Rabobank: Anyone Thinking Zelenskiy Is About To Sign A Peace Deal Making Territorial Concessions Is Delusional

Until recently, the market kept trying to trade ‘war is over’. This was delusional. After not being met with flowers or seizing the government rapidly, Russia was always going to escalate to grind out a victory: we can now add Bucha to the list of war crimes. Such Russian tactics are well-known from Chechnya; and as East Europe analyst @sumlenny notes that despite the Kremlin believing it would win rapidly, the Russian army “purchased 45,000 body bags and brought mobile crematories; I am sure they planned mass executions for Ukraine.” That tactic is well-known from the Katyn Massacre in Poland.

Some in the West will try to ignore this; say it’s fake; talk about past war crimes by others; or pivot because of political ideology. In some cases, it will be due to a wish for compromise. In other it will be due to kompromat. Either way, it overlooks a simple dynamic I have stressed many times in other contexts. If this happened, it means escalation. If someone is prepared to go to these lengths to make it look like it happened,… it still means escalation. At the very least, anyone thinking President Zelenskiy is about to sign a peace deal making territorial and security concessions is again delusional.

We will also see what the Western response is. Co-EU Presidents Michiel and VDL have already tweeted: “Shocked by haunting images of atrocities committed by Russian army in Kyiv liberated region #BuchaMassacre. EU is assisting Ukraine & NGO’s in gathering of necessary evidence for pursuit in international courts. Further EU sanctions & support are on their way. Слава Україні!” and “Appalled by reports of unspeakable horrors in the areas from which Russia is withdrawing. An independent investigation is urgently needed. Perpetrators of war crimes will be held accountable.”

Indeed, fresh outrage sees talk of Germany possibly pushing for sanctions on Russian gas. Lithuania, at the EU policy vanguard as it was re: China, is already to cut itself off entirely. Meanwhile, the slower, broader Western disengagement from Russian energy continues: the UK has agreed to set up a new development vehicle to build 7 new nuclear power stations as soon as possible. Yet Russia will itself respond to any escalation:

Politically, sociologist Greg Yudin argues: “the situation in Russia has changed, and I am not sure everyone outside Russia understands that. There is an ongoing shift here from authoritarianism to totalitarianism… And in this regard, yes, just very recently there are clearly more similarities with what is classically described as fascism.”

Economically, Friday saw confusion over ruble gas payments. Moreover, former president Medvedev threatened that Russia may stop selling food to unfriendly countries entirely as it is a "quiet but formidable weapon". That’s perhaps not devastating to the EU, but it certainly would be to the rest of the world and is obviously designed to bring them in line with Moscow.

Militarily, former Putin advisor Karaganov stresses:

“I don’t know what the outcome of this war will be, but I think it will involve the partition of Ukraine, one way or another. Hopefully there would still be something called Ukraine left at the end. But Russia cannot afford to “lose”, so we need a kind of a victory. And if there is a sense that we are losing the war, then I think there is a definite possibility of escalation. This war is a kind of proxy war between the West and the rest… for a future world order. The stakes of the Russian elite are very high – for them it is an existential war.”

Worse, of the West supplying arms to Ukraine:

There is a growing probability of a direct clash. And we don’t know what the outcome of this would be. Maybe the Poles would fight; they are always willing. I know as a historian that Article 5 of the NATO treaty is worthless. Under Article 5 --which allows a state to call for support from other members of the alliance-- nobody is obliged to actually fight on behalf of others, but nobody can be absolutely sure that there would be no such escalation… It might be that Article 5 works, and countries rally to the defence of another. But against a nuclear country like Russia… I wonder?”

In other words, Russia may attack NATO to test its resolve – or is floating that threat to try to scare it into concessions.

US neo-realist Mearsheimer, who says this war --and war crimes?-- could have been avoided by not expanding NATO, in a 1 March interview added now it has, “They have an Article 5 guarantee – that’s all that matters.” Yet Russia doesn’t seem to think so. Hal Brands, writing for Bloomberg on US deterrence, underlines Russia needs to be made to see it should - so brinksmanship. What can Mearsheimer add here? His critique says nothing about what to do now, other than retreat - as existential a threat for the EU/NATO as it is for Russia. He also doesn’t build credibility in adding: [Putin’s] never shown any evidence that he’s interested in conquering the Baltic states. Indeed, he’s never shown any evidence that he’s interested in conquering Ukraine.” Poland, now in NATO, sees things differently: it has flagged it is ready to host US nuclear missiles.

The EU-China summit on Friday was frosty: again, the Chinese side release its positive spin before the meeting was over, asking the EU to find its own way ahead, i.e., apart from the US. The EU saw VDL say: “Frank and open means that we exchanged very clearly opposing views." As the Wall Street Journal’s @launorman put it, it was “Absolutely, blindingly clear” the EU received “absolutely zero assurances” from Xi on Beijing not circumventing sanctions, supporting Russia, or seriously weighing in to stop the fighting – even though the EU threatened EU-China trade could look like EU-Russia trade: as the war escalates, the risks of EU-China decoupling increase.

