Chapter 21: “F*** the Eu”: The Ukraine Crisis, Crashed

Chapter 21 “F*** THE EU”: THE UKRAINE CRISIS

Before 2008 the driver of crisis was expected to be the balance of financial terror between the United States and China. A huge unwinding of the global disequilibrium centered on China and America and driven by profound domestic imbalances in each of them would, it was feared, rock American power to its foundations. In 2008 the expansion of the EU and NATO in the face of Russian opposition had added another dimension of risk. Georgia and Russia had clashed and Moscow had approached Beijing to mount a joint attack on America’s fragile finances. Beijing had held back. There was no great dollar selloff. The geoeconomic course of the crisis took an unexpected and innovative direction. The Fed’s liquidity swap lines stabilized the dollar-based financial system. In November 2008 the upgrading of the G20 had added a global leadership forum and this had been important in legitimizing the dramatic expansion of IMF resources in 2009. This backstopped the IMF’s urgent engagement in Eastern Europe. A year later, remarkably, the IMF would find itself committing hundreds of billions of dollars to rescuing the eurozone. At the same time, the United States was aggressively pushing a new system of regulation for global banking through the normally slow-moving Basel Committee.

In 2008 and 2009 Washington kept ahead of the geoeconomic challenges unleashed by the crisis. Could it stay on pace? In May 2010 the Obama administration and the IMF were crucial to forcing the Europeans toward the first fix for the eurozone. But then things began to get sticky. November 2010 was a turning point. The Democrats lost control of Congress. The recovery was so lame and the fiscal impasse so threatening that the Fed launched its cautious second wave of QE, to be met with violent opposition at the G20 meeting in Seoul. But carping at the G20 was one thing. When it came to chaperoning the Europeans through the near disaster of 2011 and 2012 it was obvious that only the Obama administration could serve as a counterbalance to Germany. Obama was right. At least as far as Europe was concerned, the United States as an “inside outside” arbiter was indispensable. But with the stabilization of Europe and the beginning of the second Obama administration, the questions of the Bush era returned.¹ Should Washington maintain its massive global footprint? Could it safely withdraw? Would either internal constraints or external pressures allow this to be decided as a matter of deliberate choice? Would it be an orderly retreat, leaving a legacy of stability, or would it be a disorderly rout?

I

Impelled as she was by the energy and sense of mission that descended from the 1990s as well as her own ambitions for the presidency, Hillary Clinton, as secretary of state, was in the proactive camp. In the autumn of 2011, as it finalized the pullout from Iraq, Clinton’s State Department tried to get back on the front foot. The “pivot to Asia” was its new initiative.² In military terms this consisted of the redeployment of a carrier battle group to the Pacific. In economic terms it axed on the Trans-Pacific Partnership (TPP). As Europe slid deeper into crisis in 2011, the US Treasury and trade representative pressured Canada and Mexico to join them in a wide-ranging trade and investment treaty with the leading economies of Asia, not including China. The aim was not to face China down, let alone to stop its economic growth. Everyone had too much to gain. The aim was to establish a bloc strong enough to offer a counterweight to China’s rising strength. It was, as one of Hillary Clinton’s indiscreet correspondents dubbed it, a “de facto China containment alliance.”³

Back to 1947 containment was the glue that held together the powerful alliance network that the United States had constructed in Western Europe and East Asia. That alliance system massively extended America’s reach. It was the grounds on which committed liberal internationalists defended the idea that America remained a hegemonic force.⁴ But it also exposed the United States to risk. Containment could be given different shadings, and those depended as much on America’s allies as on any decision in Washington. The allies had their own politics and their own economic problems. Their enrollment in America’s sphere, whether through finance, trade or security policy, excited those interests further. From Beijing’s point of view, America’s Asian pivot took on a distinctly darker coloration with the election in December 2012 of the nationalist politician Shinzo Abe as the Japanese prime minister. Abe was deeply concerned about China’s power. He was unabashed in his support for a stronger and more independent Japanese military. And he was also willing to override domestic economic interests for the sake of strategic cooperation with the United States. He was even willing to sacrifice Japan’s rice farmers to make his country into a key pillar of TPP.⁵ If he was willing to do that, what else might he do? By 2014 there was talk of a war scare between Japan and China.

