Reshuffling the Geopolitical Deck

The only news worth talking about this week has been out of Eastern Europe. On Thursday morning, Russia invaded Ukraine.

The attack, while not unexpected, sent markets into overdrive.

Markets hate uncertainty. Wars always bring uncertainty. But this action on the part of Vladimir Putin is creating more uncertainty than simply the outcome of this current military action. 

The actions and reactions by the countries involved now have the potential to reshuffle the world’s geopolitical balance. 

Let’s take a quick look at what’s happening and what the final outcome — where investors are concerned — could be.

Russia Thumbs Its Nose

When the Soviet Union fell in 1991, it gave up a lot of real estate. Fourteen countries (not including Russia itself) were born out of the breakup. Ukraine was one of them.

Throughout history, the area known as Ukraine has been militarily significant where Russia (and likely Putin) is concerned. In 1812 Napoleon invaded and conquered Moscow by way of Ukraine. More recently, in 1941 Hitler launched an invasion of the Soviet Union again by way of Ukraine.

Because of this history, Putin likely views Ukraine as a strategic piece of real estate that needs to be under Russian control.

However, when they became an independent state, Ukraine also got a lovely parting gift from the former Soviet Union — 1,900 nuclear weapons capable of striking the United States. President Clinton made haste to sign a deal to disarm the newly minted nuclear power. 

Under the terms of the agreement, Ukraine promised to hand their nukes over to Russia to be dismantled. In exchange for giving up a serious defensive advantage, Russia, the U.K. and the U.S. entered into the Budapest Memorandum in 1994. The document committed the three signers to “respect the independence and sovereignty and existing borders of Ukraine” and to “refrain from the threat or use of force” against that country.”

By invading Ukraine, Putin has thumbed his nose at that agreement.

Despite a mixed record in the “war” department, the U.S. is still considered the world’s leading superpower — the world’s police force so to speak. Proponents of this position refer to 70-plus years of “U.S. led peace” in Europe.

And because of our status as ”defenders of democracy” around the world — the Biden administration interjected itself into the conflict threatening a series of sanctions to make Putin think twice. 

Aside from various sanctions designed to cut Russia off financially from the rest of the world, one of the biggest sticks the U.S. could wave is a shutdown of the Nord Stream 2 pipeline.

Oil and gas exports account for roughly 60% of the country’s GDP. Nord Stream 2 gives Russia direct access to Europe and lessens their dependence on pipelines going through Ukraine. 

In addition to U.S. sanctions on companies associated with the construction of the pipeline, German Chancellor Olaf Scholz has asked the German Economy Ministry “to make sure that this pipeline cannot be certified at this point in time, and without this certification Nord Stream 2 cannot operate.”

The Big Problem with That Response

In their haste to go green, Europe has left itself highly dependent on importing fossil fuels. Its gas reserves have been drained significantly due to last year’s unusually cold winter. The ability of renewables to power the continent has proven weak at best. 

And there are no reasonable alternatives to supply their oil and gas needs. According to the AP, “Even if all Europe’s LNG (liquid natural gas) import facilities were operating at capacity, the amount of gas would only be about two-thirds of what Russia sends via pipelines.”

Cracking down on the pipeline would certainly put a dent in Russia’s GDP. But how long can Germany and the rest of Europe hold out? 

That advantage notwithstanding, there’s another factor that favors Russia where sanctions go — they just don’t care.

Indeed Russia’s ambassador to Sweden, Viktor Tatarintsev, recently said as much: “Excuse my language, but we don’t give a s*** about all their sanctions.”

This action is basically Putin flexing his geopolitical muscles, and daring the West to stop him.

Another Player Watching the Action

For over 70 years — since the Japanese surrendered in WWII — Taiwan has considered itself its own country.

China has held a different opinion. It sees Taiwan as part of its country and has, for those same 70 years, been talking about “reunifying” Taiwan with the mainland. 

Unlike Ukraine’s potential military/security value, Taiwan has a more significant value in the global economy. 

In the mid-1980s, during the birth of the microchip revolution, leaders in the industry designed and manufactured their own chips. But in 1987, Chinese engineer Morris Chang made a bet that, as semiconductor design became more advanced, there would be a growing demand to outsource their production. 

With some financial help from the Taiwanese government, he founded the Taiwan Semiconductor Manufacturing Corp (TSMC). His bet paid off in a huge way. Today, the country of Taiwan accounts for 60% of the semiconductor industry’s revenue. TSMC accounts for 54% of that by itself.

When you specialize in something, you get to be the best…

“Its (TSMC) technology is so advanced, Capital Economics said, that it now makes around 92% of the world’s most sophisticated chips, which have transistors that are less than one-thousandth the width of a human hair. …  Most of the roughly 1.4 billion smartphone processors world-wide are made by TSMC.”

They make Apple’s chips exclusively.

Estimates suggest that they supply 50% of the world’s semiconductor chip needs. That’s a lot of chips…

I don’t need to tell you that today, some 40 years later, semiconductors are in practically EVERYTHING. Your phone, your computer, your television, your car, your appliances… everything.

And if the Chinese should make some move against Taiwan — regardless of the outcome — it could result in a disruption in the flow of semiconductors coming out of Taiwan. And a disruption in that supply chain could freeze the U.S. economy for years.

Reshuffling the Balance of Global Power

While Russia is a relatively small country economically, Putin is looking to reassert it as a major political power. 

China, on the other hand, already has both economic and political sway in the world. 

Either or both of these countries can present a threat to the U.S.’s political and economic hegemony in the world.

This, of course, would be bad for the U.S. Since the end of the second world war, the U.S.’s economic and political dominance has come with certain perks. For instance, it has made the U.S. dollar the world’s reserve currency. 

That status has allowed the U.S. to behave with incredible fiscal irresponsibly and not have to bear what would be the typical consequences of that behavior. 

On Thursday, after Russia invaded, the U.S. dollar exploded — a sign of its position in the world.

That could all change if the geopolitical balance of the world shifts. 

I’m not out to spread fear porn here. I don’t believe the U.S. could instantly lose its status as the world’s reserve currency.

But even a reshuffling of power due to current events, could eventually lead to a loss of confidence in the U.S. dollar. 

And that would be devastating where investors are concerned. 

In the meantime, there is something else investors need to understand where the Russian invasion goes. While it has been the engine for volatility in the markets for the past couple weeks, it is NOT the cause of the current bear trends in stocks. 

Stocks have been heading lower because of the impact that sky-high inflation, impending interest rate hikes, and continued supply chain concerns are having — and will continue to have — on corporate earnings.

And those are three more enemies the U.S. needs to contend with.

Make the trend your friend,

Bob Byrne
Editor, Streetlight Confidential