The Geoeconomics Of Modern Conflict
Authored by James Rickards via DailyReckoning.com,
Geopolitics play a major role in the outlook for global economies. But more importantly, today, we must look at the world through the prism of geoeconomics.
What is “geoeconomics”? Obviously, it’s a portmanteau from the words geopolitics and economics. There’s nothing new about considering those disciplines in the same context.
Wars are geopolitical and are often won through industrial capacity, which is primarily economic. Economics and global strategy have always been entwined. What is new is the idea that economics are not just an adjunct of geopolitics, but are now the main event.
This does not mean that warfare is over or that military prowess no longer matters… It means that the major powers in a globalized age will base their calculations on economic gain and loss, and will use economic weapons not as ancillaries, but as primary weapons.
This change was described at the beginning of the new age of globalization by strategic thinker Edward N. Luttwak in a 1990 article titled “From Geopolitics to Geo-Economics: Logic of Conflict, Grammar of Commerce.”
Luttwak wrote that the end of the Cold War and the start of globalization meant that armed conflict was too costly and uncertain for great powers. Economic interests would now be the arena for great power conflict.
Luttwak wrote, “Everyone, it appears, now agrees that the methods of commerce are displacing military methods – with disposable capital in lieu of firepower, civilian innovation in lieu of military-technical advance and market penetration in lieu of garrisons and bases.”
Luttwak concluded, “While the methods of mercantilism could always be dominated by the methods of war, in the new ‘geoeconomic’ era not only the causes but also the instruments of conflict must be economic.”
To be clear, Luttwak’s analysis principally applied to great powers including the U.S., China, Russia, Japan, members of the EU and Commonwealth nations including Canada and Australia. Luttwak recognized that middle powers such as Israel, Iran, Iraq, Pakistan, North Korea and some others might still find warfare beneficial.
He did not rule out the fact that great powers might intervene in wars involving these middle powers, such as the U.S. interventions in Iraq and Afghanistan and Russia’s involvement in Ukraine.
His point was not that war was obsolete, but only that it would not involve direct confrontation between great powers. Interventions and wars involving lesser states would still be on the table.
Geoeconomics – great power competition using economics as a goal and a weapon – is an excellent tool for analyzing the two critical hotspots in the world today. These are Russia’s role in Ukraine and China’s threat to Taiwan.
The Western narrative that Putin is the bad guy bent on conquering Ukraine is false. Putin had warned the West about not pushing its advantage in Ukraine for over 20 years. While Putin was amenable to NATO expansion, he always drew the line at Lithuania, Ukraine and Georgia. In 2004, NATO crossed Russia’s red line by admitting Lithuania to membership, but there was little Putin could do to stop it.
The 2008 nomination of Ukraine to NATO was an unforced error. Putin had been content to leave Ukraine as a neutral buffer state. The West was not and pushed Putin too hard. Now Putin has pushed back. Why is Ukraine so important to Russia?
A quick glance at a map shows that Ukraine in NATO or even a pro-Western Ukraine is an existential threat to Moscow. The line from Estonia in the north to Ukraine in the south forms the letter “C” that encircles Moscow from the north, west and south.
Parts of Ukraine actually lie east of Moscow, opening that region to attack from the west, something that has not happened since the Mongol Empire of Genghis Khan in the 13th century. If Ukraine will not become neutral, then Putin must control it, at least the eastern half, by force if necessary.
This has obviously happened.
But conquering Ukraine was not and is not Putin’s main goal. What he wanted the whole time was a Ukraine that would not join NATO, neutrality in the Ukrainian government and full operation of the Nord Stream 2 natural gas pipeline from Russia to Germany under the Baltic Sea (too bad the U.S. blew it up!).
If Putin could have gotten all or most of that through negotiations, there was no reason to invade Ukraine. The threat to do so will have served its purpose.
That outcome would have been a perfect illustration of Luttwak’s geoeconomics definition. The goals were commercial (dependence of Western Europe on Russian natural gas), and the tools were commercial (pipelines) even though the players were sovereign states (Russia and the U.S.).
The U.S. has imposed severe economic sanctions on Russia for invading Ukraine. But these sanctions have had little impact on Russia, as I predicted before the war. Sanctions were imposed on Russia after the 2014 annexation of Crimea and have had no material impact on Russian behavior.
Before the war, Russia already moved over 20% of its reserves into physical gold bullion stored in Moscow. This gold is worth about $140 billion at current market prices. Because the gold is physical, not digital, it cannot be hacked, frozen or seized.
Importantly, U.S. sanctions have not affected exports of Russian oil or natural gas. Russia provides about 10% of all the oil produced in the world. It’s simply impossible to sanction Russian oil sales.
We still hope that Russia and the U.S. avoid direct armed conflict in Ukraine, although they keep climbing the escalation ladder.. Energy prices will probably go higher, which helps Russia. The losers are Ukraine and global energy users.
The second critical hotspot today is the potential for a Chinese invasion of Taiwan. Will it happen? The case against such a war is basically in the scenarios described above.
Events would likely escalate and spin out of control, resulting in a large-scale conflict. Gains are possible for China, especially if the U.S. does not come to the aid of Taiwan. Still, the risks are too high, and the costs are too great. Instead of an invasion, China could continue its rhetoric and its military readiness, but otherwise bide its time.
This is where Luttwak’s definition of geoeconomics casts a new light. In a pre-globalized world, China might well attack. In the post-globalized world, China might refrain militarily while continuing its progress in technology, natural resources and value-added manufacturing. This path requires cooperation, not confrontation, with the U.S. and Western Europe.
My estimate is that China will refrain from an invasion consistent with the geoeconomic thesis. At the same time, Xi Jinping will continue threats and economic confrontation with the West.
Investors should expect the following from this unstable confrontation: The U.S. and China will continue to decouple economically. Supply chain disruptions will grow worse before they get better. A new supply chain configuration will emerge involving more onshoring and shorter transportation lanes.
China’s growth will lag and it will be unable to make the technological leaps it needs to escape the middle-income trap and become a high-income developed economy. Over time, excessive debt and adverse demographics will overtake China’s ambitions and leave it an aging and low-productivity shell.
China’s economic problems will sustain its demand for energy and put a floor under energy prices. Manufacturing costs will rise as China’s labor pool evaporates. Investors should not rule out a financial crisis in China that would spread to a global collapse in capital markets, probably worse than those of 2008 and 2020.
But geopolitical tensions will disrupt global supply chains, which will result in higher input prices and transportation costs. That’s a receipt for sustained inflation, and higher interest rates.
And any form of uncertainty is a plus for the one safe-haven investment that never fails — gold.
While Americans are preoccupied with balloons and other stories that are mostly for show, more serious thinkers are applying themselves to oil, natural gas, gold, the dollar, technology and other geoeconomic benchmarks.
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