Corralling South Korea, Australia, Japan and Vietnam into the American geoeconomic alliance system was, if anything, too easy. Their interest in containing China was obvious. The risk was that America’s new engagement with Asia would harden positions and trigger regional clashes, which were not in America’s interests. That was not the case with the Europeans. But by the same token, their enrollment in the project of containing China was less reliable. The EU was deeply interested in Chinese trade and investment. Germany wanted to sell cars and engineering equipment. When they tired of the endless battles in the eurozone, Berlin’s policy elite liked to fantasize about a global future in partnership with Beijing.⁶ The City of London was angling for a special position in the internationalization of the RMB.⁷ Nor were the Americans the only ones pursuing an expansive geoeconomic strategy.

In October 2013, on his way to the APEC meeting in Bali, President Xi Jinping announced China’s new investment bank proposal. It was a bold multilateral initiative to upgrade Asia’s infrastructure. Everyone was invited to join. It was a leaf straight out of America’s own playbook, and Washington did not like it. The Obama administration let it be known that it did not approve the Chinese initiative, and South Korea, Japan and Australia promptly fell into line.⁸ But the UK, which was doing everything possible to court Chinese business, took up the offer from Beijing to become a founding member of the Asian Infrastructure Investment Bank.⁹ Washington was furious.¹⁰ London had made its decision, a State Department official let it be known, without prior consultation. America did not approve the “trend toward constant accommodation of China, which is not the best way to engage a rising power.”¹¹ But London wasn’t listening, nor were the other Europeans who promptly signed up too. Asked about US opposition, one British official commented wryly that it must be difficult for the Obama administration to conduct international economic policy under current political conditions. If Congress wouldn’t approve a tiny increase in China’s IMF quota, what was to be expected on trade and investment? “They couldn’t have got congressional approval to join the AIIB, even if they wanted to.”¹² Indeed, thanks to the congressional shutdown, Obama was prevented from attending APEC’s Bali meeting. America’s domestic political problems were spilling over into the conduct of global strategy and the world was not going to wait.

Given the stresses that the United States was evidently under, it might have made sense to invert Kissinger’s famous move in the 1970s and to seek a closer relationship with Russia as part of the effort to contain China. It is unclear whether Washington was ever willing to take Russia seriously as a strategic partner, at the level even of Japan or Saudi Arabia.¹³ In 2009 the Obama administration did set out to build better relations. With Medvedev as president, the “reset” seemed promising. To promote his modernizing agenda, Medvedev was invited to tour Silicon Valley in the company of Governor Schwarzenegger.¹⁴ Russian business eagerly seized the opportunities offered by cheap dollar funding. In 2011 Medvedev was compliant over NATO’s intervention in Libya, so much so that it provoked a counterreaction in Moscow. Putin, biding his time in the number two position as prime minister watching footage of Gaddafi’s horrible fate, became morbidly preoccupied. The same Western powers that had shamelessly courted the Libyan dictator had turned on him, bombing his military and delivering him to the vengeful mob. One would be a fool to trust them. Medvedev’s appeasement would only invite further aggression. Putin would have to take back control. This decision was only confirmed when Moscow erupted in protests over the winter of 2011–2012 following rigged parliamentary elections. Clinton barely disguised her enthusiasm for regime change. Instead of reset and détente, Putin returned to the presidency in 2012 with new determination. In opposition to the liberalism of the Obama administration, the Kremlin donned the garb of conservative cultural nationalism. Gay rights, feminist pop provocateurs and the Greek yogurt rations for America’s Olympic athletes all got sucked into a postmodern rerun of the cold war.¹⁵

It was certainly not the balancing against China that one might have expected. But nor was it the Americans who brought about the open crisis in relations between Russia and the West. It was America’s most important ally, the Europeans. The EU would later claim that it “sleepwalked” into the Ukraine crisis. This was part of a piece with its guileless insistence that “the EU does not do geopolitics.”¹⁶ That perhaps described the naïveté of some officials in Brussels, but it never really rang true. It would be fairer to say that European nation-states did not agree on the geopolitics they were pursuing by way of the EU. France and Berlin loved the détente with Moscow. Poland and Sweden did not. With active support from NATO, the “new Europeans” championed the EU’s Eastern Partnership with the post-Soviet states. It was no secret in Warsaw or Riga that this, like TPP, was a “de facto containment” policy. As far as Poland was concerned, the priority was clear. In the words of President Bronislaw Komorowski: “Never again do we want to have a common border with Russia.”¹⁷

