The Economics of a New Cold War

Russia's occupation of Georgia and the U.S. signing of a missile-defense deal with Poland have grizzled cold warriors partying like it's 1979. Once again, hard-liners are ratcheting up rhetoric and threatening sanctions because the Russian bear has stomped on one of its freedom-loving neighbors. But don't go dusting off your copies of George Kennan's "X" Foreign Affairs article and NSC 68 just yet. It's going to be a lot harder to have a cold war between Russia and the West in 2008 than it was in 1948.

During the cold war (this is for all the under-40 set) the world was to a large degree divided between the communist world – the Soviet Bloc and China – and the free world. And while there were exchanges and a limited amount of trade (in the 1970s, Pepsi began bartering Pepsi-Cola for Stolichnaya vodka, and the U.S. exported grain to the Soviet Union) commercial ties between the Eastern Bloc and the West were extremely limited.

Today, nearly 20 years after the fall of the Berlin Wall, Russia may not be a free-market paradise. But it has evolved into an important part of the global trading system, and has built deep, enduring, and significant economic ties to the West. As a result, the implications of increasing tensions are as much economic as they are geopolitical. And a renewed chill between Moscow and Washington will trouble the sleep of CEOs as much as it will agitate peaceniks. On the other hand, the close economic ties make it less likely that political tensions will erupt into actual warfare, since the executives in Moscow and New York (and London, and Frankfurt, and Milan…) will be lobbying for peace.

The economic connection between Russia and the West begins with energy. Post-Soviet Russia has become a huge exporter of hydrocarbons, and Western European countries are some of its biggest customers. According to the Energy Information Administration, Germany is second only to the Ukraine as a destination for Russian natural gas exports. (Germany relies on Russia for about 36 percent of its natural gas). A robust network of pipelines connects Russia to Western Europe. After leaving office in late 2005, former West German prime minister Gerhard Schroeder went to work for one of those pipeline companies. Italy and France are Russia's fourth and fifth largest natural gas customers, respectively. Russia is also a significant exporter of oil. Commerce Department data show that in the first half of 2008, the United States imported 17.5 million barrels of oil worth nearly $2 billion from Russia. Russian oil is just part of a larger trade flow between the two frenemies. According to the Commerce Department (see Part B, Exhibit 14 of the full release available here), in the first half of 2008, U.S. exports to Russia were $4.66 billion and imports were $13.3 billion.

The trade data doesn't come close to telling the whole story of U.S.-Russian financial relations. U.S. companies have been finding new markets in this rapidly growing economy with a population of about 142 million. When Ford Europe reported its July European sales on Tuesday, Russia was one of the few bright spots. In the core Western European markets, sales fell 6.6 percent from 2007, but sales in Russia rose 26 percent to 19,100. In July, Ford sold more cars in Russia than it did in France, and almost as many as it did in Germany.

Meanwhile, Russians have been investing heavily in the United States. This year alone, Russian steel giant Severstal has acquired the Sparrows Point plant in Maryland from Arcelor-Mittal, Esmark, Inc., and WCI Steel. Severstal's U.S. operations make it the fourth-largest steelmaker in the country. As I noted last year, Russian oil giant Lukoil, which acquired Getty in 2000, has transformed hundreds of Northeast outlets into Lukoil stations. And moneyed Russians have emerged as saviors of the high-end real-estate market, snapping up trophy ranches in Aspen, beachfront properties in Palm Beach, and townhouses and condos in New York.

Oh, and since Russia's exports of oil and other commodities have allowed it to pile up huge foreign currency reserves, Russia has been a significant buyer of American government paper. Last month, the Russian finance minister said that the Russian central bank held some $100 billion in U.S. agency debt – i.e. bonds issued by Fannie Mae and Freddie Mac. On Wednesday, the New York Times reported that the bond markets were looking for assurance to Moscow, of all places. "The Russian finance minister, Alexei Kudrin, told reporters in Moscow on Tuesday that Russia was still buying debt issued by Fannie Mae and Freddie Mac, but on a smaller scale."

So, two ironies. (1) Financially speaking, the United States needs Russia a lot more than Russia needs the United States. (2) It's likely the subprime mess will inflict greater economic damage on Russia than any coordinated Western sanctions could.

The Economics of a New Cold War | Business