Recent events in the Crimea gave many observers déjà vu, complete with discussions of a return to Cold War tensions that were long dormant or, some thought, extinct. While there is no question that Moscow will be viewed with a freshly jaundiced eye by Western officials and the larger public, the crisis also emphasized an important difference between Russian President Vladimir Putin and his communist predecessors. All things considered, Putin would rather make nice with capitalists.
The collapse of the Russian-aligned Kiev government caught many both inside and outside Ukraine off guard. In a series of military deployments, possibly pre-planned, Moscow seemed to capture the political initiative. By Sunday March 2, amid the bluster of assorted foreign secretaries and the leaders of various international organizations, journalists were speculating about when Russia was likely to invade eastern regions of Ukraine.
Debate also began to shift to the prospects for a war that risked drawing in other countries from the region or even ensnaring major Western powers in what, again, appeared to be an East-West dispute more suitable to the Cold War era. In a declaration that appeared at once to sum up the incongruity of the situation and to highlight a certain irony, U.S. Secretary of State John R. Kerry said:
You just don’t in the 21st century behave in 19th century fashion by invading another country on completely trumped up pretext.
This criticism, and the pleas of others, seemed to fall on deaf ears in Moscow, as the Russian upper house of parliament authorized Putin to use military force as he deemed appropriate in the region.
And then the markets weighed in. Where leaders in Western capitals found it easier to mention sanctions than actually to plan or implement them, investors, fearing the loss of their capital, voted decisively with their feet. As political science research suggests would happen in this situation, the Moscow stock market fell almost 11 percent in Monday trading, erasing roughly $60 billion from the balance sheets of publicly traded firms. The Russian central bank poured perhaps $12 billion into currency markets to stabilize the ruble. Whatever anyone else thought of Putin’s unfolding plans, the markets clearly believed that Putin and Russia were not bluffing.
On Tuesday morning, Putin held a news conference. His tone was much more subdued, and investors took notice. Stock and currency indexes recovered. “As for the events in Ukraine,” Putin noted, “politics always influence the stock market in one way or another. Money likes quiet, stability and calm.”
It would be difficult to imagine Joseph Stalin or Leonid Brezhnev reshaping their foreign policies to mollify “money” in this manner. Putin, of course, never admitted that he had chosen to appease investors, and his true motives are difficult to guess. At the same time, he had suddenly become much clearer about what he did not have in mind, and it is not unreasonable to think that Putin’s rhetorical transformation was related to the huge financial price tag that the markets had fixed as the cost of military adventure in Ukraine.
The idea of kowtowing to Western capital would have been unthinkable to the revolutionaries who founded and built the old Soviet empire. Things have changed, however, and market-oriented economies — even those as imperfectly constructed as those of contemporary Russia — must be courted rather than commanded by politicians. Today, a key consequence for being persuasive in the Cold War game of brinkmanship is increasingly that one’s markets collapse.
Lest one think that we are singling out Putin, the use of markets as truth serum is genuinely democratic. Investors do not play favorites with the political feet they hold to the fire. As long as profits are at stake, they will respond to, and occasionally anticipate, the economic consequences of political talk. Early in George W. Bush’s first term as president of the United States, a collision between a U.S. EP-3 “spy plane” and a Chinese fighter aircraft led to a comparable, if more diminutive, international incident. The pilot of the Chinese plane was killed, and the U.S. aircraft was forced to make an “unscheduled landing” in Chinese territory (Hainan). Recriminations occurred and escalated on both sides.
Increasing tensions also registered on Wall Street. Major U.S. stock indexes initially showed little reaction, but plummeted after a statement by President Bush on April 2 that made it clear that U.S. priorities were at loggerheads with those of the Chinese. Bush called for the immediate release of the U.S. crew and the aircraft. Other information provided by U.S. officials seemed to lay the blame for the damaging mid-air collision on the Chinese pilot.
The next day, Chinese President Jiang Zemin repeated the demand for an apology, arguing that U.S. espionage activities had violated Chinese airspace. At about noon on April 4, Bush delivered a second statement that repeated many of his previous points, but hardened his tone by saying: “It is time for the Chinese government to return our plane. This accident has the potential of undermining our hopes for a fruitful and productive relationship between our two countries.” Jiang also repeated his call for the United States to “apologize.” By its close on April 4, the S&P 500 index was down 5.5 percent from the previous Friday, before the onset of the crisis.
At this point in the crisis, Bush, like Putin, appeared to soften his stance. On April 5, the U.S. president stated his “regret that a Chinese pilot is missing” and expressed the hope that the incident would not be allowed to “destabilize relations” between the two nations. An official letter to this effect was sent to Chinese leaders. Sensing that the crisis had passed, the markets recovered the next day. The U.S. crew and eventually the aircraft were returned several days later, resolving what had briefly appeared to be an intractable dispute without further drama.
Markets have special powers to yield outcomes that are not the intended result of any member or investor. Adam Smith described this phenomenon as an “invisible hand,” referring to the social efficiencies gained when markets are allowed to allocate goods and capital, rather than relying on the judgment and authority of government officials. But markets also attach a cost to political rhetoric, making it efficient for international leaders to be slightly more candid with observers about their actual priorities. The truth has never been especially plentiful in politics. At the same time, the general lack of political candor makes the truth valuable. Mechanisms that attach costs to bluffing serve to chasten political talk, reducing the incentives for deception and forcing leaders to be (slightly) more honest, and thus credible, in their communications.
Leaders of modern, globalized states, unable to restrict markets and confronted by incentives both to compete internationally for political gain and to cooperate to appease investors must choose their priorities. As James Morrow and others argue, bluffing can be costly in economic terms; leaders who wish to win political windfalls, but who are unwilling to move past the brink of war, are better off cutting economic losses and making nice with markets. At the same time, the burdens imposed by markets make it easier for the most resolved leaders to make their determination clearer without actually having to escalate to the point of military violence.
Chicken and brinkmanship are a big part of winning one’s way in a competitive political world. But these processes are also inherently dangerous; brinkmanship has no purpose if everyone knows that things will turn out well in the end. The tensions evoked by the recent Crimean crisis clearly harken back to the Cold War, combining familiar archetypes as protagonists and evocative geography. Thus far, however, the course of the crisis has been more than a little different than those in that Cold War era. Rather than staring one another down over bulging arsenals of nuclear weapons, both sides in the crisis seemed cowed by the prospect of quite a different meltdown, one involving financial markets.
While each investor intends only his own gain, collectively their actions promote an end that is no part of the investor’s intention. By seeking only to protect themselves from the consequences of politics, they attach to political action costs that are not easily ignored by politicians. These costs can then sometimes allow leaders to demonstrate resolve before the shooting starts, or possibly to reflect and reconsider on the brink of war.
Previous posts on the recent events in Ukraine at The Monkey Cage: