Who cares about Georgia? Not the markets.

There has been a lot of talk recently about how the markets are punishing the Russian Federation for its actions in Georgia.  Dan Drezner, for example, writes:  “An estimated $21 billion left Russia last month, and the RTS Index has declined by more than seven percent this month ... this is a pretty high price to Russia to pay for creating two unrecognized buffer states.” 

It isn't just political scientists.  Investors also believe that the markets punish aggressors on their own.

I am not so sure.  No, let me be stronger.  I am almost positive that Dan Drezner is wrong about the economic damage that Russia is taking from its actions, even if I agree with his assessment of Russia’s weak political position. 

Markets do not punish successful aggressors.  Other countries can impose sanctions that punish aggressors, and that will hurt the markets.  That logic, however, runs exactly the other way from the sanguine belief that our brave new world of globalized markets contains automatic mechanisms that contain interstate war.

This chart shows the evolution of four different Russian equity indices.  The RTS-1 that Dan referred to in his post is in dark red.  The date that the Georgians started the war (August 8th) is represented by the bright red vertical bar.

Russian indices were in decline well before the war started.  If anything has happened since, it is that the decline has slowed.  This is not consistent with the hypothesis that the markets are punishing Russia for the war.

Below the fold is a closer look at the same data.  The closer look makes it even clearer that the markets are not punishing Russia for invading and carving off chunks of Georgia.

The markets reacted badly to the outbreak of war on August 8th.  They did not care about the Russian counterattack on August 9th or its naval assault on August 10th.  They liked the ceasefire agreement on August 12th.   Indices dip a little on August 26th, when Russia recognizes Abkhazia and South Ossetia, but then immediately start heading back up. 

That's it for easily apparent reactions to war-related events. 

There are two non-easily identified jumps in the markets.  They don't like something on August 19th.  They like something on August 27th-28th.  Then they don't like something on September 3rd. 

I have no idea why the markets bounced back after the Russians recognized the new Caucasian territories.  If I had to guess, I'd say it's because they recognized that their would be no sanctions forthcoming from the E.U. or U.S., but that's a shot in the dark.

On the other hand, I have a very good idea why the markets fell on September 3rd.  First, the energy minister announced that oil output was lower than expected. Second, BP finally announced that it would pull the British CEO of its TNK-BP joint-venture in Russia by the end of 2008, and (via sales of new shares) shrink BP's stake in the venture from 50% to 25% “without full compensation.” 

Shares of BP rose, because the agreement finally ended the uncertainty over how much BP would lose, but the fact the BP would lose almost half its stake in the venture has unsettled the markets.  Would you want to invest somewhere that the government could transfer your property rights to its private allies without a credible threat of sanction?  ICSID and the like protect you from government expropriation ... but the Russia Federation has discovered some very interesting work-arounds that allow for private expropriation. 

(I believe that the U.S. should encourage sovereign wealth funds to invest in the United States in order to protect our companies against these sorts of shenanigans, but that's a different issue.)

In short, the markets did not fall because they are sanctioning Russia for scarfing off parts of Georgia.  Nor did they fall because the West sanctioned Russia for scarfing off parts of Georgia.  Rather, they fell because the West failed to sanction Russia for scarfing off parts of the petroleum company formerly known as “British.” 

There are many good reasons why you shouldn't be scared of the Russian Federation or worried about its actions in the Caucasus.  The idea that markets will protect you against aggression, however, is not one of them.

Norman Angell is certainly right in the long run, but John Maynard Keynes had something to say about the long run. 

Comments

[Anonymous]

I find it hard to understand how you could frame the events as "Russian scarfing off parts of Georgia." The reality of the situation is that South Ossetia has a long-standing independence movement that was threatened when the Georgian government invaded and tried to depose the local government. Russia has not annexed any part of Georgia, but has simply forced Georgia out of the independent state.

Hardly seems like Russia was the aggressor here, and much less so than when the US did almost the same thing in Kosovo.

[CG]

There's nothing wrong with describing the Kosovo War as "the US/NATO scarfing off parts of Serbia" as the description of the war is mostly unrelated to its background. Same applies in Georgia, obviously.

[Noel Maurer]

Fair enough point, even if Russia does annex South Ossetia. My tone here is rather informal; CG has it right that I'd describe Kosovo the same way ... at least in a post that wasn't about the reasons for the war, but reactions to it.

[Jussi Jalonen]

"Anonymous" is correct when he states that the Russian intervention does not constitute an actual "aggression", any more than the various similar, unsanctioned police actions by the Western powerss. However, he's incorrect in his statement that South Ossetia is an "independent state".