The instruments of the EU’s Eastern Partnership were EU Association Agreements. These were complex documents harmonizing regulations, liberalizing trade and the movement of workers. The agreement with Ukraine, initialed in 2012, was hailed as the most extensive agreement ever completed with a non-EU member. It ran to 1,200 pages of technical detail, subdivided into the twenty-eight separate subsections of the acquis communautaire.¹⁸ Trade and business regulations were the main focus of the Association Agreements, but they were not innocent with regard to security policy. Article 4 of the Ukraine Association Agreement called for “political dialogue in all areas of mutual interest. . . . This will promote gradual convergence on foreign and security matters with the aim of Ukraine’s ever-deeper involvement in the European security area.”¹⁹ Article 7 provided for “EU-Ukrainian convergence in foreign affairs, security and defence.” Under Article 10 on “Conflict prevention, crisis management and military–technological cooperation,” Ukraine and the EU were to “explore the potential of military and technological cooperation. Ukraine and the European Defence Agency (EDA) will establish close contacts to discuss military capability improvement, including technological issues.”²⁰

By 2013 talks with Ukraine were the most advanced. But the EU’s Eastern Partnership negotiations proceeded on a broad front. At a summit conference in Vilnius on November 29–30, 2013, Brussels was hoping not only to sign the Association Agreement with Ukraine but to initial agreements with Moldova, Georgia and Armenia. Brussels had also been negotiating with Belarus.²¹ After incorporating the Baltics and the East European Warsaw Pact in the early 2000s, Brussels was now seeking to deepen and transform its relations with the rest of what had once been the western Soviet Union. It was undeniably a major shift in international relations and it was all the more significant for the fact that it clashed directly with Russia’s ambitions for the region. Since 2011 Russia had been developing its Eurasian Customs Union into a more comprehensive Eurasian Economic Union. It was clearly intended as an alternative to the EU’s Eastern Partnership. The details of its agreements were far less onerous than those demanded by the EU. But they meant entering into a lopsided relationship with Russia, and the customs union included setting a common external tariff. This was incompatible with the EU Association Agreement.

With goodwill a compromise between the EU’s Association Agreements and the Eurasian Customs Union could no doubt have been worked out. But that was not the mood on either side. The technical and economic issues of harmonizing two different economic blocs were overlaid by geopolitical tension whether Brussels acknowledged it or not. There was a choice to be made: Did the East European governments want to face west or east? Brussels let it be known that membership in Putin’s Eurasian Union was incompatible with an EU Association Agreement. Commission president Barroso refused the Kremlin’s invitation for negotiations between the two blocs.²² Brussels did not accept their equivalence. In the absence of any agreement between the two, Moscow informed Ukraine and Armenia that if they proceeded with the EU, they should expect sanctions from Russia. Signing an Association Agreement would be a “suicidal step.”²³ Under the anodyne labels of association, cooperation and convergence, a heavy geopolitical weight was being imposed on a fragile region under considerable economic and political stress.

II

Across the post-Soviet world, the economic and political recovery from the shock of 2008 was uneven. On the northern flank, the Baltics continued on their course toward the West. Estonia joined the euro on January 1, 2011. Latvia, the pivotal crisis country of 2009, adopted the common currency on January 1, 2014, followed a year later by Lithuania. The rest of Eastern Europe was supposed, under the terms of their 2004 accession, to join the euro in due course too. But progress in that direction was set back severely by the eurozone crisis. Polish foreign minister Sikorski announced in December 2011 that he looked forward to Poland joining the euro by 2016, but only if the currency union was reformed and it was clearly in Poland’s national interest to do so.²⁴ Donald Tusk, as prime minister, promised to launch a national debate on euro membership. But the main opposition, the nationalist Law and Justice party, promptly responded by denouncing any further steps toward European integration as “subordination to Germany.”²⁵

In Poland the nationalists were in opposition. In Hungary they were the government. In the April 2010 election, the ruling Socialist Party paid the price for its corrupt and duplicitous handling of economic policy and the financial disaster of 2008. Promising to protect the Hungarian nation and Hungarian pensioners from the depredations of the IMF, a coalition headed by the nationalist Fidesz party and the Christian Democrats won 53 percent of the vote. Even more startlingly, the Jobbik movement, which toyed openly with neofascism, scored 17 percent, bringing the total nationalist vote to 70 percent. Among Fidesz’s heresies was its refusal to separate the questions of political sovereignty and financial dependence. Ignoring protests from the IMF and the EU, it justified its taxes on foreign banks and a raid on private pension funds in terms of harsh historical necessity.²⁶ Since freeing itself from the Soviet yoke, over the past twenty years Hungary “had to bitterly experience the validity and truth of the old wisdom that a nation can be subjugated in two ways—with the sword or with debt.”²⁷ As Greece was submitting itself to the troika in April 2010, a defiant Prime Minister Orban told a news conference: “In my view, neither the IMF nor the EU’s financial bodies are our bosses. We are not subordinate to them.” Hungary would negotiate but it would not accept “diktats.”²⁸

