The crisis in Ukraine was always a confrontation between Russian President Vladimir Putin and U.S. President Barack Obama.
In the opening round, Russia won a huge psychological victory by humiliating America’s NATO alliance as a military paper-tiger, annexing the Crimea and gaining amnesty for Russian supporters. In the next round, Putin will use diplomacy and economic warfare as tools to strengthen his position. In this war by other means, Obama is the deer in Putin’s headlights.
Russia added two million citizens, recovered strategic Black Sea naval bases, and gained access to vast off-shore deposits of oil and natural gas by annexing the Crimean peninsula from Ukraine. The U.S. and its NATO allies are now left with the “booby prize” of having to subsidize 42 million Ukrainians that are $72 billion in debt and overwhelmed by a $27 billion annual cash shortfall. Unfortunately, it is getting worse.
Moscow was Ukraine’s largest trading partner last year. Ukraine exported $19.8 billion to Russia, but imported $30.1 billion from Russia. Over half of Ukraine’s imports from Russia are hard-to-substitute oil and gas, but its top three exports to Moscow are easily replaceable semi-finished iron, hot-rolled iron, and iron ore. Moscow can further undermine Ukraine by restricting imports. Regardless, the Obama administration through the IMF or its allies are now funding Ukraine’s purchases of Russian energy.
Ukraine’s next biggest export customer is Turkey, with $4 billion in purchases. But as diplomats in Geneva were announcing a Ukraine stand-still agreement, Putin was speaking on the phone with Turkish Prime Minister Erdogan about preserving Russian-Turkish energy cooperation. Turkey is a member of NATO and is also one of Russia’s biggest energy customers, since it buys 60% of its gas from Russia. About 12.5% of that gas each year travels in a pipeline that crosses Ukraine.
The threat of a gas cutoff to Ukraine lit a fire under Turkey’s Prime Minister after Turkey was included in the 18 European countries to which Putin wrote a letter on April 10th noticing that Ukraine was overdue on $2.2 billion in debt payments and refusing to pay. Putin warned that if Russia’s state-owned Gazprom took “extreme measures” by cutting off gas to Ukraine, they might siphon off gas to downstream customers, including Turkey.
Moscow is also strengthening economic and security integration with its allies and neighbors. Russia, Belarus, and Kazakhstan are scheduled to sign a transition of their Customs Union into the Eurasian Economic Union on May 1st. Armenia said it will also sign the treaty in May to join the economic and military security bloc in 2015.
The Obama Administration claims U.S. and NATO member sanctions against Russia will cripple its economy and encourage capital flight. However, Russia has already survived similar sanctions after it invaded two provinces in Georgia in 2008. Russia’s GDP did fall by a grim 9.8% annual rate in the first quarter of sanctions but then recovered over the next six months as Russia sold more oil and gas to other customers.
Russia’s internationally competitive industries are energy and defense. Moscow is the biggest energy exporter in the world, and defense accounts for 20% of the nation’s entire manufacturing base. Given that both sectors always benefit from turmoil, China and India just announced deals to increase Russian imports of energy and weaponry.
Because of their dependence on Russian oil and gas shipments, Germany and Eastern Europe will remain economically linked to Russia. According to the London Telegraph, if Obama economically retaliates against Russia, he “risks endangering [America’s] own alliance system if it runs roughshod over friends.”
Putin is the master of a $2 trillion economy, vast natural resources, superb scientists, and a first-strike nuclear arsenal. He is skillfully using diplomacy with his friends and is threatening to engage in economic warfare with his enemies. Having played the strategic game poorly, President Barack Obama is the deer in Putin’s headlights.
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