First, South Ossetia does not have a "long-standing" independence movement. True enough, the ethnic-national movement dates back to the 19th century, but a movement for an actual, independent Osset nation-state? That's an entirely new thing.

(Moreover, the idea of an independent Osset nation-state which would be separate from _both_ Georgia and Russia is practically nonexistent, and has not featured in this crisis in any way.)

Second, even if South Ossetia has an independence movement, so what? That does not make the region an independent state, not de facto or de jure. The Åland islands have a small, but very vocal independence movement. Big deal; they're still part of Finland.

When it comes to Noel's analysis, that's absolutely correct. In spite of all the political huffing and puffing, it's business as usual with Russia, never mind the crisis.

On a related note... I don't know if anyone of you was aware that Bessarion Gugushvili, who served as the first Prime Minister of independent Georgia under Gamsakhurdia, has lived in Finland ever since his exile. As one might expect, he still sees himself as the one and the only democratically elected Prime Minister of Georgia.

He hates Shevarnadze, and he loathes Saakashvili. In his opinion, Georgia was divided in spheres of influence between Russia and the West already in the '90s, when "the Western powers openly sanctioned Shevarnadze's coup, together with Russia".

He believes that the recent crisis has been a culmination of this development, and will result in the final partition of Georgia. Gugushvili's opinion is that the Western powers have already tacitly accepted the eventual Russian takeover of Abkhazia and South Ossetia. In exchange, Saakashvili will be allowed to rule over a rump Georgia as a Western puppet, whose sole purpose is to act as an administrator over a small region that has a pipeline on it.

In short, he believes that Georgia is a victim of a modern-day Molotov-Ribbentrop pact.

Whether one wants to take his opinions seriously... well, that's another matter, but let's just say that I've seen even more far-out opinions voiced over the recent crisis, by supposedly smart and educated people.

Cheers,

J. J.

[Nicholas Alan Clayton]

Great work fighting the conventional wisdom, you've earned yourself a link with me!

www.threekingsblog.com

[Alexey Sidorenko]

I would argue about the reasons of the market decline. It was not because of the TNK-BP case (which actually was a long drama since Winter 2007/2008). The real reason was Putin's attack on Mechel which was made public and costed coal&steel company about $5bln in capitalization. Then the decline started.

[Noel Maurer]

Alexey: I'd agree with you as a general statement. The only caveat I have is that Putin attacked Mechel on July 24th, which doesn't directly explain the early-September decline.

But I would agree that without the "send in the doctors" comment from July, investors would probably be less nervous about the announcement of a resolution of the TNK-BP dispute, especially since it is not at all clear that BP is in the right.

[FormerUofCguy]

Do Russian markets not follow a random walk model? Why should we expect them to continue to decline post-invasion because they were already declining pre-invasion? Can I get rich betting on the Russian markets' momentum?

[Noel Maurer]

I'm shorting Russia.

[Will Baird]

Noel:

See this?

http://news.bbc.co.uk/2/hi/business/7622944.stm

Is this a linear extrapolation of what you ahd above or is it a plunge after the implosion over here?

[Noel Maurer]

Short answer: I have no idea.

Educated guess: it's both. Russia isn't viewed as a safe place to keep your money, which means that when American markets start to cough up blood, Russia gets slammed.

I still don't think that it has anything to do with Georgia, though. Once it became clear that the E.U. was not going to sanction (probably a wise policy), I just can't see why investors would care.

I should do a follow-up. Man, I wish sleep were optional, and that it was sunny all day, 24 hours straight.

[Will Baird]

I'll have to say that this isn't related to Georgia. In fact, Russia's going to get off scott free, actually, for that one.

I should do a follow-up. Man, I wish sleep were optional, and that it was sunny all day, 24 hours straight.

A-fuckin-men.

It'll only get worse when you two take the kidlet plunge. Just ask Doug and Claudia! heh.

Will (sleep deprived and wouldn't have it any other way...uuuuh...)

[Landi]

By all counts it was a successful aggression. Russia showed, or thought it did, that it needs to be taken seriously or else. They lost a couple of planes and tanks but also got some experience out of it. What if investors feel that Russia is not done yet, and more wars are in the horizon? So while they beat Georgia badly they might sent the wrong vibes to the investors.

Russia has been ripping off private companies for quite a while now, yet once war started the money started to pull back. Maybe it was the last straw and already scared investors just needed an extra push to act?

I disagree with the 'succeed and you will not be punished'. Maybe only because Russia might not have succeeded yet; the markets might wait for the final tally if they think that more aggression will follow for Russia.