The indisputably dramatic events in Ukraine in recent months seemingly presage an East-West confrontation reminiscent of Cold War days. Putin looks to us like a global thug. However galling Putin's annexation of Crimea and build-up of forces east of Ukraine, however, I ultimately expect this tempest to be obscured by a more significant Russia story-namely the emergence of an economic battlefield pitting the U.S. and North America against a Russian, Chinese and German axis.
Yes, Germany. While Ukraine grabbed headlines, another little noticed story could potentially prove much bigger. On March 28, amidst the Ukraine crisis, China's President Xi visited Duisburg, a middle-sized Germany city of half a million people, a large pig iron producer and also-the big lure for Xi-the world's largest inland port.
Two years ago the so-called Yuxinou train, roughly eight football fields long, weekly traveled the 6,800 miles from Chongqing, China's central industrial hub, to Duisburg, laden with goods. Now, it runs three times weekly and-to accommodate a sevenfold increase volume since 2012-soon will go daily. Now Germany's third-largest trade partner after the Netherlands and France, trade from China could by 2020 well surpass that of Germany's two geographically closer neighbors.
Yuxinou, a joint venture of Russian Railways with Germany's Deutsche Bahn, should prevent Germany from playing too tough with Russia. Otherwise, it risks losing a major source of trade, the one with the greatest growth potential. In an economy dependent on trade for its growth and well being, that prospect would not be taken lightly.
Notwithstanding the verbal rebuke Merkel gave Putin, I don't think Germany's premier will act all-out to undermine him. This makes the U.S. much weaker vis-à-vis Russia than our leaders might assume. For the same reason, Putin probably won't aggravate Merkel's difficulties by invading Ukraine. Can he really risk it?
Germany's economic self-interest requires it to maintain a stable relationship with Russia. The apparently genuine rapport and friendship between Putin and Merkel does not hurt. Each fluently speaks the other's language, and they talk frequently.
With time, I expect a strong Germany-China-Russia nexus to grow ever more influential, increasing disadvantages for the U.S. and its economy. For one thing, this could hasten the dollar's loss of reserve currency status, a topic I've discussed previously. Within a few years, I reasonably expect the U.S. dollar to play a relatively minor role among the world's currencies, with China's yuan, Germany's mark, Russia's ruble-and gold-assuming more important places. Gold and other precious metals should win big, along with other commodities-especially oil-whose dollar price would soar. Inflation, now more or less off-the-radar, would then surge.
I don't consider this change imminent but will keep a close eye on the situation.
Another factor to blend into this strange Russia, Germany and China mix is the sharp recent jump in Iraqi oil production. In March, various international energy agencies reported that Iraqi oil production reached 35-year highs.
Incremental production derives from development Rumaila and West Qurna, Iraq's two largest oilfields, the latter controlled by Russian oil giant Lukoil (OTCPK:LUKFY). Iraq's other international players include Exxon (NYSE:XOM), Norway's Statoil (STO), and China's two oil giants, PetroChina (OTCPK:PCCYF) and CNOOC (NYSE:CEO). The Russian and Chinese companies retain the major edge in violence-wracked Iraq, however, given their access to paramilitary protection. (Such protection has also allowed China to successfully mine copper in Afghanistan even as the U.S. waged a war costly in both lives and treasure.)
Germany and China both need Russian oil and gas exports to build their respective renewable energy infrastructures. Russia's rich conventional oil and gas reserves aside, any additional oil obtained from Iraq or elsewhere could significantly bolster its global strategic position.
Russia faces its potentially most difficult geopolitical task in the Middle East, given that region's dearth of win-win situations. Producing oil in Iraq, for example, while adding to overall global oil supplies, indirectly harms Iran, whose friendship Russia eagerly wants to cultivate. Similarly, Russia's relationship with both Iran and Syria's Assad government sticks in the side of Saudi Arabia, with which Russia also obviously wants to keep close ties.
Highly speculative rumors hold that Russia could circumvent sanctions on Iran via goods-for-oil barter. American journalist Brooklyn Middleton suggests that any such deal could include some parts for nuclear facilities. After all, Russia has already proven an integral cog in Iran's nuclear program, supplying both parts and engineering expertise. Such a deal could dissipate Iranian anger stirred by Russia's work in Iraqi oilfields. Ironically, it could also make Russia the one country able to categorically prevent Iran from developing nuclear bombs. That upshot would cause the Saudis to heave a tremendous sigh of relief. China, already strengthening its ties with the Saudis, would also reap increased influence by virtue of the Russian-Chinese nexus.
Whatever happens, a few basic questions highlight the growing economic isolation of the U.S. from major Eastern economies. Germany looks likely to consider Russia-a key energy supplier and critical link to China-more critical to its long-term growth than neighboring France, a leading trading partner, or. I thus expect an emerging Germany-China-Russia bloc to increasingly compete with North America.
If I'm even partially correct, to remain relatively competitive, the U.S. must become energy independent. It therefore must increase fracking and other unconventional sources of oil. Otherwise, the only other potential route to U.S. energy independence: a dramatic cutback in our standard of living (and indeed statistics since 2000 suggest that is exactly what is happening).
I hope I am wrong, but I don't think fracking can sustain much long-term growth. As with so many other commodities, once developers pick the low-lying fruit, scaling the proverbial tree grows increasingly costly. The energy required to extract hydrocarbons via fracking already increasingly stifles U.S. living standards. But for now, the U.S. must continue fracking, something I expect to continue a while longer.
Investors can profit in part by betting on products and services to help produce unconventional energy. The rails, for example, serve a critical role, transporting both materials needed for fracking and oil produced. Union Pacific (NYSE:UNP) and Canadian Pacific (NYSE:CP) are two strong choices. I also like Wabtec (NYSE:WAB), the leading provider of parts to railroads. Likewise, I expect growth from the major oil service companies, including National Oilwell Varco (NYSE:NOV) and Schlumberger (NYSE:SLB).
Despite China's head start, even U.S. renewable energy development offers some hope. Berkshire Hathaway's (NYSE:BRK.A) (NYSE:BRK.B) MidAmerican utility subsidiary provides the nation's largest supply of renewable energy. Berkshire also owns the best-financed major U.S. railway, Burlington Northern. More speculative plays include Solar City (SCTY), which could become a national model for U.S. mini smart grids.
Investors should also own gold and other precious metals as a critical hedge against the dollar's loss of global monetary hegemony, a highly predictable consequence of Eastern success.
Finally, I advise readers to ignore all stories purporting to prove that China is in dire straits. Instead read Sun Tsu's ancient Chinese military classic The Art of War and acknowledge that the book has lasted millennia, longer than Christianity. It provides an effective guide to China's current strategy. China is probably most content to showcase its weaknesses and it may experience a tough year or two. For 16 of the last 18 centuries, however, China lead the world economically. Unfortunately, it will lead again in coming centuries too.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.