Ukraine: A Perspective From Europe

The eminent historian Niall Ferguson in an op-ed for the Financial Times (Friday August 1^st) made a comparison between the events leading up to the start of WW1 and the Ukraine situation today. While the comparison is apposite given the 100-year anniversary of the former, these are very different times. The assassination of the successor to the Austria-Hungarian Empire in Sarajevo by anarchists was initially dismissed as a local difficulty in an obscure province, which had been annexed from the Ottoman Empire in 1906. While regrettable and unexpected to observers outside the Balkans there was no reason to suspect the chain of events that followed would lead to the greatest war in history.

It is still a mystery to many historians as to how and why this event led to the slaughter of nine million people, and this uncertainty is admitted in Ferguson’s article. But his analysis of different parties to the original event pursuing their own vested interests without a grasp of the bigger picture certainly rings true of the Ukrainian situation today with regards to the West, embodied in a disparate committee called NATO. The similarity with the chaotic diplomacy that led to WW1 stops there: Russia under Vladimir Putin’s leadership appears to have a good grasp of its objective.

The History Is Important

The relevant history of Ukraine and the interests of the great powers go back to the Second World War, when it was fought over between Germany and Russia with tremendous loss of life. When Germany was finally defeated Ukraine ended deep in Soviet territory. Stalin subdued all nationalism by executing dissenters or transporting them to the gulags rarely to return. There was a high element of ethnic cleansing, and this affects political relationships to this day.

It was inevitable that following the collapse of the Soviet Union Ukrainian nationalism would reassert itself. But Ukraine’s borders had never been fixed and its claim to be a well-defined state is dubious: at best it was no more than a federation of provinces that retained their individual identities over the centuries. Crimea was never part of Ukraine: it had been “gifted” by Khrushchev in 1954 it is said in a drunken moment. The eastern provinces of Luhansk and Donetsk are heavily populated with ethnic Russians. Luhansk held a referendum in early May and the organisers claimed that 96% of the population voted in favour of self-rule (allied to Russia) on a turn-out of 81%. A similar referendum in Donetsk claimed 88% in favour on a 75% turnout.

Putin distanced Russia from these referendums, asking the breakaway governments to delay them, there being at that time a degree of diplomatic cooperation between Russia and the other G8 nations. This has now evaporated, but Putin had at least tried even though he probably smiled on the result. And everyone has forgotten that imperfect though the polling process might have been (lack of international observers, alleged intimidation of minorities etc.) there can be no doubt the clear majority in these two provinces wish to secede to Russia.

Europe in the knowledge the referendum results were certain to back independence condemned this show of democracy when first proposed. European politicians have a fundamental problem with the idea that geographical parts of a country’s population might want political independence anyway. Think Basque separatists and think Scotland. So far as Brussels is concerned, the existence of individual member countries is a passing phase towards full political integration, so fragmentation is a retrograde step. What happened in Luhansk and Donetsk was counter to all the EU’s own statist ambitions which are behind the development and continuing integration of the EU. This sets the tone behind the automatic support Europe affords the Ukrainian government. Furthermore European politicians have an unquestioning belief in the benefits of EU membership and expect anyone who shares the EU’s socio-economic ideals to align themselves accordingly.

So on the political level there is a natural dialog between the Kiev government desperate to escape the embrace of the Russian Bear and the EU. On a military level relationships and geopolitical interests are managed through NATO, which is funded mostly by the US. And as the principal financial backer, America expects and usually gets the deference from Europe it wants. America’s military and strategic objectives are however very different from the EU’s economic interests, because the EU is dependent on Russian energy, other raw materials and trade.

There is however a military fly in the ointment so far as NATO is concerned. Ukraine is surrounded by Russia and Russian-supporting enclaves, including Belarus to the north and north-west of Ukraine, and the breakaway state of Transnistria, which lies along the border between Moldova and Ukraine. Only about 20% of Ukraine’s borders are with NATO allies. NATO simply cannot afford to have boots on Ukrainian soil, because its supply lines can be cut off by Russia. Perhaps for this reason the approach favoured by the west has been to undermine the Ukrainian relationship with Russia by encouraging Kiev towards both economic and military cooperation with the west, rather than upping the west’s presence.

