Balancing The Interests of Moscow and Mins

Chapter 21
“F*** THE EU”:
efore2008 the driver of crisis was expected to be the balance of
financial terror between the United States and China. A huge
unwinding of the global disequilibrium centered on China and
Americaand driven by profound domestic imbalances in each of them
would,itwasfeared, rock American power to its foundations. In 2008 the
expansionofthe EU and NATO in the face of Russian opposition had added
anotherdimension of risk. Georgia and Russia had clashed and Moscow
hadapproached Beijing to mount a joint attack on America’s fragile fiMances. Beijinghad held back. There was no great dollar selloff. The geoeconomiccourse of the crisis took an unexpected and innovative direction.
TheFed’sliquidity swap lines stabilized the dollar-based financial system.
InNovember2008 the upgrading of the G20 had added a global leadership
brumand this had been important in legitimizing the dramatic expansionofIMFresources in 2009. This backstopped the IMF’s urgent engagementinEasternEurope. A year later, remarkably, the IMF would find itself
Committinghundreds of billions of dollars to rescuing the eurozone. At
esametime, the United States was aggressively pushing a new system of
gulationfor global banking through the normally slow-moving Basel
In2008and 2009 Washington kept ahead of the geoeconomic chalgesunleashedby the crisis. Could it stay on pace? In May 2010 the
VOAMadministrationand the IMF were crucial to forcing the Europeans
Washington did not like it. The Obama administration let it beknownthat
it did not approve the Chinese initiative, and South Korea,JapanandAle.
tralia promptly fell into line. But the UK, which was doingeverythingpos.
sible to court Chinese business, took up the offer from Beijing tobecomea
founding member of the Asian Infrastructure InvestmentBank Washing.
ton was furious.!” London had made its decision, a State Department off.
cial let it be known, without prior consultation. America did notapprove
the “trend toward constant accommodation of Chin, which is notthebest
way to engage a rising power.”l But London wasn’t listening, norwerethe
other Europeans who promptly signed up too. Asked about USopposition,
one British official commented wryly that it must be difficult fortheObama
administration to conduct international economic policy undercurrent
political conditions. If Congress wouldn’t approve a tiny increaseinChinas
IMF quota, what was to be expected on trade and investment? “Theycouldnt
have got congressional approval to join the AIIB, even if theywantedto.”
Indeed, thanks to the congressional shutdown, Obama waspreventedfrom
attending APEC’s Bali meeting. America’s domestic political problems
were spilling over into the conduct of global strategy and the worldwasnot
going to wait.
Given the stresses that the United States was evidently under, itmight
have made sense to invert Kissinger’s famous move in the 1970sand toseek
a closer relationship with Russia as part of the effort to contain China. Itis
unclear whether Washington was ever willing to take Russia seriouslyasa
strategic partner, at the level even of Japan or Saudi Arabia. 3 In 2009the
Obama administration did set out to build better relations. WithMedvedev as president, the “reset” seemed promising. To promote hismodernizing agenda, Medvedev was invited to tour Silicon Valley in thecompanyof
Governor Schwarzenegger.4 Russian business eagerly seized the opportunities offered by cheap dollar funding. In 2011 Medvedev wascompliant
over NATS intervention in Libya, so much so that it provoked acounterreaction in Moscow. Putin, biding his time in the number two positionas
prime minister watching footage of Gaddafi’s horrible fate, becamemorbidly preoccupied. The same Western powers that hadshamelesslycourted
the Libyan dictator had turned on him, bombing his military anddelivering
him to the vengeful mob. One would be a fool to trust them.Medvedev’s
anea5ementwould only invite further aggression. Putin would have to
take backcontrol.This decision was only confirmed when Moscowerupted
nrotestsover the winter of 2011-2012 following rigged parliamentary
Antions.Clinton barely disguised her enthusiasm for regime change. Indeadofreset and dtente, Putin returned to the presidency in 2012 with
newdetermination.In opposition to the liberalism of the Obama adminisntion,the Kremlin donned the garb of conservative cultural nationalismn.
Gayrights, feminist pop provocateurs and the Greek yogurt rations for
America’sOlympic athletes all got sucked into a postmodern rerun of the
in prot
cold war.Is
Itwas certainly not the balancing against China that one might have
expected.But nor was it the Americans who brought about the open crisis
inrelationsbetween Russia and the West. It was America’s most important
aly,theEuropeans.The EU would later claim that it “sleepwalked” into the
Ukrainecrisis.This was part of a piece with its guileless insistence that “the
EUdoesnot do geopolitics.”6 That perhaps described the naivet of some
offcialsinBrussels, but it never really rang true. It would be fairer to say
thatEuropeannation-states did not agree on the geopolitics they were pursuingbyway of the EU. France and Berlin loved the dtente with Moscow.
PolandandSweden did not. With active support from NATO, the “new
Europeans”championed the EU’s Eastern Partnership with the post-Soviet
states.Itwasno secret in Warsaw or Riga that this, like TPP, was a “de facto
containment”policy. As far as Poland was concerned, the priority was
dear.Inthe words of President Bronislaw Komorowski: “Never again do we
wanttohave a common border with Russia.”17
The instruments of the EU’s Eastern Partnership were EU AssociationAgreements. These were complex documents harmonizing regulations,liberalizingtrade and the movement of workers. The agreement with
Ukraine,initialed in 2012, was hailed as the most extensive agreement ever
completedwith a non-EU member. It ran to 1,200 pages of technical detail,
sbdividedinto the twenty-eight separate subsections of the acquis comMUnautaire.8 Trade and business regulations were the main focus of the
ASsociationAgreements, but they were not innocent with regard to secutitypolicy.Article 4 of the Ukraine Association Agreement called for “polialdialoguein allareasof mutual interest…. This will promote gradual
convergence on foreign and security matters with the aim ofUkraine’s
ever-deeper involvement in the European security area.” Article 7 provided for “EU-Ukrainian convergence in foreign affairs, security anddefence.” Under Article 10 on “Conflict prevention, crisis managementand
military-technological cooperation,” Ukraine and the EU were to”explore
the potential of military and technological cooperation. Ukraine andthe
European Defence Agency (EDA) will establish close contacts todiscuss
military capability improvement, including technologicalissues.”0
By 2013 talks with Ukraine were the most advanced. But theEU’sEastern Partnership negotiations proceeded on a broad front. At a summit conference in Vilnius on November 29-30, 2013, Brussels was hoping notonly
to sign the Association Agreement with Ukraine but to initialagreements
with Moldova, Georgia and Armenia. Brussels had also beennegotiating
with Belarus.? After incorporating the Baltics and the EastEuropeanWarsaw Pact in the early 2000s, Brussels was now seeking to deepen andtransform its relations with the rest of what had once been the westernSoviet
Union. It was undeniably a major shift in international relations and itwas
all the more significant for the fact that it clashed directly withRussia’s
ambitions for the region. Since 2011 Russia had been developing its Eurasian Customs Union into a more comprehensive Eurasian Economic Union.
