War is the continuation of Politik by other means.
– Carl von Clausewitz (1780-1831)
Regrettable though it maybe, but politics hasn’t died. Which means war hasn’t died either; though the tools of warfare are constantly evolving.
Clausewitz’s quote came to mind recently, when I read snippets from a recent interview the BBC’s Robert Peston did with Hank Paulson, US Treasury Secretary during the 2008 financial crisis. Paulson recalls how desperate he was that the Chinese – owners of some $1.7 trillion of mortgage-backed bonds issued by Fannie Mae and Freddie Mac – not start dumping these securities, so potentially leading to an even bigger crisis.
At which point things got interesting:
Here I’m not going to name the senior person, but I was meeting with someone… This person told me that the Chinese had received a message from the Russians which was, ‘Hey let’s join together and sell Fannie and Freddie securities on the market.’ The Chinese weren’t going to do that but again, it just, it just drove home to me how vulnerable I felt until we had put Fannie and Freddie into conservatorship [the rescue plan for them, that was eventually put in place].
In one sense, it’s hard to see how the Russians would have benefited had their plan played out, given the collapse in oil and gas prices occasioned by the 2008 deflationary shock. But revenge apparently counted for more among some in Moscow – revenge for America’s humiliating victory over the Soviet Union in the Cold War; revenge for the oligarchs’ rape of their country under western supervision during the 1990s; and revenge for the EU and NATO’s constant advances east since the collapse of the USSR in 1991.
Which begs the question: what are these men thinking and doing now, given all that’s happened in Ukraine over the last couple of months?
As far as conventional warfare is concerned, Mutual Assured Destruction (MAD) still governs relations between the USA and Russia. Which means a “hot” war is more or less unthinkable. But, as in the Cold War, MAD doesn’t preclude skirmishes via proxies – to America’s cost in Vietnam during the 60s and 70s, and to the Soviets’ cost in Afghanistan during the 80s. The fact that conventional warfare is no longer a means of conducting politics between great powers – the costs being too high for all concerned – means that new methods will be found.
100 years on from 1914, and one less-noted aspect of the First World War was the extent to which it destroyed the generally liberal trade environment that existed in the late 19th and opening years of the 20th century. As described by historian Niall Ferguson at the start of his book War of the World: History’s Age of Hatred:
“The world on September 11, 1901 was not a bad place for a healthy white man with a decent education and some money in the bank. Writing eighteen years later, the economist John Maynard Keynes could look back, with a mixture of nostalgia and irony, to the days when the class to which he belonged had enjoyed ‘at a low cost and with the least trouble, conveniences, comforts, and amenities beyond the compass of the richest and most powerful monarchs of other ages.
All gone with the wind, as finance and accumulated wealth was sacrificed in the name of the war effort. Britain – lynchpin country behind the classical gold standard – ditched sterling’s link with gold in 1914, and never really returned.
Events in the summer of 1914 triggered a major financial crisis. Until surprisingly close to outright declarations of war traders remained blasé about the risk of conflict, hopeful that – as at Agadir three years earlier – the great powers would find a face-saving way out of the ruckus caused by Franz Ferdinand’s assassination.
However, all of that changed on 23 July following the Austrian ultimatum to Serbia. Suddenly a wave of selling hit stock and bond markets, as participants dashed for cash. Monday 27 July saw the breakdown of the City’s foreign exchange and discount markets, with London Stock Exchange closing on 31 July. It did not reopen for another five months.
As noted by Richard Roberts at the Oxford University Press blog, conditions in London at the time were far from unique:
The financial crisis of 1914 was also a global crisis. More than 50 countries or colonies experienced bank runs and asset crashes. For six weeks during August and early September every stock exchange in the world was closed, with the exception of New Zealand, Tokyo and the Denver Colorado Mining Exchange. The financial crisis of 1914 was an extraordinary and unique moment in global economic history.
Back in the 21st century
Events in 1914 are a useful reminder that we shouldn’t underestimate the power of geopolitical uncertainty to hurt markets. The major difference between then and now is that in 1914, finance was a means to an end as far as war was concerned. Men shooting at each other on battlefields was still the central means by which countries practiced war.
Today, as Paulson’s revelations highlight, finance is turning into a war weapon in itself – as detailed in James Rickards’ interesting new book The Death of Money. The sophistication of modern finance provides plenty of opportunities in terms of the type of weapon used; Warren Buffett’s famous description of derivatives as “financial weapons of mass destruction” was perhaps truer than he realised. Crucially, it also offers plausible deniability.
The Russian state has a formidable army of hackers at its arms-length disposal. Mysterious outages at western stock exchanges, like the three-hour NASDAQ crash on 22 August last year, are perhaps one weapon at Putin’s disposal should the US and EU become more aggressive towards Moscow. The same hackers could presumably be used to target banks and other critical infrastructure in western nations.
Moscow would of course officially deny involvement in such shenanigans. Unofficially of course, there would be little doubt.
Waiting for the penny to drop
We haven’t yet reached a stage of popular consciousness regarding financial war. There has yet to be a “Somme, 1916” moment as far as this curious new phenomenon is concerned. But given human nature, modern technology and the seeming desire on the part of many western politicians to talk up a new Cold War, we may soon be confronted with one.
Recommended: Charting the Federal Reserve's Assets - 1915 to 2012