Orban’s aggressive nationalism and Fidesz’s campaign to curtail civil liberties and political pluralism reversed the liberalization of Hungarian political culture since the end of communism. But, after their own fashion, Orban’s aggressive revenue-raising measures and nationalist austerity worked. Inflation came down to below 2 percent. In December 2011 an agreement was reached with the foreign banks on a deal to share the cost of restructuring household debts. With Hungary having met the 3 percent budget deficit target, the EU lifted the humiliating Excess Deficit Procedures under which the country had labored since its accession to the union. In the context of the emerging market boom, foreign lenders looked leniently on Orban’s nationalist experiment. With ample funding, in the summer of 2013 Hungary paid off the IMF and asked the Fund to shut its office in Budapest.²⁹ To further bolster his position, in early 2013 Orban embarked on a new détente with Moscow. An alliance with Russia was by no means an obvious choice for a Hungarian nationalist. But Orban was given a warm welcome in the Kremlin. Putin cheered his experiment in illiberal democracy and offered material assistance in the form of nuclear reactor technology and subsidized gas supplies, which were popular with Fidesz voters.³⁰

Securely embedded in both the EU and NATO, Hungary could afford to take the risk of balancing between East and West. A tiny candidate country for an EU Association Agreement, like Armenia, menaced by sanctions from Russia, was not in the same position. Faced with a clear threat from Moscow, in September 2013 Yerevan pulled back. It declared its intention of joining Putin’s Eurasian Customs Union, prompting Brussels to close the door on the Association Agreement.³¹ This setback for the EU’s Eastern policy made Ukraine all the more important. Given its size and geopolitical significance, it was Kiev’s posture that would decide the balance of influence in the region. The EU was convinced of its own legitimacy. It offered the rule of law and prosperity. Its promise was the future. Ignoring the evident risk that Ukraine was too weak economically, too fragile politically and too exposed in geopolitical terms to stand the pressure generated between Russia and the West, Brussels pushed forward.

That Ukraine needed a change was undeniable. Even after the losses of 2008–2009 were made good, according to official figures average incomes in 2013 were barely higher than in 1989. Unlike in its neighbors to the west, the post-Communist transition in Ukraine had produced a generation of stagnation. While a tiny minority grew fabulously rich, the standard of living for the least well-off was kept at a tolerable level only by a system of pensions and energy subsidies that consumed 17 percent of GDP. In 2008 the IMF had provided emergency assistance. But the program came with demands for changes in taxes and benefits that made it impossible for a government to sustain legitimacy. By the time of the February 2010 election, much of the population was deeply disillusioned. Ukraine was falling further and further behind not only its Western neighbors but Putin’s Russia too. President Yushchenko effectively withdrew from the electoral race, leaving Prime Minister Tymoshenko to go head-to-head with Yanukovych, whose fraudulent election had triggered the revolution of 2004. With the electorate split between East and West, in 2010 it was Yanukovych who won a narrow majority fair and square.

Yanukovych was a corrupt manipulator who tacked back and forth between the West and Russia. He took funds from the IMF. He continued negotiations with the EU.³² He imprisoned Tymoshenko on corruption charges and used her as a pawn. At the same time, he dallied with Putin and his Eurasian bloc. As his clan enriched itself, his popularity drained and foreign exchange reserves dwindled. On the occasion of the next elections, which he had little hope of winning, it seems that he was preparing the security forces for a showdown.³³ But the 2014 election was not the only deadline. Already in 2013, negotiations with the EU and the Russians had reached a point that forced Kiev to a decision that would depend, among other things, on the shifting international financial climate.

Source: Benn Steil and Dinah Walker, “Was Ukraine Tapered?,” February 25, 2014, Geo-Graphics Blog CFR, https://www.cfr.org/blog/was-ukraine-tapered.