It was clearly intended as an alternative to the EU’s Eastern Partnership.
The details of its agreements were far less onerous than those demandedby
the EU. But they meant entering into a lopsided relationship with Russia,
and the customs union included setting a common external tariff. Thiswas
incompatible with the EU Association Agreement.
With goodwill a compromise between the EU’s AssociationAgreements
and the Eurasian Customs Union could no doubt have been worked out.
But that was not the mood on either side. The technical and economic issues of harmonizing two different economic blocs were overlaid bygeopolitical tension whether Brussels acknowledged it or not. There was achoice
to be made: Did the East European governments want to face west oreast?
Brussels let it be known that membership in Putin’s Eurasian Union was
incompatible with an EU Association Agreement. Commission president
Barroso refused the Kremlin’s invitation for negotiations between the two
blocs.” Brussels did not accept their equivalence. In the absence of any
rementbetweenthe two, Moscow informed Ukraine and Armenia that
stheyproceeded with the EU, they should expect sanctions from Russia.
Signingan Association Agreement would be a “suicidal step.”2 Under the
an0dynelabels of association, cooperation and convergence, a heavy geopoliticalweight was being imposed on a fragile region under considerable
eConomicand political stress.
Acrossthe post-Soviet world, the economic and political recovery from
theshockof2008 was uneven. On the northern flank, the Baltics continued
ontheircourse toward the West. Estonia joined the euro on January 1, 2011.
Latvia,thepivotal crisis country of 2009, adopted the common currency on
January1,2014, followed a year later by Lithuania. The rest of Eastern Europewassupposed, under the terms of their 2004 accession, to join the
euroinduecourse too. But progress in that direction was set back severely
bytheeurozone crisis. Polish foreign minister Sikorski announced in December2011that he looked forward to Poland joining the euro by 2016, but
onlyifthe currency union was reformed and it was clearly in Poland’s nationalinterestto do so. Donald Tusk, as prime minister, promised to launch
anationaldebateon euro membership. But the main opposition, the nationalistLawandJustice party, promptly responded by denouncing any further
stepstoward European integration as “subordination to Germany.”25
InPolandthe nationalists were in opposition. In Hungary they were
thegovernment.In the April 2010 election, the ruling Socialist Party paid
thepricefor its corrupt and duplicitous handling of economic policy and the
financialdisaster of 2008. Promising to protect the Hungarian nation and
Hungarianpensioners from the depredations of the IME, a coalition headed
bythe nationalist Fidesz party and the Christian Democrats won 53 percentofthevote. Even more startlingly, the Jobbik movement, which toyed
openlywith neofascism, scored 17 percent, bringing the total nationalist
Voteto70 percent. Among Fidesz’s heresies was its refusal to separate the
questionsof political sovereignty and financial dependence. Ignoring prolestsfromthe IMF and the EU, it justified its taxes on foreign banks and a
raid on private pension funds in terms of harsh historical necessity”Since
freeing itselffrom the Soviet yoke, over the past twenty yearsHungary’ha
to bitterly experience the validity and truth of the old wisdom thatanation
can be subjugated in two ways–with the sword or with debt.”TAsGreece
was submitting itself to the troika in April 2010, a defiant PrimeMinister
Orban told a news conference: “In my view, neither the IMF nor theEUS
financial bodies are our bosses. We are not subordinate to them.”Hungary
would negotiate but it would not accept “diktats.”3
Orban’s aggressive nationalism and Fidesz’s campaign to curtail civil
liberties and political pluralism reversed the liberalization ofHungarian
political culture since the end of communism. But, after their ownfashion,
Orban’s aggressive revenue-raising measures and nationalist austerityworked.
Inflation came down to below 2 percent. In December 2011 anagreement
was reached with the foreign banks on a deal to share the cost ofrestructuring household debts. With Hungary having met the 3 percentbudet
defcit target, the EU lifted the humiliating Excess DeficitProceduresunder
which the country had labored since its accession to the union. In thecontext of the emerging market boom, foreign lenders looked lenientlyonOrban’s nationalist experiment. With ample funding, in the summer of2013
Hungary paid off the lMF and asked the Fund to shut its office inBudapest.> To further bolster his position, in early 2013 Orban embarkedona
new dtente with Moscow. An alliance with Russia was by nomeansanobvious choice for a Hungarian nationalist. But Orban was given awarmwelcome in the Kremlin. Putin cheered his experiment in illiberaldemocracy
and offered material assistance in the form of nuclear reactortechnology
and subsidized gas supplies, which were popular with Fideszvoters.0
Securely embedded in both the EU and NATO, Hungary couldaford
to take the risk of balancing between East and West. A tinycandidatecountry for an EU Association Agreement, like Armenia, menacedbysanctions
from Russia, was not in the same position. Faced with a clear threatfrom
Moscow, in September 2013 Yerevan pulled back. It declared itsintention
ofjoining Putin’s Eurasian Customs Union, prompting Brussels toclosethe
door on the Association Agreement. This setback for the EU’sEastern
policy made Ukraine all the more important. Given its sizeandgeopoltical
significance, it was Kiev’s posture that would decide the balance ofinfluence
dheregion. The EU was convinced of its own legitimacy. It offered the
aileoflawand prosperity. Its promise was the future. Ignoring the evident
ik thatUkrainewas too weak economically, too fragile politically and too
ingeopoliticalterms to standthepressuregeneratedbetweenRus- exp
Gaand the West, Brussels pushed forward.
