Geopolitical Developments: Russia Is The Big Winner From The Afghanistan Tragedy, But Thankfully It Can’t Do Much With Its Good Fortune

The fallout from the Afghanistan tragedy continues to dog Biden and make his economic agenda precarious, a negative for the US markets. The volatility risk premium points to a higher market over the next few days, but my technical reading of key stocks in the S&P 500 is neutral. Yesterday's cross-asset action brought several positive factors for US stocks. The action in major currencies indicates the $US is weakening, while inflation expectations are stabilizing based on measures of Treasuries and TIPS. I see each of these positives reversing over the next few days: consequently, expect the S&P 500 to be range-bound over the next few days.

Russia benefits from the Afghanistan tragedy for three reasons:

1) Its influence in Afghanistan via its Central Asian neighbors (e.g., Tajikistan) increases now that the Afghan government is not allied to the US, and these Central Asian nations need help since islamic jihadists (like important elements within the Taliban) are a threat to them.

2) Pakistan and India will both beef up their relationships with Russia. Pakistan does so because Afghanistan provides an opening for shared interests, and Pakistan would like another partner so that it can improve its bargaining position with its “all-weather friend” China. India does so because the Taliban’s gains are a huge loss (India backed the wrong horse), and it can’t go to its enemy China to regain influence; rather it must go to Russia and theoretically Iran.

3) The loss of prestige to Biden naturally helps Russia since the nations are ideological adversaries.

But Russia can’t do much with its good fortune, since there is no straightforward way for Russia to advance the goals of Central Asian nations. Russia is a chauvinistic nation with a strong Christian bent and a history of anti-Islamic policies and actions. What Russia sorely needs is what China has: the financial and economic heft to help Central Asia materially, and thus win their support in geopolitical ventures. Russia can’t do this because the US has checked it profoundly with financial sanctions.

These sanctions debilitate Russia and there is little Russia can do about it. As the Economist notes Russia’s strategy for evading US financial sanctions has been smart but unsuccessful:

“Yet it was not until the annexation of Crimea in 2014 that these indignities came to be seen as acute vulnerabilities. America and Europe imposed sanctions that were designed to hurt misbehaving Russian banks and President Vladimir Putin’s cronies. Visa and Mastercard briefly blocked cards issued in Crimea or by blacklisted banks. American senators and the European Parliament called for Russia to be cut off from swift (though it remains connected). The ensuing economic crisis “triggered innovation and what-if thinking”, says Tom Keatinge of the Royal United Services Institute, a think-tank. The central bank now publishes regular reports about its strategy for “payment sovereignty”.

Central to that plan is a homemade rival to Visa and Mastercard. The central bank set up a payments system (nspk) with its own card, named Mir (“world”, or “peace”, in Russian). Legislators passed a law forcing Visa and Mastercard, in effect, to have their payments processed at a clearing-house owned by the Russian payments system. In 2019 the nspk made 11.9bn roubles ($160m), or three-quarters of its revenue, from charging clearing fees to foreign card brands. These proceeds have allowed it to lower Mir’s commission rate to 0.8%, well below the typical credit-card interchange fee of 1.2-2% in Russia.

Pensioners and civil servants are required to receive their incomes on a Mir card. Businesses must accept payments from it. Seven years after its launch Mir accounts for 30% of cards issued in Russia (and 24% of total transaction value). Last month it had about 100m cards in circulation. On July 20th Mir announced that it was connected to Apple Pay—a big deal, given that mobile phones make up 60% of contactless payments in Russia.

Mir wants even more. It bombards Russians with promises of special treatment if they switch cards. A ride on the St Petersburg metro is roughly half price when the commuter taps a Mir card at the gates. A “cashback” scheme offers a 20% discount on any holiday inside Russia booked with Mir. On August 17th Wildberries, Russia’s answer to Amazon, began charging Visa and Mastercard users an extra fee of 2%.

Outside of Russia, though, Mir does not fulfil its worldly ambitions. Most banks abroad do not accept it (Turkey, the most popular tourist spot for Russians, is an exception). Efforts to produce a version of the card co-badged with Mastercard’s Maestro brand, which would see it accepted more widely, have not solved the problem. Similar obstacles abound for another central-bank creation, spfs, the analogue for swift. It manages just a fifth of the domestic traffic that swift handles. And only a measly 12 foreign banks, including ones based in Belarus and Kazakhstan, are linked up (compared with 11,000 worldwide for swift), making it all but useless for foreign transactions. Banks must bear the costs of adopting spfs, but have little incentive to do so while swift still works.

Nonetheless, both have their value at home. They reduce the risk of chaos if Russia loses access to Western plumbing. Mir also serves to protect the banks and businessmen that sanctions were meant to hurt. Take Bank Rossiya, “a huge linchpin in the Russian patronage network”, according to Brian O’Toole, a former sanctions architect with the American government. The bank was cut off from the Western financial system in 2014, including from Visa and Mastercard. That hurt. But Mir helps keep the bank humming away.

Observers argue that America faces a blacklister’s bind: the overuse of sanctions as a tool of foreign policy might prompt targets to develop a parallel financial system, undermining not only the sanctions but Western power itself. Russia’s payments innovations certainly suggest some truth to the first bit of the theory. Still, the global might of the West’s financial architecture remains daunting.”

But while the US has checked Russia, it hasn’t checkmated Russia into shrinking back into what Obama memorably described as a regional power and Putin as a “bored kid in the back of the classroom.” The problem the US faces in dealing with chauvinistic and routinely malevolent Russia is there is no strong alliance the US can muster to put Russia in its place. European division over Russia occurs not just in Slavic nations but in Germany, France and Italy. And when considering the Russia-China quasi-alliance, the one nation we should be able to count on that could profoundly affect both nations is Japan, and that is simply not happening. Japan is an ally to the US in nuanced ways and fundamentally not reliable in executing US foreign policies.

Effectively the Japanese have always been free riders on western security and anti-communist efforts, benefitting economically from the wars. And when it comes to human rights or sanctions against despicable behavior, Japan has been reluctant to do anything against even longstanding enemies like Russia and China, let alone Myanmar. As The Diplomat notes, “Despite being a close ally to the United States and the other G-7 members, Japan implements sanctions comparatively sparingly toward China and Russia. Now that the G-7 has placed a greater priority on tackling illicit finance in the June 2021 Cornwall Summit, Japan risks being left behind if it continues in its hesitation to impose the same sanctions its G-7 allies do. As sanctions coordination increases between the United States and its allies, Japan must join them with similar sanctions of their own, or risk becoming a hub for Chinese and Russian sanctions evasion.”

Yesterday I sold my positions in K-Force (KFRC) and Facebook (FB). My current market positions are in Pfizer (PFE) and Starbucks (SBUX), and a short position in the SPX (UPRO and SPXU).