“The lamps are going out all over Europe, and we shall not see them lit again in our lifetime”
Sir Edward Grey, British Foreign Secretary, 03 August 1914
Zeitenwendei
When US President Joe Biden recently tried to extract a promise from Chinese leader Xi Jinping not to supply Russia with military assets at this sensitive juncture, the conversation via video link apparently turned sour. After nearly two hours, the Chinese leadership was left with the impression that the sanctions regime now in place against Russia might soon be extended to China too.
Anyone who is still investing in China should be aware of the ratcheting up of political risk. Only last week, Fidelity’s Tom Stevenson was arguing that “Brave investors should be ready to give China another chance”. Yet we have known about restricted technology flows from the US to China (and vice versa) for some time. We have known about the incarceration of untold numbers of Uyghur people in Xinjiang, and we have witnessed the incremental extinction of democracy in Hong Kong. And yet we continued to buy semiconductors from China and Apple, even now, manufactures its iPhones there.
The idea that our continued engagement with China would make the country more like us passed its sell-by date long ago. Yet Western firms were loath to extricate themselves from a market of 1.4 billion people where purchasing power was growing fast. The German automotive giant Volkswagen even has a factory in Xinjiang. In fact, just as Germany is overwhelmingly reliant on Russia for its energy, German industry is beholden to China for much of its manufacturing exports. Both these phenomena represent Angela Merkel’s catastrophic legacy.
In the space of a month, about 400 major western companies pulled out of Russia, or at least suspended operations there. That was partly because of a risk of sanctions, though more to do with fears of a backlash by their core customers in their home countries. But it might not be so easy for the corporate titans to quit China in the same timeframe, should the need arise. China is the world’s largest importer and exporter of intermediate goods. It is much more integrated into the global economy than Russia. US corporations would probably find it easier to step back from China than German ones – although Tesla is deeply rooted in China now.
If China, Russia’s “limitless friend”, were to invade Taiwan, many western corporations will have to re-think their strategies. But they should have done so already, since the world has fundamentally changed since 24 February.
The Chinese stock markets recorded both their worst and their best days for a decade in March. The turning point was when Chinese premier Liu He had a Draghi-style “whatever it takes” moment. He indicated that Beijing would stimulate the economy just as Western countries were tightening monetary policy. Investors interpreted Liu’s remarks as a reversal of the Beijing government’s policy of persecuting any listed company of which they disapproved. But was that justified? This, at a moment when China’s zero-Covid policy (New Zealand times 300) seems to be paying diminishing returns. And there are other reasons to be cautious about investing in China.
The critical agenda to reduce dependence on Russian hydrocarbons in the West is associated with the realisation that advanced nations cannot continue to rely on “offshoring” to nations whose fundamental political and value systems are inimical. Russia supplies roughly one third of Europe’s oil, 45 percent of its natural gas and nearly half of its coal. Nearly everyone now agrees that that must change – even the Germans, who did not admit previously that it was insane. Since 2014, when Russia annexed Crimea, Germany alone has paid Russia €170 billion for gas, coal and oil. That has nicely funded Putin’s war machine. Rosneft, the Russian oil giant is even the majority shareholder in the Schwedt oil refinery. The Germans will find it impossible to wean themselves off Russian hydrocarbons entirely without widespread blackouts – only Lithuania has achieved that so far.
Simultaneously, the penny has dropped that seeking to locate manufacturing offshore where labour is cheaper is a false economy. Supply chains are breaking down and high-end components such as semiconductors are becoming scarcer, with the result that several automotive players have had to halt production lines of late. In 1990, Europe and North America produced about 80 percent of required electronic components and imported about 20 percent from Asia: now, it is the other way round. If China were to seize Taiwan and North Korea were to make war on its southern neighbour (two geopolitical events which could be related), the West would become overwhelmingly dependent on China’s goodwill to source essential components – which might then be withdrawn at any moment.
The question now is whether western corporations will wait until the next geopolitical crisis before extricating themselves from China; or whether they will act pre-emptively and dial down their exposure to China while they still can. Quitting Russia, even for companies with deep involvement there, like Renault (after three weeks of prevarication), was an affordable sacrifice. (Though Renault maintains its two thirds holding in Avtovaz, the producer of the iconic Lada).
Clearly, it is much easier for companies which are asset-light such as auditors to withdraw from a national market than companies which have capital intensive business models. Some western companies have remained in Russia, justifying their continued presence on the ground that they provide “essential” goods and services. Amongst these are Carlsberg, Danone, Kellogg, Kraft-Heinz, Mars and PepsiCo. Nestlé insists that it is now only selling baby food and hospital meals in Russia.
But the Chinese market is ten times bigger that the Russian market, and many western companies would incur substantial actual and opportunity costs by quitting China. Equally, Russia only offers hydrocarbons to the west – it has almost no manufactured goods still less services that we want to buy. In contrast, the chances are that your home or your office are full of goods manufactured in China. (I’ve just been in the garden shed and the pond pump was manufactured in Wuhan and the leaf blower in Guangzhou).