The Russian Dimension

Russia’s reactions to NATO and the EU’s policy ambitions towards Ukraine have been perfectly logical and could easily have been foreseen by any competent analyst. In this context there are two elements to consider, Russia itself and the personality of President Putin.

The Russian people have enjoyed a significant uplift in their standard of living under Putin, and a new middle class has emerged, which is growing and becoming wealthier by the day. Unlike more advanced, welfare driven economies this improvement has been real and not degraded by ever-accumulating debt. There is much that is wrong in Russia as western critics continually tell us, but the fact is that Russia is economically more resilient than its western counterparts, and her people are thankful and loyal to a strong leader.

This strength is seriously underestimated by western economists who have been brought up in the ivory-tower world of Keynesian and monetarist economics. This is why they mistakenly think cutting Russia off from western capital markets is a severe punishment. It is not: the Russian leadership are not dependant on access to debt finance, not intimidated, and they feel no need to hurry their responses. Putin’s advisers are fully aware that implementing sanctions will harm NATO members far more than Russia, and nothing done so far is likely to affect their minimum objective of ensuring Ukraine does not become a vassal state of the west.

Now that Russia has recovered her identity following the fall of communism her people naturally wish to secure and enhance it. They see their own “flesh and blood” in Luhansk and Donetsk being subjugated by a corrupt Nazi-sympathising Ukrainian regime. They know that America and NATO have been actively undermining Russo-Ukrainian ties having supported first the Orange Revolution and more latterly the fall of Viktor Yanukovych earlier this year. They also know that the west supported the neo-fascists in Yanukovych’s overthrow, reviving for the Russians memories of the terrible losses inflicted by the Nazis in the Second World War.

At this stage to counter economic threats Russia is generally content with sending signals that she is not dependent on the west for trade. To this end she has concluded pan-Asian energy deals with China and India, deals that were in the pipeline, so to speak, anyway. Russia is activating her relationships within the Shanghai Cooperation Organisation (the SCO), which was set up with China twelve years ago for this purpose. Furthermore, the population of full SCO members is set to double to over 3.5 billion people in September, when India, Pakistan, Iran and Mongolia become full members.

Putin’s Personality

President Putin, like many of Russia’s political in-crowd and some of the supporting oligarchs, is an ex-KGB officer. By all accounts he is controlling, hard-working, focused and dedicated. He is 5’6” tall which compared with western male leaders is noticeably short (though his Prime Minister, Dmitry Medvedev is only 5’3”). Short men often feel a need to assert themselves in the company of taller men, and Putin appears to exhibit these traits, with his annual holiday pictures depicting him as an action-man. As judo black-belt he throws larger men with ease and has been deliberately filmed doing so.

Putin is a man who the west turned its back on when he would have personally wanted to be accepted at the top-table of world leaders. This is the second time: the first was the spat with the UK over the murder by polonium poisoning of an ex-KGB officer, Alexander Litvinenko, in London in 2006. The Russians refused extradition requests for the principal suspect, Andrey Lugovoy and four others. In July 2007 Britain expelled four Russian diplomats.

It took a long time for the dust to settle from the Litvinenko affair, and it was only in the last eighteen months that the UK went out of her way to repair foreign relations with Russia, putting the Litvinenko affair behind it. So when the Ukrainian crisis broke six months ago there were very few entrenched vested interests at the political level between the UK and Russia, and therefore little invested on the British side to maintain relations.

The western view of Vladimir Putin as portrayed by the media is often very wide of the mark. And it is with some irony that we observe left-wing European politicians denouncing this pragmatic ex-communist, but their instincts, that he is a modern mercantilist are correct. His wealth and position are built on the wealth of his people: socialism’s power by contrast is derived from wealth destruction, which explains much of the political divide. While European socialists have no coherent political and economic philosophy, Putin is a realist. He doesn’t care who he deals with, so long as the profit, or reason, stacks up. And it is Russia’s vast natural resources, making her the world’s largest exporter of energy and with monopoly or duopoly power in a range of strategically important elements that gives him the power to forge a favourable political settlement anywhere he chooses.

We should think of Putin as the ringmaster in control of the Mackinder Heartland, which Mackinder summed up as follows:

Who rules East Europe commands the Heartland;

Who rules the Heartland commands the World-Island;

Who rules the World-Island controls the world.

