheap, those are trading markets, requiring considerable focus and dexterity to get out in one piece – furthermore, stagnation of the G7 economies has a significant knock-on effect on Russian GDP growth, thus we are far more comfortable enjoying the carry in the fixed income sector.

Russian Eurobonds offer a totally lopsided risk-reward ratio: given the huge Forex reserves and the clear commitment of the Central Bank to supporting any corporate issuer impacted by the unlawful Western sanctions, the default risk on both the financial and the industrial sectors should be very close to nil.

Current pricing is more a function of market microstructure than of underlying risk – market-makers currently do not make markets, bank trading books are flat and margin lending has been slashed – assets yielding 3-4% 6 months ago now pay 400 bp more absent any deterioration in their fundamentals (indeed, with the Russian Central Bank converting 2008-vintage bailout loans to equity, it could be argued that the fundamentals have improved significantly).

Risk-averse investors should look to the Russian state-owned banks – Gazprombank and Sberbank are two favorites. In the industrial sector, the mobile carriers MTS and Vimpelcom, as well as Severstal (steel) and TMK (pipes) offer yields in the high single digits. Those willing to take more volatility should consider the better Russian mid-tier banks – e.g. Alfa, Nomos/Otkritie and Promsvyazbank – the latter two are currently yielding above 10% in the longer maturities.

Finally, an old favourite of ours – the totally aberrant agency ratings for the main Kazakh banks, especially KKB but also BCCRD and ATF, constitute a very attractive mispricing for yield-seeking investors.

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