Up to the spring of 2013, under the impulse of the Fed’s quantitative easing, dollars flowed even to Ukraine. On April 10, 2013, Kiev turned down the latest offer from the IMF to help finance its gaping current account deficit and instead launched a 1.25 billion eurodollar bond issue, which was eagerly taken up by the markets at the comparatively modest interest rate of 7.5 percent.³⁴ But then Bernanke’s taper pronouncement of May 22 hit the markets. Interest rates surged to 10 percent. Searching for alternative sources of funding and personal enrichment, Yanukovych canvassed the world for options. He explored shale-gas development with Shell and Chevron. In the fall of 2013 a deal was on the books to lease to China an enormous holding of 7.5 million acres of prime farmland—5 percent of the entire land mass of Ukraine, 10 percent of its arable land, an area the size of Belgium. China was not just after Lebensraum. It was also offering to put $10 billion into port facilities in Crimea.³⁵ But it was the talks with the EU that were pivotal. The promise that Yanukovych had made to the Ukrainian population was the promise of Europe. Ukraine’s officially sponsored media were talking up the Association Agreement as a prelude to full membership. The EU gave no indication that that was likely, but it did nothing to deflate expectations. Western press sources billed the Vilnius summit quite openly as the climax of a “six-year campaign to lure Ukraine into integration with the EU and out of the Kremlin’s orbit.”³⁶

The threat was not lost on Russia, and its threats of sanctions mattered: 25 percent of Ukraine’s exports went to the EU, but 26 percent went to Russia, and much of the rest went to CIS states within Putin’s reach. In early September Yanukovych was still browbeating reluctant pro-Russian members of his party to accept the Western deal.³⁷ What was not clear, until Kiev received the IMF’s letter of November 20, 2013, was quite how unattractive the Western terms would be. The IMF offered Ukraine only $5 billion and noted that it would be expected to use $3.7 billion of it to repay the 2008 loan due in 2014. No one in Kiev had reason to expect generosity from the IMF. But the EU’s offer came as a real shock. A committee of German experts had estimated that Ukraine would stand to lose at least $3 billion per annum in trade with Russia due to sanctions. In Kiev the estimated loss had been inflated to something closer to $50 billion. Brussels swept all these figures aside.³⁸ In conjunction with the Association Agreement, all that the EU was willing to offer was 610 million euros. In exchange the IMF demanded big budget cuts, a 40 percent increase in natural gas bills and a 25 percent devaluation.³⁹ It was anything but the pot of gold that Yanukovych had promised. There were Ukrainian oligarchs with personal fortunes larger than this. Even without considering the sanctions to be expected from Russia, to have accepted such a deal would have been a political disaster.⁴⁰ In Kiev there was outrage. “We could not contain our emotions, it was unacceptable,” Ukraine’s permanent representative for NATO told Reuters. When his country turned to Europe for help, they “spat on us. . . . [W]e are apparently not Poland, apparently we are not on a level with Poland. . . . [T]hey are not letting us in really, we will be standing at the doors. We’re nice but we’re not Poles.”⁴¹ Fortunately for Kiev, or so it seemed, Moscow had an alternative plan. On November 21, 2013, Putin offered, and Yanukovych accepted, a gas contract on concessionary terms and a $15 billion loan. The condition was that Ukraine, like Armenia, would join the Eurasian Customs Union.

In light of subsequent events, Yanukovych’s decision would come to be seen as the Pavlovian response of a pro-Moscow stooge. It was quite possible that he was subject to Russian blackmail. But setting such rumors aside, his choice was hardly inexplicable. As Ukraine’s prime minister, Mykola Azarov, explained, “[T]he extremely harsh conditions” of the EU-IMF package had decided the issue.⁴² Nor was this logic hidden from the Europeans in the immediate aftermath of the debacle. On November 28, 2013, speaking to Der Spiegel, European Parliament president Martin Schulz admitted that EU officials made mistakes in their negotiations with Ukraine. “I think we underestimated the drama of the domestic political situation in Ukraine.”⁴³ Ukraine, he said, “had been in a deep economic and financial crisis” since the introduction of democracy. “They desperately need money and they desperately need a reliable gas supply.” Schulz said he understood why Ukraine moved toward Russia. “It is not especially popular in Europe to help states which are in a crisis . . . and if you look at Moscow’s proposals, they would offer Ukraine short-term assistance that we, as Europeans, cannot and do not want to afford.”

What no one reckoned with—not Yanukovych, the Russians or the EU—was the reaction of a vocal and bold minority among the Ukrainian population. The opinion poll evidence does not suggest that there was an overwhelming majority for a decisive shift toward the EU. According to Kiev’s International Institute of Sociology, in November 2013 only 39 percent of respondents favored association with the EU, barely 2 percent more than the 37 percent who favored a Russian-led customs union.⁴⁴ And those numbers were based on a hypothetical, not the stern terms offered by the IMF and the EU. But events in Ukraine in 2013 were not decided by a referendum on the basis of clearly costed alternatives. They were driven by enthusiastic, fired-up minorities inspired by hopes and fears of Russia and Western Europe and an eclectic range of political imagery drawn from every part of the political spectrum.