The Heartland runs from the Volga to the Yangtze, and the World-Island is the inter-linked continents of Europe, Asia and Africa. Halford Mackinder’s paper was presented to the Royal Geographical Society in London in 1904. Since then the Russia he knew has been destroyed twice, once by the October Revolution of 1914 and once by communism. Yet still Russia survives, her power remains, and Putin is now master of it all.

The Consequences for Western Europe

The greatest concerns over Russia’s actions come from the countries that were previously suppressed by the Soviet Union and are proximate to Russia. These include Poland, the Baltic States, and ex-members of the Austrian-Hungarian Empire in middle Europe. Twelve of the twenty-eight NATO members were former communist satellites and very sensitive to Russia’s real or imagined territorial ambitions. They are a large bloc in voting terms, a frightened group sometimes aggressively supportive of intervention.

The other main category of European states is the welfare economies of the original European Union, some of which have significant economic and financial ties with Russia. Best known in this group is Germany, dependent on Russia for 38% of her gas, 35% of her oil and 25% of her coal imports. There are no suitable alternatives in sight that could cover shortfalls of these magnitudes. Short-term, some extra gas could be piped from the Netherlands and Norway, two of her other import sources; but this is North Sea gas which is being rapidly depleted and demanded by other customers. Fracking from shale rocks is possible in North Rhine-Westphalia, but this takes time to establish and strong environmental opposition would have to be overcome. Then there are the commercial energy deals. Gazprom and Germany’s Wintershall, a subsidiary of BASF, have executed a large share swap. They jointly own Germany’s “Gascade” 2,000 km pipeline and Russia through Gazprom now controls all Germany’s gas storage facilities.

Naturally, an increasingly wealthy Russian middle class buys large quantities of Mercedes, BMWs and VWs. Furthermore, Russia imports from Germany chemical products, food and agricultural products. It is estimated that one in ten German exporters traded with Russia last year exporting €36bn worth of goods. German companies have invested €16bn in Russia.

France and Italy export about €10bn each to Russia, and import €11bn and €18bn respectively, mostly energy. France has also built one Mistral Class helicopter carrier which is undergoing sea trials and crew training, and a second carrier is in production. At President Holland’s insistence, this deal is excluded from the EU’s arms embargo: a good litmus test for the degree of EU solidarity.

Western Europe’s banking system also has significant exposure to Russia. French banks have an estimated $50bn, Italian $28.6bn, German $23.7bn, British $19.1, Dutch $17.6, Swedish $14bn, and Swiss $6.8bn out of an estimated $184bn, or 76% of total foreign bank lending to Russia. Individual banks with high exposure include France’s Society Generale with $30bn, representing half this highly geared bank’s equity. Unicredit of Italy has exposure of $25bn, representing 40% of its shareholder funds. These are two prominent examples of potential casualties in a financial war with Russia. Furthermore European corporates also have substantial investments in Russia, notably BP.

It is clearly not in the interests of the long-standing members of the EU to escalate a ‘sanctions and financial conflict’ with Russia. The European Central Bank will have almost certainly discussed contingency plans with the major regional central banks in the Eurozone, because the banking system might have to make available special credit and financing facilities, i.e. a rescue from a financial crisis if NATO goes much further down the sanctions route. This is why politicians are walking on eggshells, paying lip-service to America and the scared Eastern fringe members of NATO while hoping this goes no further.

So long as this is the case it is clear that NATO members are powerless to stop Russia from wresting control of all or parts of Ukraine from the government in Kiev. Putin knows this; unfortunately it is not clear to us that the American government does. All in all it seems likely that after a period of slow-burn as Putin dictates the pace of developments, the political situation in Ukraine will deteriorate with some unhelpful nudges from Russia.

In Part 2: The Rise of the East, we outline how the Ukrainian situation is likely to develop. Spoiler alert: Russia has a hand full of aces.

And on a higher level, we explore the growing commitment in the East to charting its own course, one much more separated from western influence than seen in the past century. Increasingly, the East is challenging why the needs of its population of 5 billion should be so deferential to the West’s 1 billion.

Click here to access Part 2 of this report (free executive summary; enrollment required for full access)