That Ukraine needed a change was undeniable. Even after the losses of
08-2009 were made good, according to official figures average incomes
in2013werebarely higher than in 1989. Unlike in its neighbors to the west,
thepost-Communist transition in Ukraine had produced a generation of
sHgnation.While a tiny minority grew fabulously rich, the standard of livingfor the least well-off was kept at a tolerable level only by a system of
pensionsand energy subsidies that consumed 17 percent of GDP. In 2008
theIMF had provided emergency assistance. But the program came with
demandsfor changes in taxes and benefits that made it impossible for a
governmento sustain legitimacy. By the time of the February 2010 election,much of the population was deeply disillusioned. Ukraine was falling
furtherand further behind not only its Western neighbors but Putin’s Russatoo.President Yushchenko effectively withdrew from the electoral race,
leavingPrime Minister Tymoshenko to go head-to-head with Yanukovych,
whosefraudulent election had triggered the revolution of 2004. With the
electoratesplit between East and West, in 2010 it was Yanukovych who won
anarrow majority fair and square.
Yanukovychwas a corrupt manipulator who tacked back and forth betweentheWest and Russia. He took funds from the IME. He continued negotiationswith the EU.” He imprisoned Tymoshenko on corruption charges
andusedher as a pawn. At the same time, he dallied with Putin and his
Eurasianbloc. As his clan enriched itself, his popularity drained and foreignexchangereserves dwindled. On the occasion of the next elections,
whichhe had little hope of winning, it seems that he was preparing the
securityforces for a showdown.3 But the 2014 election was not the only
deadline.Already in 2013, negotiations with the EU and the Russians had
Teacheda point that forced Kiev to a decision that would depend, among
otherthings, on the shifting international financial climate.
Upto the spring of 2013, under the impulse of the Fed’s quantitative
easing,dollars flowed even to Ukraine. On April 10, 2013, Kiev turned
Ukraine: 7-Year Government Bond Yield
December 17: Russia pledges toinvest
$15 billion in Ukrainian governmentbonds
September 18: Fed surprises
May 22: taper markets by not tapering
talk begins
November 29:
Yanukovych doesn’t sign
EU Association Agreement
6 T
4/4/2013 6/4/2013 8/4/2013 10/4/2013 12/4/2013 2/4/2014
Source: Benn Steil and Dinah Walker, “Was Ukraine Tapered?,” February25,2014, Geo-Graphics
Blog CFR, https://www.cfr..
down the latest offer from the IMF to help finance its gapingcurentaccount deficit and instead launched a 1.25 billion eurodollar bondissue,
which was eagerly taken up by the markets at the comparativelymodest
interest rate of 7.5 percent.34 But then Bernanke’s taperpronouncementof
May 22 hit the markets. Interest rates surged to 10 percent.Searchingfor
alternative sources of funding and personal enrichment, Yanukovychcanvassed the world for options. He explored shale-gas developmentwithShel
and Chevron. In the fall of 2013 a deal was on the books toleasetoChina
an enormous holding of 7.5 million acres of prime farmland-5 percentof
the entire land mass of Ukraine, 10 percent of its arable land, anareathe
size of Belgium. China was not just after Lebensraum. It wasalsooffering
to put $10 billion into port facilities in Crimea.5 But it was thetalkswith
the EU that were pivotal. The promise that Yanukovych hadmadetothe
Ukrainian population was the promise of Europe. Ukraine’soffciallyspot
sored media were talking up the Association Agreement as apreludetofull
membership. The EU gave no indication that that was likely, but itdidnothr
ing to deflate expectations. Western press sources billed theVilniussummt
as the climax of a “six-yearcampaign to lure Ukraine into in- quiteopenly
srationwith the EU and out of the Kremlin’s orbit.”3%
Thethreatwas not lost on Russia, and its threats of sanctions mattered:
25nercent of Ukraine’s exports went to the EU, but 26 percent went to
Dusia,andmuch of the rest went to CIS states within Putin’s reach. In early
SontemberYanukovych was still browbeating reluctant pro-Russian membersof his party to accept the Western deal.” What was not clear, until
Kieyreceivedthe IMF’s letter of November 20, 2013, was quite how unatractivethe Western terms would be. The IMF offered Ukraine only $5
hlionandnoted that it would be expected to use $3.7 billion of it to repay
the2008loan due in 2014. No one in Kiev had reason to expect generosity
fromtheIME. But the EU’s offer came as a real shock. A committee of Germanexperts had estimated that Ukraine would stand to lose at least $3
blionper annum in trade with Russia due to sanctions. In Kiev the estimatedloss had been inflated to something closer to $50 billion. Brussels
Sweptallthese figures aside.8 In conjunction with the Association Agreement,all that the EU was willing to offer was 610 million euros. In exchangethe IMF demanded big budget cuts, a 40 percent increase in natural
gasbillsand a 25 percent devaluation.9 It was anything but the pot of gold
thatYanukovychhad promised. There were Ukrainian oligarchs with personalfortunes larger than this. Even without considering the sanctions to
beexpected from Russia, to have accepted such a deal would have been a
politicaldisaster.* In Kiev there was outrage. “We could not contain our
emotions,it was unacceptable,” Ukraine’s permanent representative for
NATOtoldReuters. When his country turned to Europe for help, they “spat
on us…. [Wle are apparently not Poland, apparently we are not on a level
withPoland….[T]hey are not letting us in really, we will be standing at the
doors.Werenice but we’re not Poles.” Fortunately for Kiev, or so it seemed,
Moscowhadan alternative plan. On November 21, 2013, Putin offered, and
Yanukovychaccepted, a gas contract on concessionary terms and a $15
bllionloan.The condition was that Ukraine, like Armenia, would join the
EurasianCustoms Union.