That said, Xi’s China is already thinking about deglobalisation and de-coupling. Xi has talked about a “dual circulation” economy that, while not a Maoist autarky, would be less dependent on international trade. I suspect that the Chinese leadership calculates that globalisation and China’s period as “workshop of the world” (just as Britain was in the mid-19th Century) was a temporary stage on the road to something much more sinister.
The view from Beijing…
China is concerned about the economic fallout from Western sanctions against Russia – which will only intensify as new reports of Russian atrocities are disseminated. Last week, a top Chinese diplomat, Yang Jiechi, met Jake Sullivan, the US National Security Advisor in Rome. China refuses to denounce Russia for its aggression and avoids the word “invasion”. And Chinese state media continues to push a pro-Russian and anti-American line, repeating Russian claims that there are US chemical weapons facilities in Ukraine. On 05 April, the New York Times reported that the Chinese Communist Party is mounting an ideological campaign aimed at state officials and students to build domestic sympathy for Russia.
And there is evidence of Chinese complicity. China launched a massive cyber-attack against Ukraine’s military during the Winter Olympics, culminating on 23 February, the day before the Russian army crossed into Ukraine. More than 600 government websites were hacked according to the SBU, Ukraine’s security service.
Just as several European nations have pledged to increase their defence expenditure, so China too is planning to ramp up its armed forces. Beijing’s defence budget will rise by 7.1 percent this year $229.5 billion. Some analysts believe that China’s true defence budget is much higher than that because this figure does not include military R&D which is conducted across a plethora of academic institutions and state agencies. Chinese soldiers cost far less than US GIs, so China can afford more men in uniform. The Chinese People’s Liberation Army is the largest in the world with 2.185 million active personnel and 1.17 million reservists. It has 6,300 tanks and 7,000 artillery guns. The Chinese navy has around 70 submarines, of which six carry nuclear-capable long-range missile platforms, more than 130 destroyers, frigates and corvettes. Its air force has 1,600 fighters, 450 bombers and 400 transport aircraft.
Historically, China has sourced much of its military technology from Russia – as, indeed, has India. Its Shenyang J-11 fighter is based on the Sukhoi-27 and the Sukhoi-30. That said, China now produces all its munitions and hand-held weapons.
Military analysts all over the globe are examining every video frame coming out of Ukraine and are drawing similar lessons about the inadequacy of Russian logistics, and the errors of a poorly-trained conscript army. You may be sure that Chinese military analysts are amongst the most assiduous. China will have noted soberly that the West has responded with unexpected solidarity, and that a rigorous sanctions regime was rolled out against Russia within days.
China is not actually showing Russia “limitless friendship”. China’s economy has been knocked by the spike in gas prices – China is energy-inefficient, using twice as much energy per unit of GDP as France or Germany. It has abandoned the rouble-yuan currency peg, thus making Chinese goods more expensive for Russian buyers. Chinese firms have been urged to “fill the void” created by the evacuating west.
In response, Russia has effectively returned to the gold standard, with the value of gold now set at 5,000 roubles per gram for the next three months. As a result, the currency’s value has surged back to pre-war levels. This is what Donald Trump wanted to do with the dollar – and is a sign of things to come. Russian government spokesperson Dmitri Peskov has spoken opening about the need to displace the Bretton Woods global monetary system. If the Europeans agree to Putin’s demands and begin to pay for Russian hydrocarbons in roubles, then the currency will be buoyed even higher.
…and from Tokyo
Japan’s deep wish for many years has been to form a “partnership” with Russia to counter China – much like India. That was always going to be a delicate balancing act. Japan has had a territorial dispute with Russia since 1945 over the occupation of the Kuril Islands, about which some nationalist elements regularly protest. But the country has sought to be pragmatic, especially since a significant part of its gas supplies are imported from Siberia. And the political consensus has been, until now, that Japan could never outplay a combined Russia and China.
Former Japanese Prime Minister Shinzo Abe wooed Putin with the promise of investing in Russia’s fast-depopulating Far East. Mitsui and Japan Oil invested in the planned second phase of the Arctic liquefied natural gas project, backed by Russia’s Novatek and Total of France. Mitsui and Mitsubishi also have a stake in the Sakhalin II oil and gas project alongside Shell and Gazprom. Itochu and Marubeni are already involved in Sakhalin I.
Since the invasion of Ukraine, Japanese diplomats no longer refer to Russia as a “partner” but rather as a “security challenge”. Ukraine’s President Zelensky addressed the Tokyo diet (parliament) on 23 March. Japan imports just four percent of its oil and nine percent of its oil from Russia. Like Germany, Japan discerns an opportunity to dilute its post-1945 pacifism in the face of Russian aggression. That is something that Mr Abe has been pushing for some time. Japan is a very substantial power – so why should it not act like one?
The defence bonanza
One sector that has a spring in its step of late is the defence sector as nations vie with one another to ramp up military expenditure. Shares in France’s Thales have risen by about 25 percent since the invasion, and in Sweden’s Saab by nearly 70 percent. US aviation giants Lockheed Martin and Raytheon have also surged. Britain is sending 6,000 more missiles to Ukraine, having already sent 4,200 NLAW anti-tank weapons which are finished in Belfast by Thales UK and are based on a design by Saab.
