Food For Thought: Instability and Political Interference

There are instances where markets need the comforting hand of politically justified guidance.  However, such instances are few and far between.  The ongoing efforts of the world’s leading Central Banks as they strive to maintain calm and confidence in short term money markets is perhaps one of those rare instances.

However, market interference is becoming a more regular feature of today’s newsflow.  The EU is reportedly considering pronouncing the European energy industry ‘strategic’.  The French government has finally engineered the merger of Suez and GdF.  Political interference/influence is the modus operandi of the Russian energy industry.  And today we are reminded that it is not only energy that government’s consider to be strategic.  It is also food.

Russia is considering imposing a ban on its wheat exports.  The apparent reasoning is not so much strategic as economic:  the ban is designed to restrict inflationary pressures in Russia’s own food prices.  Russian inflation rose to 8.7% in July from 8.5% in June and was partially driven by higher food prices.

Global cereal markets are under substantial and protracted pressure.  The emerging Chinese and Indian middle classes are fuelling demand for cereals as their aspirations evolve away from traditional rice-based diets.  Poor harvests in Europe, North America and Australia have dented the supply-side of the equation.  The costs of the world’s most basic need is increasing and nobody seems confident those costs will subside any time soon.

Rather than allowing the operation of markets to deal with the supply/demand imbalance, the Russian government is simply shifting its own inflationary pressures abroad and creating artificially low prices for its own consumers.  Short-term political expediency fails to resolve long-term structural issues.

Traders will not want to short wheat and cereal markets will continue to soar as they discount the possibility of delivery defaults and watch the Australian weather with heightening tension.

Not only are the costs of life’s basics increasing, as energy and food prices fuel inflation, but markets are having to discount political interference as a key variable in evaluating value.  The consequences for markets could well be catastrophic.  The fact of the matter is there is an emerging dislocation between operation of free-markets and the reality of political interference.  This dislocation is certain to have one long lasting effect:  instability.

Bluff or Dare?

Vladimir Putin seems determined to fuel the imagination of every leader writer in the Western media.  Don’t we just love to agonise over that gnawing question:  is this a new Cold War?  We are still obsessed by the Cold War and doesn’t Putin know it!

Incidents such as the cyber-attack on Estonia’s government websites, the war of words over America’s plans to place missile defence systems in Eastern Europe and Russia’s declaration of control over the Arctic’s natural resources have plotted a narrative that drips with potential for the more hawkish media pundits.

In what is beginning to look like a premeditated unravelling of Putin-inspired events, he has ordered the resumption of strategic nuclear bomber patrols over the North Atlantic and at the opening of the Moscow Air Show proclaimed, “the task stands before us of maintaining our leadership in the production of military aviation technology.”

His words do not seem designed to convey a sense of general well-being in the USA and Europe. So, are these the opening steps of a new Cold War dance?

It’s important to recognise that Putin’s posturing does seem to be just that:  political posturing for consumption home and abroad.  Domestically his own electorate revels in Putin’s increasingly assertive nationalism.  For a man who is due to step down from the Presidency he doesn’t seem to be losing his appetite for popular opinion in Russia.  The stronger a leader he appears and the more popular he becomes, the more we can presume the Russian people will support whoever Putin declares as his successor.

His successor, on the other hand, will know exactly where his own power will be rooted.  Perhaps it was no coincidence that the current favourite, Sergei Ivanov, was at Putin’s side throughout the Moscow Airshow.

Ivanov, apart from being First Deputy Prime Minister and regarded as a ‘hawkish’ Defence Minister, is also Chair of OAO United Aircraft Corporation.  Putin has great aspirations for UAC and following his success in establishing global power in Russia’s energy champions he appears determined to replicate that success in rebuilding Russia’s corporate defence systems.

Furthermore, UAC is due to make its market debut sometime either late 2007 or early 2008.  What else was Putin going to say, with buyers expected to place over $1 Billion of new orders with UAC throughout the duration of the show?

Putin’s principle responsibility is to maximise Russian wealth and strategic power, just as is the fiduciary duty of any Chief Executive Officer.  As Adam Smith stated in The Wealth of Nations, “The great object of every country, is to increase the riches and power of that country.”

It is in analysing Putin’s behaviour from the economic point of view, rather than the political, that we can begin to identify a clear pattern emerging and that is not the pattern of a power-crazed dictator.  It is the behaviour of an extremely aggressive, recently emboldened Chief Executive.

The Russian economic organisation has a significant competitive advantage:  its enormous reserves of natural resources.  Applying prevailing market prices to Russia’s oil and gas reserves values those reserves at approximately $17 TRILLION.  That’s the same value as the American equity markets.

Neck and neck, you might think.  America’s economic power lies principally in the efficient operation of its markets.  Russia’s economic power still lies below the Motherland’s generous and productive soil.

However, should Russia be seen to be more strident, more assertive and more of a military threat, what do you suppose would happen to the value of its hydrocarbon reserves?  And, more importantly, what would then happen to the value of those American equity markets?

While those leader writers revel in a return to the days of Checkpoint Charlie perhaps somebody should nudge them gently and remind them of the horse and cart of military and industrial.  The military is there to protect wealth.  Industrial is there to create wealth.

It’s that distinction that may actually make this more serious than the Cold War ever was.  These could be the first steps in a valuation war that could have profound consequences for Western free market dogma.

What price the pair trade:  short the US equity markets and long the RTS?