In light of subsequent events, Yanukovych’s decision would come to
beseenas the Pavlovian response of a pro-Moscow stooge. It was quite
possible that he was subject to Russian blackmail. But setting suchrumors
aside, his choice was hardly inexplicable. As Ukraine’s prime minister,Mykola
Azarov, explained, “[T]he extremely harsh conditions” of the EU-IMFpack.
age had decided the issue.2 Nor was this logic hidden from theEuropeans
in the immediate aftermath of the debacle. On November 28,2013,according to DerSpiegel, European Parliament president Martin Schulzadmited
that EU officialsmademistakes in their negotiations withUkraine. Ithink
we underestimated the drama of the domestic political situation inUkraine
Ukraine, he said, “had been in a deep economic and financial crisis’since
the introduction of democracy. “They desperately ned moneyandtheydesperately need a reliable gas supply:” Schulz said he understood whyUkraine
moved toward Russia. “It is not especially popular in Europe to helpstates
which are in a crisis …and if you look at Moscow’sproposals,theywould
offer Ukraine short-term assistance that we, as Europeans, cannot anddo
not want to afford.”
What no one reckoned with-not Yanukovych, the Russians or the
EU–was the reaction of a vocal and bold minority among theUkrainian
population. The opinion poll evidence does not suggest that therewasan
overwhelming majority for a decisive shift toward the EU. According to
Kiev’s International Institute of Sociology, in November 2013 only 39percent of respondents favored association with the EU, barely 2percentmore
than the 37 percent who favored a Russian-led customs union.# Andthose
numbers were based on a hypothetical, not the stern terms offered bythe
IMF and the EU. But events in Ukraine in 2013 were not decided byareferendum on the basis of clearly costed alternatives. They were drivenby
enthusiastic, fired-up minorities inspired by hopes and fears ofRussiaand
Western Europe and an eclectic range of political imagery drawn fromev
ery part of the political spectrum.
In November and December hundreds of thousands ofpeoplerallied
to Kiev’s freezing streets to protest Yanukovych’s abrupt decision toreject
the Association Agreement. But they made no overthrow attempt andYanukovych might have ridden out the storm but for the ill-adviseddecision,
encouraged by Moscow, to crack down. By using his majority inparliament
to ram through constitutional changes, on January 16 he triggered asecond
wave of mass protests and the occupation of government buildingsacross
lkraine. At this point, the involvement of the EU and the United States
me overt. Quite how deeply Washington was engaged was revealed by became
beinfamousbugged conversation between Victoria Nuland, assistant secretaryof state for European and Eurasian affairs, and the US ambassador
nUkraine,which is as illuminating in its characterization of US-EU relaionsat this point as it was in its blunt instrumentalization of Ukraine’s
odliticians.On January 28, 2014, as Nuland discussed options with AmbasadorPyatt,she casually remarked: “That would be great I think to help glue
tisthingandhave the UN glue it and you know, fuck the EU” For Nuland’s
Aste,the EU was too slow moving and too willing to compromise with
PresidentYanukovych, with whom it had been eagerly pursuing a comprehensiveAssociation Agreement only a few months earlier. Without flinching,AmbassadorPyatt replied: “We’ve got to do something to make it stick
together,becauseyou can be pretty sure that if it does start to gain altitude
theRussianswill be working behind the scenes to try to torpedo it.”s
Twoweeks later, a desperate last stand in the streets of Kiev brought an
endto Yanukovych’s presidency. On February 21, in talks that were brokeredby the foreign ministers of Germany, France and Poland and witnessedby Putin’s representative on the spot, Yanukovych was offered the
protectionof his office until new presidential elections were held at the end
of2014.Butas support from within his party and the security forces melted
away,he thought better of taking the risk.** He too remembered Gaddafi’s
fate.Early in the morning on February 22 he fled, leaving a vacuum. Shortcircuiting constitutional procedures, a new provisional government took
oficepending elections scheduled for May 25. What the EU had intended
asa protracted transition had become a revolutionary overthrow. And
ratherthan waiting for the outcome of the election, the provisional government,dominated by Tymoshenko’s Fatherland Party and a sprinkling of
Maidanactivists, moved rapidly to consolidate the new dispensation. It
wouldreverse Yanukovych’s abrupt decision of November. It would draw a
dleanline with Russia, sign the European Association Agreement and concludenew financial agreements not with Russia but with the IMF and the
European Union.
Howwas Moscow to react? The choice at Vilnius in November 2013
hadbeen pitched by both sides as a strategic turning point. Thanks to the
niggardliness of the IMF-EU offer, Moscow had won a significant victory, only for that to be overturned by popular protest and regimechange,
which, even if it had the support of a considerable fraction oftheUkrainian
people, was of dubious legality and was undeniably Western inspired.For
Russia to have meekly accepted this outcome would have beenworsethan
f Yanukovych had signed the Association Agreement in the firstplace.On
the night of February 22-23 the Kremlin decided to act. Takingadvantage
of local protests and activating plans prepared in 2008 to counter afasttrack NATO application, on February 27, 2014, Russian troops in perfunctory disguises seized control of the Crimean peninsula. A fewdayslater,to
further ramp up the pressure on Kiev, Russia put its muscle behind aseparatist uprising in the eastern region of Donetsk.
The comprehensive economic, political and diplomatic clashbetweenthe
West and Russia that had been foreshadowed in the proxy war inGeorgia
in 2008 was now unleashed on an altogether more significant stage.With
Ukraine’s territorial integrity at stake, on April 13, 2014, the provisional
government in Kiev launched an “antiterrorist” operation to takebackcontrol of the Donbass. In Washington and at NATO headquarters therewere
those calling for immediate military aid for Kiev and a full-throated return
to the cold war. McCain and other Republican hawks would havelovedto
have rallied a war party. Doing so perhaps might have contributed to restoring coherence to their troubled party. But as he had done in Syriain
2013, Obama refused the call to escalate.$ In Europe there was nosupport
for military action. It was not that Ukraine would be deniedweapons.But,
as in Syria, the arms would be supplied through covert channels. Thepublic front of the West’s reaction was economic sanctions.