In November and December hundreds of thousands of people rallied to Kiev’s freezing streets to protest Yanukovych’s abrupt decision to reject the Association Agreement. But they made no overthrow attempt and Yanukovych might have ridden out the storm but for the ill-advised decision, encouraged by Moscow, to crack down. By using his majority in parliament to ram through constitutional changes, on January 16 he triggered a second wave of mass protests and the occupation of government buildings across Ukraine. At this point, the involvement of the EU and the United States became overt. Quite how deeply Washington was engaged was revealed by the infamous bugged conversation between Victoria Nuland, assistant secretary of state for European and Eurasian affairs, and the US ambassador to Ukraine, which is as illuminating in its characterization of US-EU relations at this point as it was in its blunt instrumentalization of Ukraine’s politicians. On January 28, 2014, as Nuland discussed options with Ambassador Pyatt, she casually remarked: “That would be great I think to help glue this thing and have the UN glue it and you know, fuck the EU.” For Nuland’s taste, the EU was too slow moving and too willing to compromise with President Yanukovych, with whom it had been eagerly pursuing a comprehensive Association Agreement only a few months earlier. Without flinching, Ambassador Pyatt replied: “We’ve got to do something to make it stick together, because you can be pretty sure that if it does start to gain altitude the Russians will be working behind the scenes to try to torpedo it.”⁴⁵

Two weeks later, a desperate last stand in the streets of Kiev brought an end to Yanukovych’s presidency. On February 21, in talks that were brokered by the foreign ministers of Germany, France and Poland and witnessed by Putin’s representative on the spot, Yanukovych was offered the protection of his office until new presidential elections were held at the end of 2014. But as support from within his party and the security forces melted away, he thought better of taking the risk.⁴⁶ He too remembered Gaddafi’s fate. Early in the morning on February 22 he fled, leaving a vacuum. Short-circuiting constitutional procedures, a new provisional government took office pending elections scheduled for May 25. What the EU had intended as a protracted transition had become a revolutionary overthrow. And rather than waiting for the outcome of the election, the provisional government, dominated by Tymoshenko’s Fatherland Party and a sprinkling of Maidan activists, moved rapidly to consolidate the new dispensation. It would reverse Yanukovych’s abrupt decision of November. It would draw a clean line with Russia, sign the European Association Agreement and conclude new financial agreements not with Russia but with the IMF and the European Union.

How was Moscow to react? The choice at Vilnius in November 2013 had been pitched by both sides as a strategic turning point. Thanks to the niggardliness of the IMF-EU offer, Moscow had won a significant victory, only for that to be overturned by popular protest and regime change, which, even if it had the support of a considerable fraction of the Ukrainian people, was of dubious legality and was undeniably Western inspired. For Russia to have meekly accepted this outcome would have been worse than if Yanukovych had signed the Association Agreement in the first place. On the night of February 22–23 the Kremlin decided to act. Taking advantage of local protests and activating plans prepared in 2008 to counter a fast-track NATO application, on February 27, 2014, Russian troops in perfunctory disguises seized control of the Crimean peninsula.⁴⁷ A few days later, to further ramp up the pressure on Kiev, Russia put its muscle behind a separatist uprising in the eastern region of Donetsk.

III

The comprehensive economic, political and diplomatic clash between the West and Russia that had been foreshadowed in the proxy war in Georgia in 2008 was now unleashed on an altogether more significant stage. With Ukraine’s territorial integrity at stake, on April 13, 2014, the provisional government in Kiev launched an “antiterrorist” operation to take back control of the Donbass. In Washington and at NATO headquarters there were those calling for immediate military aid for Kiev and a full-throated return to the cold war. McCain and other Republican hawks would have loved to have rallied a war party. Doing so perhaps might have contributed to restoring coherence to their troubled party. But as he had done in Syria in 2013, Obama refused the call to escalate.⁴⁸ In Europe there was no support for military action. It was not that Ukraine would be denied weapons. But, as in Syria, the arms would be supplied through covert channels. The public front of the West’s reaction was economic sanctions.

