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Markets Trump Tanks -- The Number One Lesson From Ukraine

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Carl Von Clausewitz the Prussian military theorist of the 1800s famously stated that, "War is the continuation of Politik by other means." Although his word 'politik' has been translated as either policy or politics over the years, Clausewitz's statement has been a key principle taught and debated in war colleges and schools of international relations for almost 200 years.

Now like so much in our Globalized, geo-political world, the Russian incursion into Crimea has upended Clausewitz's famous statement. It has also called into question whether the period of world history that began with the fall of the Berlin Wall in 1989 is over; a time when the idea that integrated, globalized markets and commerce would act as a shield against major powers recklessly violating established treaties. Of course, as we all have learned Globalization's shield is not a deterrent against aggression by rogue actors and failed states; if anything it is a catalyst. But, the idea that a G8 nation like Russia, would violate its treaty obligations (no matter how historically related Ukraine is) and act with the same rationale that the Nazis used in the Sudetenland, was a concept supposedly buried in the ashes of the Berlin Wall.

Globalization and it's companion, market integration, has not gone away. What has happened is that they have radically altered the game of major state aggression. Historically states acted aggressively for many reasons, often to protect their markets. Now states are the global market with a multitude of Lilliputian-like constraints binding them to each other.

States might be rivals, but within their economies they are each others' joint venture partners. This should provide a check on the most blatant aggression i.e. Russia's entry into the Ukraine proper. Just look at Russia's energy relationship with Europe: Russia supplies about a third of the European Union's energy, but that supply is responsible for 40 percent of the Russian government's budget. This situation is a perfect example of Harvard Professor Michael E. Porter's concept of the Buying Power of the Customer, where the customer has an extraordinary leverage over the supplier.

The huge decline in the ruble during the last several weeks has also had an impact on Russian foreign policy. A hundred years ago when Germany, France, England, Austria and Russia were entering World War I, surely the price of middle class consumer items did not factor into their decision making on how to proceed. There would have been no reason for it (and sadly it probably did not figure into Putin's calculations until after the fact). Such items were all made within each individual country. Today a large percentage of Russian consumer items are imported and thus subject to an almost immediate price increase caused by the falling Ruble. Given the fact that the Russian economy is already weak, it will now be hurt further with rapid inflation. Such inflation would add tothe political pressure for changes in policy on any government, whether autocratic or democratic.

Obviously, when a leader feels aggrieved and is isolated by the lack of checks and balances he is not going to stop aggressive actions merely because of the price of sweaters. But it is more than sweaters, the Ruble has now fallen to all-time lows against both the dollar and the euro. This has forced the Russian central bank to aggressively intervene to support its currency, and by doing so it is "temporarily" raising interest rates from 5.5 to 7 percent.

Compounding this stress on interest rates are the tremendous capital outflows caused at least in part by the threat of harsh sanctions on capital flows in the future as well as the current politically-related banking sanctions recently imposed by the United States.

Andrei Klepach, Russia's deputy economy minister, stated that capital outflows in the first quarter were expected to be closer to the top end of a $65bn-$70 billion government estimate. That would exceed the $63 billion that flowed out of the country in the whole of last year, and is higher than the $50 billion figure estimated by Mr. Putin's economic adviser Alexei Kudrin just two weeks ago.

All and all, the Crimea invasion is pushing the Russian economy into a very difficult space: a space usually occupied by countries with huge imbalances on their current account balances that are awaiting IMF bail outs. Of course many of those countries do not have the oil reserves that Russia has.

Globalization and economic integration have created a new weapon and a new deterrent: the potential use of the marketplace against an aggressive nation state. Countries that have the power to adroitly move markets (like the United States with its reserve currency and sophisticated banking system) now have something totally new in their arsenal, a pre-military weapon that can cause severe economic pain and thus possible political disruption. The reality now is that markets are continuation of politik by other means.

One can assume that Putin clearly understands Von Clausewitz's doctrine. What it appears he has failed to appreciate until this week is that Von Clausewitz did not live in a world of global market integration or market power.