Vlad the Derailer

Wachovia’s Bill O’Grady is a bright guy.  I’m not sure I know of a guy who breaks things down in a way that allows readers of his articles to understand matters of importance, withouth the sensationalistic crap we normally are exposed to.

 In his piece, entitled Vlad the Derailer, O’Grady discusses Russian President Vladimir Putin’s historic visit to Iran on Oct. 17. At that meeting, which came on the heels of contentious talks with U.S. officials, the Russian president not only promised sales of arms to Iran, he also indicated that the Caspian Sea nations would not support any efforts to conduct military operations against Iran. This claim was pointed directly at the Bush administration, which has been in talks with Azerbaijan with regard to using its air bases if action against Iran occurs. In this report, he examined Russia’s motives for supporting Iran, how solid that support is and the impact of Russia’s behavior on the financial markets.

In 2005, at ceremonies marking the 60th anniversary of the end of World War II, President Putin remarked that the fall of the Soviet Union was one of the world’s “great tragedies.” The statement was shocking to Western ears, as the fall coincided with the West’s victory in the Cold War. It also unnerved some of the former Eastern Bloc nations, which suffered decades of Soviet subjugation. However, for Russia, there is a ring of truth to the statement. Russia, the primary state in the Soviet Union, has seen itself fall from superpower status, its economy collapse and its life expectancy for men decline — the first time on record such an event happened to an industrialized nation outside of war.Putin’s behavior suggests his goal is to resurrect the Soviet Union. He has worked to undermine “color” revolutions in Georgia and Ukraine, cutting off energy supplies to both nations and, in the case of Georgia, supporting rebel elements and persistently threatening to intervene militarily. He has discouraged the energy-rich “stans” from developing alternative transmission routes for oil and natural gas, encouraging these nations to use the Soviet-era pipeline system. He has improved diplomatic relations with the Persian Gulf OPEC nations in a bid to keep energy prices high. He has also used energy policy to weaken Western Europe’s support for the former Eastern Bloc nations.Putin sees U.S. foreign policy as designed to keep Russia weak. He believes that the Bush administration, through support for nongovernmental organizations, fostered the Orange Revolution in Ukraine and the Rose Revolution in Georgia. In other words, the Bush administration’s policy supporting global democratization is a cover for undermining Russia’s influence in its “near abroad.” In the aftermath of Sept. 11, Russia supported America’s use of former Soviet air bases in Uzbekistan and Kyrgyzstan for operations in Afghanistan. However, Putin has made it clear he didn’t expect U.S. control to continue this long and has been encouraging the governments in the region to end the relationship with the U.S. military.Russia’s recovery under President Putin has been impressive.  However, much of this growth has been due to the extraordinary strength in crude oil prices; note that real per capita GDP made its trough in 1998, when crude oil was declining towards $10 per barrel. There is little evidence to suggest that Russia’s authoritarian political system is helping support economic diversification. Still, compared with the downward spiral seen in the Yeltsin administration, it is no wonder that most Russians view Putin as a successful president.

Prior to Putin’s meeting with Iranian officials on Oct. 17, the Russian president met with U.S. Secretary of State Rice and Defense Secretary Gates in Moscow. U.S. officials wanted to continue negotiations on a controversial U.S. missile defense shield. The United States wants to base installations in the Czech Republic and Poland. Ostensibly, these facilities would be to protect Europe and the United States from a nuclear missile attack from a rogue Middle Eastern power. The Russians don’t see it that way. Instead, this looks like the United States is building a missile shield to protect Western Europe and the United States from Russian nuclear weapons. Given the current state of technology, Russian intercontinental ballistic missiles could overwhelm the proposed missile shield. However, the Russians are likely not afraid of the current system but fear that in a couple of decades the United States may be able to render the Russian nuclear missile system useless. Or perhaps a more realistic concern is that the missile shield could lure Russia into an arms race that, even with Russia’s recent economic improvements, they could not hope to win.In addition, there are other Cold War-era treaties that the Putin administration is negotiating. The Intermediate-Range Nuclear Forces Treaty (INF) prohibits the development and deployment of short-, medium- and intermediate-range land-based missiles, which have a range of 300 to 3,400 miles. Putin wants to jettison this treaty. Russia faces a myriad of threats from these missiles on its periphery and needs to develop these weapons to create numerical parity with surrounding nations. The United States opposes Russia’s withdrawal from the INF.At the same time, Russia would like to extend the Strategic Arms Reduction Treaty I (START I). This treaty, which covers strategic weapons, is set to expire in 2009. The Bush administration appears to be willing to let it expire in order to give the United States freedom to make changes and perhaps rebuild or expand America’s nuclear deterrent. Again, Russia does not want to participate in another arms race and would like to extend the treaty, so the Bush administration’s refusal is a problem. 