Putin’s line had always been that geoeconomics were geopolitics. In Ukraine, struggles over trade negotiations and customs treaties had escalated into an undeclared war. Now the economy itself would be weaponized. Or would it? To pressurize Iran, the United States had developed a ferociously effective regimen of sanctions. Russia as a globally integrated economy was far more vulnerable. Not only did Russian businesses need to export but they had supped deeply at the trough of cheap dollar credit. By early 2014 they owed $728 billion.⁴⁹ But by the same token, large vested interests in the West were at stake. Apart from anything else, Russia was the number two supplier of oil and gas exports to world markets. At a time of extreme fragility in the emerging market economies, the United States did not want to precipitate further tension in commodity markets. To the frustration of the hard-liners, the United States stayed its hands and never applied the full force of its sanctions weapon. Instead it targeted individual members of the clique close to Putin, the most prominent of whom was Igor Sechin, the boss of oil giant Rosneft.⁵⁰ Furthermore, Washington limited access to capital markets for key corporations—Rosneft, Novatek, Gazprombank and VEB.⁵¹ This was painful, but given the limited volume of US-Russian economic relations, it was far from decisive.

The crucial question was whether Europe would throw its weight behind America’s sanctions. Russia-EU trade was ten times larger than Russia-US trade. The EU received 41 percent of all Russia’s exports. This gave the EU considerable leverage, but also meant it had more to lose. German corporate leaders and senior politicians, such as ex-chancellor Gerhard Schröder, continued to cultivate friendly relations with Putin even as Russia’s troops made incursions into Ukraine. France had two big aircraft carriers on order from Russia. Italy’s energy corporations were deeply entangled in Black Sea projects. London, the playground of the oligarchs, was the place to make sanctions tell. The Cameron government talked a good game, but was less quick to act. Nor was it merely economic interests that were at stake. In Germany there was deep skepticism about any overhasty alignment with the United States.⁵² Since the summer of 2013 the NSA spying scandal had cast a deep shadow over German-US relations. A year later, the percentage of Germans who saw the United States as a “trustworthy partner” was down to 38 percent, numbers last seen in the Bush era.⁵³ Whereas 68 percent of Americans favored extending NATO to Ukraine, 67 percent of Germans were against it. Likewise, 63 percent of Germans rejected EU membership for Ukraine.

To the indignation of right-wingers in Congress, all that the EU could agree to were individualized sanctions against eighteen leading Russian figures. Senator John McCain was moved to declare, “If the Europeans decide that the economic considerations are too important to impose severe sanctions on Vladimir Putin . . . then they are ignoring the lessons of history.”⁵⁴ Appeasement had failed against Hitler in 1938. It would fail against Mr. Putin. In May transatlantic tensions were mounting to such a pitch that Merkel and Obama hastily convened talks in the White House. Merkel had no doubt about the need for action, but she could not ignore European public opinion, and McCain’s outbursts were not helpful. The two agreed that Obama would restrain the American hawks while Merkel moved to build a consensus in Europe around tougher measures.

In the meantime, if no military aid was forthcoming and only minimal sanctions were applied to Russia, would the West at least provide generous financial support to Ukraine? Just to meet its outstanding obligations, the new government in Kiev estimated that it needed $35 billion over two years. That was not far off the estimates presented by Yanukovych’s regime six months earlier, which had been rejected out of hand. In March 2014 Kiev put in a request for $15 billion from the IMF. The Obama administration backed the appeal and sought to leverage it to break the deadlock in Congress over IMF reform. The administration linked a $1 billion loan guarantee for Ukraine that was popular with the Republican right wing to a proposal to unblock IMF funding.⁵⁵ The Ukraine crisis was a clear demonstration, the White House insisted, of the IMF’s strategic importance to the United States. Globalist critics of the IMF pounced on the pronouncement.⁵⁶ The subservience of the IMF as a tool of US policy stood starkly revealed. Except that the Republicans in Congress did not agree. They cut out the IMF funding proposal.

Lagarde and the IMF soldiered on without America’s full backing.⁵⁷ For a well-run country, at peace and with the institutions to make the most of its ample endowments, Ukraine’s debt burden would have been far from excessive. But Ukraine was none of those things. Given the huge political uncertainty, the insecurity produced by Russian intervention and its weak institutions, there was, in fact, a strong case to be made that Ukraine’s debts were insupportable. Ukraine was insolvent and its debt should be written down. That would have been IMF protocol. But Ukraine was no ordinary case. In 2010 Greece had been funded under the “systemic exemption.” The risk of financial contagion justified an unsustainable bailout. In April 2014 in Ukraine, systemic risk was recast in geopolitical terms. The IMF’s main shareholders did not want to see the embattled pro-Western regime in Kiev declared bankrupt within weeks of an anti-Putin revolution. So despite the obvious risks and despite Ukraine’s appalling track record of program compliance, the IMF plunged in once again. Out of enthusiastic talk of reform and overoptimistic assumptions about economic recovery, the IMF concocted a scenario that allowed it to lend Ukraine $17 billion over two years. A further 11 billion euros would come from the EU and $1 billion in loan guarantees from the United States. Japan chipped in too. In addition, the EU agreed to take 98 percent of Ukraine’s exports tariff free. Visa-free travel was envisioned for 2015. For the winter, the EU promised to backstop Ukraine’s energy supplies by providing a flow of gas through Slovakia, Poland and Hungary.