Putin’s line had always been that geoeconomics were geopolitics. In
Ukraine, struggles over trade negotiations and customs treaties hadescalated into an undeclared war. Now the economy itself would beweaponized. Or would it? To pressurize Iran, the United States had developeda
ferociously effective regimen of sanctions. Russia as a globally integrated
aconomywas far more vulnerable. Not only did Russianbusinessesneed to
ex0ortbut they had supped deeply at the trough of cheap dollar credit. By
early2014 they owed $728 billion.9 But by the same token, large vested
nterestsin the West were at stake. Apart from anything else, Russia was
thenumbertwo supplier of oil and gas exports to world markets. At a time
ofextreme fragility in the emerging market economies, the United States
didnotwant to precipitate further tension in commodity markets. To the
frustrationof the hard-liners, the United States stayed its hands and never
appliedthe full force of its sanctions weapon. Instead it targeted individual
membersof the clique close to Putin, the most prominent of whom was
lorSechin,the boss of oil giant Rosneft.5 Furthermore, Washington limtedaccessto capital markets for key corporations–Rosneft, Novatek, GazDrombankandVEB.S1 This was painful, but given the limited volume of
US-Russianeconomic relations, it was far from decisive.
Thecrucial question was whether Europe would throw its weight behind
America’ssanctions. Russia-EU trade was ten times larger than Russia-US
trade.The EU received 41 percent of all Russia’s exports. This gave the EU
considerableleverage, but also meant it had more to lose. German corporate
leadersand senior politicians, such as ex-chancellor Gerhard Schrder, continuedto cultivate friendly relations with Putin even as Russia’s troops made
incursionsinto Ukraine. France had two big aircraft carriers on order from
Russa.Italy’s energy corporations were deeply entangled in Black Sea projects.London, the playground of the oligarchs, was the place to make sanctionstell. The Cameron government talked a good game, but was less quick
toact.Nor was it merely economic interests that were at stake. In Germany
therewasdeep skepticism about any overhasty alignment with the United
States. Since the summer of 2013 the NSA spying scandal had cast a deep
shadowover German-US relations. A year later, the percentage of Germans
whosawthe United States as a trustworthy partner” was down to 38 percent,numberslast seen in the Bush era. Whereas 68 percent of Americans
favoredextending NATO to Ukraine, 67 percent of Germans were against it.
Likewise,63 percent of Germans rejected EU membership for Ukraine.
Tothe indignation of right-wingers in Congress, all that the EU could
agreetowere individualized sanctions against eighteen leading Russian fgres.SenatorJohn McCain was moved to declare, “If the Europeans decide
that the economic considerations are too important to imposeseveresanctions on Vladimir Putin… then they are ignoring thelessonsofhistory”%
Appeasement had failed against Hitler in 1938. It would fail againstMt.
Putin. In May transatlantic tensions were mounting to such a pitch that
Merkel and Obama hastily convened talks in the White House. Merkelhad
no doubt about the need for action, but she could not ignoreEuropean
public opinion, and McCain’s outbursts were not helpful. The twoagreed
that Obama would restrain the American hawks while Merkel movedto
build a consensus in Europe around tougher measures.
In the meantime, if no military aid was forthcoming and onlyminimal
sanctions were applied to Russia, would the West at least providegenerous
financial support to Ukraine? Just to meet its outstanding obligations,the
new government in Kiev estimated that it needed $35 billion over two
years. That was not far off the estimates presented by Yanukovych’sregime
six months earlier, which had been rejected out of hand. In March2014
Kiev put in a request for $15 billion from the IME. The Obamaadministration backed the appeal and sought to leverage it to break the deadlockin
Congress over IMF reform. The administration linked a $1 billion loan
guarantee for Ukraine that was popular with the Republican right wingto
a proposal to unblock IMF funding.55 The Ukraine crisis was a cleardemonstration, the White House insisted, of the IMF’s strategic importance tothe
United States. Globalist critics of the IMF pounced on the pronouncement.56 The subservience of the IMF as a tool of US policy stood starkly
revealed. Except that the Republicans in Congress did not agree.Theycut
out the IMF funding proposal.
Lagarde and the IMF soldiered on without America’s full backing”For
a well-run country, at peace and with the institutions to make the mostof
its ample endowments, Ukraine’s debt burden would have been far from
excessive. But Ukraine was none of those things. Given the hugepolitical
uncertainty, the insecurity produced by Russian intervention and itsweak
institutions, there was, in fact, a strong case to be made that Ukraine’s
debts were insupportable. Ukraine was insolvent and its debt should be
written down. That would have been IMF protocol. But Ukraine wasno
ordinary case. In 2010 Greece had been funded under the “systemicexemption.” The risk of financial contagion justified an unsustainable bailout.In
April2014 in Ukraine, systemic risk was recast in geopolitical terms. The
IMES main shareholders did not want to see the embattled proWestern
regimein Kiev declared bankrupt within weeks of an anti-Putin revolution.
Sodespitethe obvious risks and despite Ukraine’s appalling track record of
programcompliance, the IMF plunged in once again. Out of enthusiastic
talk of reform and overoptimistic assumptions about economic recovery,
the IMF concocted a scenario that allowed it to lend Ukraine $17 billion
Overtwo years. A further 11 billion euros would come from the EU and $1
billion in loan guarantees from the United States. Japan chipped in too. In
addition,the EU agreed to take 98 percent of Ukraine’s exports tariff free.
Visa-freetravel was envisioned for 2015. For the winter, the EU promised
tobackstop Ukraine’s energy supplies by providing a flow of gas through
Slovakia,Poland and Hungary.
