The Cold Economic War

by: Herve van Caloen


A new economic war is already in full swing.

Germany' Merkel is the new leader of the free world.

A new investment paradigm with new winners and losers.


On 12 March 1938, Hitler's troops crossed the Austrian border and marched to Vienna. In a blink of an eye, the German-speaking Austrians were united with their northern cousins. A plebiscite was held a month later, which revealed that 99.75 % of Austrians had always dreamed of becoming part of the great German nation!

The markets sold off after this blatant violation of a country's sovereignty. The S&P lost 20% in two weeks before bouncing back. By October, it was 60% above the low reached on April 1.

Markets want the status quo above all. After the annexation of Austria, Hitler's appetite seemed to be satiated. Europe's map had changed a bit, but investors believed there would be no further invasions. Stock markets recovered. Too bad the movie didn't stop there.

The Crimea and Ukraine.

The Crimea is a financial basket case. So, why would the Russian people care about this desolate little island? Even the military does not need Crimea for so-called strategic reasons. With the Russian navy firmly anchored in Sebastopol, it is ludicrous to believe there was even a remote possibilty of the Ukrainians trying to dislodge the world superpower from its base in the Black Sea.

It is hard to believe that the master in the Kremlin himself cares much about Crimea. What he is eyeing is the real prize: Ukraine - at least that part in the eastern part of the country that used to be called New Russia. But for now, markets don't seem to think that Putin will go on to grab anything else. They seem to believe that the European map has changed a bit, but there will be no further invasions.

Putin is No Hitler.

Isn't it convenient to convince oneself that Putin will go no further? He is too smart to invade all the former Soviet countries, isn't he? He is no Hitler, don't you agree? History doesn't repeat itself, does it? Markets no longer price in risks, they deny them. In today's environment, the only perceived risk is missing out on the next bull run.

Unfortunately, history does have a tendency to run in circles. Some patterns are recurrent and a vacuum always needs to be filled. We do not know where this is going to end even though another military move from Putin should not be dismissed out of hand. But that would most likely not affect markets for long either.

What is worse for the world economy, and eventually for companies' profits is a trade war, declared or undeclared.

The Cold (Economic) War.

So far, Western leaders are treating Russia as the kleptocracy it truly is. US and European leaders are punishing the kleptocrats, not the Russians. This may work, but it is difficult to believe such a response will not escalate into an economic war. Tit-for-tat is going to continue until someone throws in the towel.

My money is on the West to cave first. By then, it probably would not matter anymore. It would not prevent trade with Russia to substantially fall. Instead of an outright trade war, one should expect something more like a cold war attitude. Europe will reduce its supply of energy from Putin and his cronies. They, in turn, will try to boost sales to China. European companies will put investments in Russia on hold. Countries, like Switzerland a few days ago, will cancel free trade negotiations. The French will sign fewer contracts of sophisticated arms, and so forth.

A Reluctant Leader of the Free World: Angela Merkel.

Obama's America has reverted to an old tradition of isolationism. The US is determined to lead from behind in a crisis that seems so far away from our shores. At best, the US is willing to consider a gradual escalation of sanctions.

Already, the French and the British are bickering about who should bear the pain of sanctions. The latter are telling the French to cancel large defense contracts with the Russian Bear. The French retaliate by advocating a freeze of Russian assets in the City of London. Both agree that the burden should be shared by the Germans. Since Germany (and The Netherlands) are the biggest importers of Russian LNG, France and England argue, a better way to punish Russia is to turn off the spigot.

This leaves Merkel in charge of defending the free world, albeit reluctantly. With American retreat, British selfishness and French pettiness, Germany has no choice but to step in.

Here is a country that seemed happy minding its own - very profitable - business when the euro crisis forced it to throw its weight around to save Euroland. Today, again, Germany is indispensable. The world needs Germany to save the world from Putin's megalomania.

Theodore Roosevelt am Rhein.

Chancellor Merkel believes in quiet diplomacy. She speaks softly, but she carries a big economic stick. Germany is the largest economy on the continent. It is Russia's most important trading partner. Russia may be a military superpower, but it remains an economic pigmy entirely dependent on a few basic industries. As Chancellor Merkel pointed out last week, German bilateral trade with Russia (76 billion euros) is not worth much more than German trade with the Czech Republic (60 billion euros), a much smaller country.

German Vulnerability is Also Its Leverage.

Germany imports roughly 22% of its primary energy supply (i.e. oil, gas and coal) from Putin and his cronies.

On top of large companies like Volkswagen (OTCPK:VLKAY), Daimler (DDAIY) or Siemens (SI), more than 6,000 medium sized German companies are actively doing business in Russia. In short, Germany has leverage. Will it have the courage to use it?

The Cold Economic War Is On.

Putin is likely to win the first round. He is already adjusting the subsidized gas prices sold to Ukraine to market levels. Since Ukrainians are unable to pay, the West is stepping in. Our help to Ukraine will thus go straight into Putin's coffers.

However, bit by bit, VW (OTCPK:VLKAY) or Siemens will get out of some contracts, fail to renew others and close some facilities. Already RWE, Germany's second largest utility, decided to sell its oil-and-gas production unit to Mikhail Fridman, the Russian billionaire. Switzerland is chipping in. The Swiss halted free trade talks with Russia, proving that the cold trade war is already in full swing.

Russian money held in custody by the Federal Reserve Bank has surely been repatriated by now. It did not go unnoticed that in the week from March 5 to March 12, US bonds held by the Fed dropped $104 billion. Russians are unlikely to buy our Treasuries for a while.

The risk today is that a gradual escalation of sanctions could evolve from these economic skirmishes into an all-out trade war, or worse.

Some winners and losers.

The biggest loser is the BRIC acronym. Russia is no longer up-and-coming. Other losers include global growth, the G8 or globalization. ( I wrote an article about the end of globalization one year ago, but this is the last nail in the coffin.

Winners include Norway and Georgia. The former will benefit from a boost in demand for non-Russian LNG. The latter's pipeline linking the Caspian Sea with the Black Sea has greatly increased in value.

Other winners could include certain capital goods companies. It makes sense, for example, to expect President Obama to speed up approvals of more LNG terminals, which require large investments in special port facilities. Some European countries are also likely to overcome their strong resistance to fracking. The UK, Poland, Germany or France are believed to have large shale gas reserves under ground.

With tensions mounting in Eastern Europe as well as Asia, defense related companies are likely to command higher valuations. MTU (OTCPK:MTUAY) in Germany, Rolls Royce (OTCPK:RYCEY), Airbus (OTCPK:EADSY) or even Mitsubishi Heavy (OTCPK:MHVYF) in Japan and Boeing (NYSE:BA) have to be looked at with this in mind.

Other obvious losers include companies with large operations in Russia, including Pepsico (NYSE:PEP), Danone (OTCQX:DANOY) or Renault (FR:RNO).

In conclusion, the post-cold war global expansion is over. The pendulum has swung back. Already emerging markets are reflecting this.

Disclosure: I am long MHVYF, RYCEY, MTUAY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.