Continued U.S. support for democratization in Russia’s near-abroad, the support of NATO expansion into the Eastern Bloc, the Eastern European missile shield and the disagreements on nuclear treaties are all threats to Russia. Thus, it would make sense that President Putin would try to improve his negotiating position. Iran has become the perfect lever. In his recent trip to Iran, President Putin offered to sell military equipment to the clerical government and promised that no government surrounding the Caspian Sea would participate in an attack on Iran. It isn’t clear whether Putin has the authority to deliver such a promise, but clearly he intends to try. This new support comes in a context of Russia’s refusal to support stronger sanctions from the United Nations, using its veto on the Security Council to weaken Western efforts to constrain Iran.In effect, Putin is working to show the United States that Russia can be a problem. By supporting Iran, the clerical regime has cover to continue supporting the insurgency in Iraq and can raise the costs of directly attacking Iran. What is interesting about this situation is that Russia and Iran have historically not been friendly. Iran has been concerned about Russian/Soviet influence in the region, especially with regard to the Caspian Sea, and since the overthrow of the shah, the Russians have worried about Iranian support for Islamic groups. Thus, this is a “marriage of convenience.”The one thing Russia made clear to Iran is that it doesn’t support any moves toward making nuclear weapons. President Putin indicated he didn’t believe Iran was working to create such weapons, but he also suggested the slow progress on the Bushehr nuclear power plant would continue. Russia has been delaying fueling this plant for years and has shown little interest in actually starting up the facility.Neither Russia nor the United States wants Iran to possess nuclear weapons. In fact, Russia is at greater risk, as Iran’s missile capability can reach Russian soil. It will be years before Iran could threaten the United States with its missiles. Thus, Russia will support Iran in order to improve its negotiating position with the United States; if or when this occurs, we would expect Russia to be more than willing to end its support for the Iranians.

The key issue for the markets near term is the potential for a military conflict with Iran. Russia’s recent behavior, at least on the surface, would suggest the risks have declined, as the support for Iran’s military and the inability to use bases in the Caspian region make military operations more difficult. However, we suspect that Iranian officials realize their “friendship” with Russia is tenuous at best and if the latter can cut a deal with the United States on issues important to them, Iran will find itself with considerably less support. The Iranian government’s recent decision to accept the “resignation” of its nuclear negotiator, Ali Larijani, suggests a harder line from Iran. Larijani is considered a pragmatist; the more that hard-liners dominate the government, the greater the odds that a conflict between Iran and the United States will take place. Thus, if we see Russia and the United States coming to agreement on some of the issues described above, it probably signals that the chance of a conflict with Iran has increased.If such a conflict occurs, the most likely outcome would be a short-term spike in oil prices, a decline in global equities and a rally in Treasuries. At this point, the odds of a conflict are still rather low, but President Putin appears to have given the parameters of a deal. Although the United States could still move against Iran even with Russian interference, not having it would make the situation easier. Therefore, we will continue to watch for signs of a U.S./Russian thaw. If that occurs, it may indicate a decision to ratchet up pressure on Iran.

Thanks to Bill O’Grady for his contribution.  

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Published in: on October 31, 2007 at 9:42 pm  Leave a Comment  

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