Itwas a substantial commitment. But it fell well short of what Ukraine
needed.The aid from Europe would be stretched over seven years. The IMF
loan,as always, came with tough conditions. Gas prices were to be raised
by56 percent and the government payroll cut by 10 percent. The foreign
exchangeswere to be liberalized to allow the exchange rate to adjust to a
competitivelevel, a high-risk operation that was likely to put huge pressure
onUkraine’s banks. The largest risk of all were the military operations in
easternUkraine. The IMF had never previously lent to a country at war. So
in putting together the April 2014 package, the Fund simply ignored the
evidenceof the escalating conflict. As Lagarde admitted in a press statement,this put the entire program in jeopardy from the start.9 Within days
oftheconclusion of the financial package it became clear that Ukraine did
indeedface the worst-case scenario. Rather than calming, the conflict in
easternUkraine intensified.4 In early May, scrambling to raise an army,
Kievwas forced to reintroduce conscription. As the oligarch Petro Poroshenkotook office as Ukraine’s president in the last week of May 2014, he
facedthe impossible challenge of implementing an IMF austerity program
while fighting a war; a war, moreover, that Russia would not let Ukraine
Win.Kiev’s only hope was that while military escalation placed ever greater
stresson Ukraine’s fragile economy, it would also clarify the political stakes
ofthe conflict and suck in the West.
In July a vigorous offensive by Ukraine’s forces was on the point of
overwhelming the Donbass rebels. Moscow’s response was to resupplythe
breakaway militia with heavyweapons. A conflict ofsmall-scaleskirmishes
was escalating into a more or less openly declared war involving themobilization of tens of thousands of men, mass displacement andthousandsof
casualties. On July 17 a rebel antiaircraft battery armed with newRussian
nissiles jubilantly reported that they had shot down a heavy transport
plane. It turned out to be Malaysian Airlines flight MH17, with 298passengers and crew on board. It was the moral indignation in the aftermathof
that outrage that enabled Merkel to push through a much strongersanctions regime. The EU blocked the export to Russia of any military equipment, oil industry equipment and the issuance of long-term debt in the
EU by Russia’s state-owned banks and energy corporations. The United
States doubled down by restricting access to capital markets forSberbank
and pressuring ExxonMobil and BP to drop their collaborations withRussian energy partners. But the real thrust of twenty-first-century sanctions
was financial. By September 2014 Rosneft, Transneft, Gazprom, Novatek,
Sberbank, VTB, Gazprombank and Bank of Moscow, along with arms
makers United Aircraft Corporation and Kalashnikov, were all lockedout
of Western financial markets. Two of the banks most closely linked toPutin
and his entourage had hundreds of millions of dollars frozen in USacCounts.61
Moscow, for its part, resorted to mnore classic retaliation. It did notcut
off gas supplies. But it issued a blanket ban against agricultural imports
from Europe while increasing its military support for the Donbassrebels,
who mounted a bloody counteroffensive on August 23-24. With the front
line frozen, Kiev was forced to accept a ceasefire brokered in Minsk by
Germany and France on September 5. With the new cold war between
Russia and the West having escalated into a comprehensive and violent
confrontation, it now came down to a trial of strength.
Since the shock of 2008, Russia’s official financial position hadbeenrebuilt.
In early 2014 Moscow’s foreign currency reserves stood at $510 billion. As
2008,itwasnottthe state but Russia’s globalized private sector that was
didnot lie. The escalation of tensions over Ukraine caused an immediSiantroops on Ukrainian territory, it was followed on “Black Monday”
uinerable.Though the oligarchs of course toed Putin’s line, the markets
dlecapital outflow. When the Russian Federation Council, on Saturday,
March1,2014,gave a patriotic vote of approval for the deployment of RusMarch3, by a spectacular l1-12 percent market slump. For internationlizedRussian banks like Sberbank–a giant that controlled 28 percent of
Russianbank assets–sanctions created a truly schizophrenic situation. As
isCEO, Herman Gref, mused, 50 percent of Sberbanks freely marketable
hareswere held by US and British investors, but the bank was now barred
fomraising funds in the West.” Perforce, over the course of2014,Russian
companiespaid down their foreign debt from $729 billion to $599 bilion,
withthe central bank deploying its reserves to enable the repayment.6″ Tensionwas building, but it was not until autumn that the crisis broke.
Thethird round of sanctions in the wake of the downing of MH17 bit
dep.At the same moment, Janet Yellen’s Fed finally ended QE3, tightening
creditconditions around the world. And then cooperation in OPEC broke
down.Saudi Arabia ended its production restraint and oil prices collapsed.
Withor without sanctions, by the autumn of 2014 Russia would have been
inseriousfinancial difficulty. The combination of sanctions, Fed monetary
tighteningand a plunge in commodity prices was devastating. So devastating,infact, that it has raised the question of whether this conjunction was
entirelycoincidental, or whether the United States and the Saudis were
collaboratingto launch a strike against Russia.5
Oil politics are a rich field for conspiracy theory. There certainly are
backchannels between Washington and Riyadh. Secretary of State Kerry
wasinthe gulf in the fall of 2014. The Saudis had every reason to act, if not
overUkraine then over Syria.6$ Along with Iran, Russia was the main backer
ofAssad’sdie-hard regime. Saudi Arabia was its sworn enemy. There is no
Conclusiveproof. Nor is a conspiracy necessary to explain these concurrent
events.The oil market was under stress. America’s new fracking technology
hadopened up a new source of supply that was cheap and highly elastic.
rom the point of view of the Russian economy, in any case, the ultimate
motivationwas irrelevant. Oil prices plunged from $112 per barrel in June
Ruble-Dollar Exchange Rate and Oil Prices
$120 Russian troops seize Crimean Parliament
– Malaysian Airlines Flight MH17
shot down over Ukraine
US and EU
sanctions announced
Additional US, EU, and Japanese
sanctions announced
G7 countries extend
sanctions another six months
EU and Canada
toughen sanctions
EU extends sanctions
another six months
EU extends sanctions
until July 2016
Brent oil price per barrel (left axis)
Sept sept Dec’14 n15 arn6
Mar Mar’15 Dec
Russian ruble (right axis)
Jun’ Jun
Source: Bloomberg, Global Investors.
to around $60 per barrel by December 2014 and kept on falling. On topof
sanctions and tightening credit conditions, it was a body blow.