At the same time, we see another election victory for pro-Putin Orban in Hungary, which will rattle the EU; and for the pro-Russia party in Serbia; economic chaos in Sri Lanka; political chaos and new elections in Pakistan - where a general just gave a public speech talking about the desire to balance relations between China and the US; Russian and US shuttle diplomacy to India, the former offering $35 discounts on oil, the latter saying Russia won’t be there when China moves on the Indian border again; and, on Bloomberg, an op-ed argues ‘To Save Democracy, We Need a Few Good Dictators’, and President Biden should aim “for an orderly world where the law of the jungle does not operate. Thus, we should welcome a number of autocracies into this struggle.”

Niall Ferguson opines not only on the threat of escalation in Ukraine but, hypothetically, of China moving on Taiwan next year, and Iran attacking in its region. This, in his words, takes us from a ‘1970’s’ geopolitical scenario to something closer to 1939.

Just such a co-ordinated pushback against US hegemony was floated in my 2018 report ‘The Rise and Fall and Rise of the Great Powers (and the Great Currencies)’ - to admittedly very little interest at the time. “TL:DR” - markets weren’t interested in paradigmatic shifts back then, just the ‘New Normal’. Understandably, there is now a swell of chatter about shifts in the financial architecture. There is a particular focus on what money itself is or isn’t (i.e., commodity, fiat, crypto) and the --valid-- argument that this is always a (geo)political issue.

In some cases, these arguments are Lord Haw-Haw crowing from sources asking deep questions like ‘Vladimir Putin, a Bismarck for the Modern Age?’ - although it’s another leader of Germany many are thinking of right now. The more nuanced arguments echo some of the same themes: that FX hegemony comes from power; power from the military; the military from the economy; and the economy, partly, from finance. Both are arguing for the emergence of RUB and CNY as alternatives to the US dollar. For example, Brazil’s central bank has increased CNY and decreased EUR and USD holdings (even if CNY is still only 5%).

Yet CNY is not a commodity currency: it is a currency entirely dependent on imported commodities. Can it then be an FX reserve? Yes, as Sterling showed in the past. However, one needs to control access to and pricing of global commodities. The British had an empire to do so and military primacy to control it. China can access Russian commodities - at the risk of decoupling from the US and EU, and maybe Brazil’s too(?) -  but is it going to build an empire when the US Navy still controls which commodities go where at sea, globally?

If commodities are support for FX, why are BRL and ARS, to name two, so volatile? Despite a structural bull market for commodities now, eventually resulting demand destruction will see a recession --on which, please see here from Philip Marey on yield curve downturn signalling: he’s looking for a key level of -16bp in 2s-10s as a trigger-- and commodity prices will tumble again. Logically, what you need is a commodity that doesn't vary in price: so one with either inelastic demand and/or a global monopoly position. Yet the EU is going to decouple from Russian energy, showing there are almost always alternatives.

The common thread is that countries should run a trade surplus, commodity or industrial; and have control of their and their trade partners’ supply chains. That is not a new theory, but an old one: MERCANTILISM. The problem with mercantilism is once you do it, others mirror it. And then things get geopolitical quickly. This is why, as far back as 2015, I was pointing out that a China no longer even pretending to sit under US global hegemony, but running a trade policy like pre-Plaza Accords Japan, was going to end very badly.

If you are then going to try and make your currency ‘hard’, by tying it to gold, or gas, or a digital fixity like Bitcoin, then the geopolitics gets even worse. If there is a fixed stock of money, the only way to grow *your* stock is to take it from someone else's: it’s zero-sum – or, if not, deeply deflationary when we know we don’t like either inflation or deflation. David Graeber’s ‘Debt: the First 5,000 Years’ echoes Polanyi in showing that, historically, ‘gold ages’ are violent or imperial; debt ages are more peaceful, as the money stock grows endogenously, until the paradigm collapses. Which, yes, is clearly where we are now.

But even if we start again, if you wanted to choose a currency with lots of commodities behind it, and lots of military --and the ability to force supply chains to come back-- it would still be the US dollar - although to say its strong hand is being played badly so far is an understatement. Indeed, as I have added before, if you think a petro-rouble or renminbi is going to beat a Eurodollar, you are presuming almost all Eurodollar debt will default. Enjoy that trade!

In fact, if China is so keen on a new ‘commodity-backed’ currency, why is it blinking in its stand-off with the US SEC over audits of US-listed Chinese firms? Who needs all those silly fiat dollars when you have so many rock-solid CNY? Either the news of China blinking is fake, to frame the inevitable delisting as the fault of the US, or CNY needs the USD far more than it lets on.

More so with the Fed still leaning towards hiking a lot, and market chatter of a 50bp hike. With another strong payrolls report on Friday, with strong upwards revisions and average earnings data, that chatter will linger – and yet the relative lack of importance of that datapoint is why I placed it last today. (The ECB, despite CPI hitting a shocking 7.5% y/y, won’t be following, of course.)

Moreover, largely unnoticed due to all of the meta and macro developments, at the micro level, US unions just achieved landmark victories at both Amazon and Starbucks, in David vs. Goliath wins. That’s another battle being fought with enormous longer-term market implications, and again the presumed victor is suddenly struggling.