The US has pledged $1 billion of military aid to Ukraine including 2,000 Javelin anti-tank weapons made by Raytheon, as well as 1,000 light anti-armour weapons and 6,000 of Saab’s AT-4 anti-tank systems. It is also sending 800 of Raytheon’s Stinger anti-aircraft systems, at a cost of around $120,000 apiece. A British company, Avon Protection, makes gas masks, helmets and other battlefield protective equipment. Its share price was up by over 20 percent at one point but has since fallen back. BAE Systems is up over 20 percent.
On Wednesday (06 April) we learnt that the AUKUS pact nations (Australia, UK and the USA) have launched a joint programme to develop hypersonic missiles. We await more news on this. And then there is the ongoing war in cyberspace, about which I will have something to say shortly.
The end of globalisation
Donald Trump was sworn in as US President in January 2017 with an apparently Sinophobic agenda, at least in trade terms. America first – and, by implication, China last. And yet, for all Mr Trump’s rhetoric, we seem to be more beholden to China than in 2016, especially since the electrification agenda is driving an insatiable demand for batteries, which, along the rare Earth metals used to make them, are overwhelmingly sourced from China. It would be ironic if Mr Biden, Trump’s nemesis, out-trumps Trump by any formal policy of “de-Chinafication”. But that seems quite likely to me now.
As for Russia, I heard the BBC’s Moscow correspondent, Steve Rosenberg say on the Today Programme on Wednesday (06 April) that the Russia he knew and loved has vanished since 24 February. It feels like an oppressive prison under siege. One of the greatest tragedies of all this is that a great nation, full of passion, humour and talent, which might once have been a partner, has now died.
It is depressing that a significant proportion of the Russian population seems to have swallowed the Kremlin’s narrative about the denazification of an enemy state – one supposedly ruled by drug addicts and paedophiles. Even worse, some Russians apparently embrace the ideology that Russia must reclaim lost territories which have been subverted by the malign corruption of the West. They want to annihilate “anti-Russian” Ukraine and to repopulate it. The Russian Orthodox Church even thinks that this is a just war.
The ex-oligarch, Mikhail Khodorkovsky, now in exile in Germany after 15 years in a maximum security Russian prison, gave CNN his analysis this week. He knows how the Kremlin works and had personal dealings with Putin before he crossed him. He thinks that Putin once loved money but that now he aspires to legacy. He wants to be Peter the Great II and to establish a Eurasian empire that will last for generations. For him, all tactics, however barbaric, are justified for that end. If he succeeds in seizing Ukraine, he will soon move on the Baltics, no doubt with more nuclear blackmail. Indeed, Russian public opinion is already being prepared for this, says Khodorkovsky.
There is no chance of returning to “normal” relations with Russia – even if there is a peace deal, which in my view is not imminent. There will be a Cold War which will be much more dangerous than the US-USSR Cold War of 1947-91. The risk of nuclear war breaking out over the next two years is chillingly high – much higher than during the Cuban Missile Crisis of 1962. But, as Jim Mellon told a packed audience at the Master Investor Show on 19 March: if there is no Armageddon, we just buy on the dip; and if there is then we won’t need the money anyway.
We are living in the early phase of The Great Bifurcation in which the world splits into mutually hostile states systems. China will follow Russia as a no-go zone for Western investment relatively soon. I’ll consider shortly which significant nations will join the Russia-China axis. (I’m deeply worried about India – and Brazil could go either way). The impending New World Order will be poorer, though more resilient.
Orwell’s Nineteen Eighty-Four was more prescient than we could have imagined. In that dystopia, three trans-continental superstates – Oceania, Eurasia and Eastasia – slog it out in a state of perpetual mutual hostility. Dmitri Medvedev, the former Russian president, even spoke this week about a “Eurasian state extending from Lisbon to Vladivostok”.
At least we have returned to a world of moral conviction. After a period of moral relativism, Good versus Evil is back.
***
May I take this opportunity to wish my Christian readers a happy Easter as I won’t be posting next week. I’m going on a pilgrimage during Holy Week, which this year takes place in the sacred Muslim month of Ramadan. So very best wishes to my Muslim readers too. And not forgetting my Jewish readers who celebrate Pesach from 15 April.
I find it difficult to give things up for Lent – much as I admire those who do. Call it a lack of self-discipline, if you will. But from time to time, I don my walking boots and rucksack and head for the hills. I used to be able to walk for an entire day on minimum rations. When I walked across Spain in 2005, I lost eight kilos. I once spent two days snow-bound in the Pyrenees without any food at all – an experience I would not want to repeat.
It must be something deep in the blood. People I admire like Rory Stewart, with whom I once walked for a day in Scotland, and Robert Macfarlane have the same inclination. So, I can’t be mad. Can I?
Listed entities cited in this article which merit further analysis.
- Volkswagen AG (RTR:VOW)
- Thales SA (EPA:HO)
- Saab AB (STO:SAAB)
- Lockheed Martin (NYSE:LMT)
- Raytheon (NYSE:RTX)
- Avon Protection (LON:AVON)
- BAE Systems (LON:BA)
i German, meaning “a turning of the times”.