In October the Russian central bank intervened heavily to preventan
immediate ruble collapse. But it needed to husband its reserves,and in
November it exited the market. Starting at 33 to the dollar beforethe
Ukraine crisis began, by December 1, 2014, the ruble had fallen to 49against
the dollar. This was terrifying for Russian corporate borrowers, whoowed
$35 billion in debt repayments by the end of the year. There was ascramble
for survival. Rosneft, which had $10 billion to pay, was in the market
hoovering up euros and dollars,7 The strain on weaker Russianbusinesses
was unbearable. In December, Trust Bank, a high street lender, andUTair,
Russia’s third-largest airline, failed, and the central bank was forced tooffer
guarantees for the entire banking sector.68 On the morning ofMonday,
December 15, the ruble began to plunge, ending the day down by 8percent.
That night, after a long evening of debate involving Putin himself, thecentral bank decided that it would hike interest rates from 6.5 percent to17
percent. The announcement was made at one a.m. It was intended toreas-
e investorsand punish speculators. It didn’t work. It was read not as
ossurancebut as a sign of panic. As markets opened on the morning of
Dsia’s “Black Tuesday:” December 16, the foreign exchange ma
atofree fall. By the end of the day the ruble had fallen to 80 against the
dollar.The following day Sberbank came under concerted attack. A million
ofitscustomersreceived text messages from addresses outside Russia warningthatthe bank was about to be cut off altogether from external liquidity.
OnDecember18, $6 billion were withdrawn. Over the following week the
totalcame to $20 billion.9%70 It was a spectacular bank run even by the
standardsof 2007-2008.
Theoligarchs were once again exposed. Estimates vary, but the combinationofthe Ukraine imbroglio, the oil price shock and the December 2014
turmoilcost the twenty richest Russians between $62 billion and $73.4
blion.”Onceagain Putin called in favors and demanded action. Measures
werepassedcalling for the end to the offshore hoarding of wealth. An amnestywasoffered to those who would bring their cash home. Meanwhile,
thecentral bank attempted to get a grip on the situation with an increase
indepositinsurance and the recapitalization of ailing banks. President Putincalledfor the authorities to abandon general principles of policy. They
wouldneed to be in “manual override” to see the country through. But
therewas one general principle that would not be abandoned. Russia did
notwantto ruin its reputation in the eyes of foreign investors by resorting
tocapitalcontrols. Instead, to provide the necessary foreign exchange, the
centralbank ran down its reserves, which dipped as low as $388.5 billion
onDecember26. This cushioned the collapse of the ruble, but the pressure
continued.The Western ratings agencies started by downgrading Gazprom.InJanuary they lowered the rating of Rosneft, Transneft and Lukoil.
Thentheruble slumped by 7 percent, giving up much of the ground it had
recoveredsince the end of 2014.2 That, in turn, posed the question of the
centralbank’s reserves. What Russia was struggling to contain was somethingakin to the bank-sovereign doom loop that had menaced the euroZoneuntil2012. But what was now at stake was not just financial solvency
butvictory in a geopolitical tug of war.
In his first period as president, Putin’s legitimacy had been based in
largepart on a sustained recovery in living standards. That easy narrative
was broken by the crisis of 2008. From 2014 onward economicexpectations
were further diminished. Over the winter of 2014-2015 GDPwasfallingby
more than 10 percent per annum. It would not stabilize until thesecond
half of 2015. For ordinary Russians the crisis of 2014-2015 wasconsiderably worse than that of 2008-2009. Real wages fell more sharply andre.
bounded less vigorously. The Russia that emerged from the Ukraineclash
was above all a nationalist regime whose citizens were called upon topay
whatever price was necessary for their nation’s reemergence on theglobal
stage. It was tough, but it was a role that came easily. And, indeed, insome
respects one might even say it was convenient.” As prime ministerduring
the 2008 crisis Putin had thrown himself into hands-on domesticcrisis
fighting.4 Since his return to the presidency in 2012, the Kremlin hadbeen
inciting nationalism to offset disappointing economic growth anddisappointing poll ratings. Given the collapse in oil prices in 2014-2015,some
campaign of nationalist incitement was only to be expected. Thecrisisin
Ukraine was perfectly timed. Even with the economy languishing,Putin’s
personal popularity surged from a low in 2013 in the mid-40s to arecord
89 percent approval in June2015.75
Russia sufered, but if the economy was a weapon, it cut bothways.You
could not damage Russia without damaging its neigbors. Themuch-feared
emerging market crisis hit the post-Soviet world with avengeance.”*Between the end of 2013 and early 2015 the currencies ofKazakhstan,Azerbaijan and Belarus devalued by 50 percent against the dollar. TheKyrgyz,
Moldovan and Tajik currencies lost between 30 and 35 percent of their
value. Across Central Asia, the effect was to force sudden and sharp increases in interest rates and to place enormous pressure on thebalance
sheets of those banks and businesses that had globalized andborrowed
abroad.”” Meanwhile, family incomes were squeezed as remittances from
migrant workers in Russia plunged.”” In Tajikistan, the mostremittancedependent country of the world, where approximately one half of its
working-age males earned their living in Russia, it threatened acatastrophic
fall in household income and foreign exchange earnings. Kyrgyzstan,the
world’s second-most remittance-dependent country, was also badly af
But if the crisis took its toll on the entire region, the epicenterofthe
hockwasUkraine. In the emergency bailout of April 2014, the IMF had
ated itsestimate of Ukraine’s economic situation from an exchange rate
the dollar. The IMF had called on Kiev to impose cur- of12.5hryvnia to
rencycontrols to prevent capital flight, while letting its currency float and
allowingdomestic prices to adjust to whatever level would ensure the viahily ofgovernment-ownedgas firms. If this program had beenadopted, it
wOuldhavesqueezed both ordinary Ukrainians and wealthy Ukrainians,
whowouldsee their funds trapped in a depreciating currency. Instead, the
1Ukrainiancentral bank did thereverse.80It permitted billions of dollars to
leethe Ukrainian banking system while using its precious exchange reservesto stem the decline in the exchange rate. While prices surged by 50
percent,the result was to favor the most wealthy Ukrainians, who swapped
theirassetsinto dollars at favorable exchange rates. Alltold $8 billion drained
fromthe currency reserves. Whatever money was pumped into Ukraine
simplybled out. With exchange reserves depleted to as little as $4.7 billion
byFebruary2015, the central bank finaly abandoned the exchange rate. As
theEuropeanpowers struggled to make diplomacy work and the hawks in
Washingtonand at NATO headquarters were urging ramped-up military
support,between February 5 and February 6 the currency plunged by 50
percentin twenty-four hours,! Prices were adjusted on a daily basis, and to
combathoarding, a system of de facto rationing was introduced, which
limitedeach consumer to buying fixed quantities of flour, oil, rice and
buckwheat.Meanwhile, GDP fell by almost 18 percent year on year, making
Ukraine’sdebts progressively less and less sustainable.
Withthe battle in the Donbass ongoing, the government of the revolutionof2014, like its predecessor in 2004, was seeing its legitimacy evaporatein the face of insurmountable economic problems. To enable the new
Ukrainianregime to survive, in the spring of 2015 there was no alternative
tofurther foreign assistance. On March 11, 2015, the IMF recommitted
itselftoUkraine, relaunching the agreement of the previous year, this time
ratedat$17.5 billion. It would be the cornerstone of a $40 billion four-year
deal,supportedby the EU. But this time, at last, the IMF acknowledged that
therewouldhave to be debt restructuring.
In 2014, the comprehensive crisis, both geopolitical and financial, thathad
threatened the post-Soviet sphere in 2008 had arrived and the verdict it
delivered on the hegemony of the United States and its alliancesystemwas
ambiguous, to say the least. A popular upheaval had swung Ukraineforcibly toward Europe. The Association Agreement eagerly signed byPresident
Poroshenko in June 2014 was finally ratified in July 2017. The West hadnot
let Ukraine sink. But neither had it saved it from crisis. Ukraine’s financil
position remained precarious. The debt restructuring deal that waseventually done in August 2015 satistied the IMF’s demand for privatesector
involvement in formal terms. But, in fact, it imposed minimal lossesonthe
hedge funds that had gobbled up Ukraine’s distressed debt. It boughtUkraine
only the slightest amount of debt relief, cutting its debts from $71 billionto
$67 billion, while Ukraine’s GDP continued to plunge. 2 The viability ofthe
package would depend on the unpredictable course of domestic reformand
the intensity of the confrontation with Russia, which neither the United
States nor Europe had mustered the resources or political will todecisively
repel. As far as Russia was concerned, even in combination with the oil price
shock, the sanctions were painful but not decisive. By the spring of2015
Putin’s regime had regained its grip. If and when oil prices began tostabilize, Moscow’s position would recover. Sanctions would soon provedeeply
unpopular within the EU. To general amazement, Russia would findprominent sympathizers even in the United States. While it bided its time,Moscow could cause trouble in the Middle East, it could fish in troubledwaters
in the United States and it could look for new strategic partners farther
In the cold war the interplay among Washington, Beijing andMoscow
had been crucial in shifting the balance of power. In principle, aresurgent
China could pick and choose. It had no particular reason to prefer Putin.
But in the spring of 2014 in the East Asian arena, tensions betweenJapan
and China were rising to a dangerous level. Washington gave notice that it
meant to stand behind its strategic pivot. It would not countenanceChina’s
assertion of rights in the South China Sea. But for America to take astrong
Besin Asia while at the same time confronting Russia in Europe had its
orice.It offeredRussia an opportunity and Putin seized it. In the spring of
nl4, as the seriousness of Russia’s confrontation with the West became
deat,the Moscow leadership resolved on a strategic approach to China.
Chinawould provide Russia with support against the West. If the United
sttesand the EU were determined to oppose Russia in economic terms, it
wOuldfind markets in China and sources of capital in Shanghai and Hong
Kong,China, for its part facing resistance in the South China Sea, could
huildaEurasian land route via Russia and Central Europe. The EU had shown
nointerest in joining America’s “de facto containment alliance” in Asia.
Russiawould provide the bridge. A start was made in May 2014 with the
signingofa $400 billion, thirty-year Sino-Russian gas deal.4
Thoughthe strategic logic was strong, in practice, Moscow found that
doingbusiness with China was fraught with difficulty. The Chinese were
toughnegotiators. Russia’s hard-pressed oligarchs were reluctant to committo long-term deals when they were not negotiating from a position of
strength.Laying the necessary infrastructure eastward was monumentally
expensiveandRussia’s elite were leery of opening up Siberia to ever greater
Chineseinfluence. Gas diplomacy in an age in which prices for fossil fuels
weregyratingwas a volatile business. But for both Moscow and Beijing, the
pointwentbeyond economics. It was about redefining the balance of power
andafirming multipolarity. It would not be the incumbent hegemon that
but the rising power of Asia and
itsallies.In so doing, Moscow and Beijing were also giving a new ending to
thetwentieth century.85 The symbolism of guest lists at the anniversary
celebrationsfor victory in World War II in 2015 was hard to ignore. Seventy
yearsafter that struggle, in which China, Russia, the United States, Britain
andFrancehad been united against the Axis, a new relationship was being
constructedbetween China and Russia, a relationship that had the potentialtoreshape Eurasia. In Moscow on May 9 and Beijing on September 3,
Xilinpingand Vladimir Putin were each other’s guests of honor at spectacularcommemorative ceremonies. Obama, Cameron, Hollande and Merkel
gavetheirexcuses,.86In the spring of 2015 the one Western leader who
wouldlook to the former allies of World War II for support would be the
embattledleft-wing prime minister of Greece.

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