It was a substantial commitment. But it fell well short of what Ukraine needed. The aid from Europe would be stretched over seven years. The IMF loan, as always, came with tough conditions. Gas prices were to be raised by 56 percent and the government payroll cut by 10 percent.⁵⁸ The foreign exchanges were to be liberalized to allow the exchange rate to adjust to a competitive level, a high-risk operation that was likely to put huge pressure on Ukraine’s banks. The largest risk of all were the military operations in eastern Ukraine. The IMF had never previously lent to a country at war. So in putting together the April 2014 package, the Fund simply ignored the evidence of the escalating conflict. As Lagarde admitted in a press statement, this put the entire program in jeopardy from the start.⁵⁹ Within days of the conclusion of the financial package it became clear that Ukraine did indeed face the worst-case scenario. Rather than calming, the conflict in eastern Ukraine intensified.⁶⁰ In early May, scrambling to raise an army, Kiev was forced to reintroduce conscription. As the oligarch Petro Poroshenko took office as Ukraine’s president in the last week of May 2014, he faced the impossible challenge of implementing an IMF austerity program while fighting a war; a war, moreover, that Russia would not let Ukraine win. Kiev’s only hope was that while military escalation placed ever greater stress on Ukraine’s fragile economy, it would also clarify the political stakes of the conflict and suck in the West.

In July a vigorous offensive by Ukraine’s forces was on the point of overwhelming the Donbass rebels. Moscow’s response was to resupply the breakaway militia with heavy weapons. A conflict of small-scale skirmishes was escalating into a more or less openly declared war involving the mobilization of tens of thousands of men, mass displacement and thousands of casualties. On July 17 a rebel antiaircraft battery armed with new Russian missiles jubilantly reported that they had shot down a heavy transport plane. It turned out to be Malaysian Airlines flight MH17, with 298 passengers and crew on board. It was the moral indignation in the aftermath of that outrage that enabled Merkel to push through a much stronger sanctions regime. The EU blocked the export to Russia of any military equipment, oil industry equipment and the issuance of long-term debt in the EU by Russia’s state-owned banks and energy corporations. The United States doubled down by restricting access to capital markets for Sberbank and pressuring ExxonMobil and BP to drop their collaborations with Russian energy partners. But the real thrust of twenty-first-century sanctions was financial. By September 2014 Rosneft, Transneft, Gazprom, Novatek, Sberbank, VTB, Gazprombank and Bank of Moscow, along with arms makers United Aircraft Corporation and Kalashnikov, were all locked out of Western financial markets. Two of the banks most closely linked to Putin and his entourage had hundreds of millions of dollars frozen in US accounts.⁶¹

Moscow, for its part, resorted to more classic retaliation. It did not cut off gas supplies. But it issued a blanket ban against agricultural imports from Europe while increasing its military support for the Donbass rebels, who mounted a bloody counteroffensive on August 23–24. With the front line frozen, Kiev was forced to accept a ceasefire brokered in Minsk by Germany and France on September 5. With the new cold war between Russia and the West having escalated into a comprehensive and violent confrontation, it now came down to a trial of strength.

III

Since the shock of 2008, Russia’s official financial position had been rebuilt. In early 2014 Moscow’s foreign currency reserves stood at $510 billion. As in 2008, it was not the state but Russia’s globalized private sector that was vulnerable. Though the oligarchs of course toed Putin’s line, the markets did not lie. The escalation of tensions over Ukraine caused an immediate capital outflow. When the Russian Federation Council, on Saturday, March 1, 2014, gave a patriotic vote of approval for the deployment of Russian troops on Ukrainian territory, it was followed on “Black Monday,” March 3, by a spectacular 11–12 percent market slump.⁶² For internationalized Russian banks like Sberbank—a giant that controlled 28 percent of Russian bank assets—sanctions created a truly schizophrenic situation. As its CEO, Herman Gref, mused, 50 percent of Sberbank’s freely marketable shares were held by US and British investors, but the bank was now barred from raising funds in the West.⁶³ Perforce, over the course of 2014, Russian companies paid down their foreign debt from $729 billion to $599 billion, with the central bank deploying its reserves to enable the repayment.⁶⁴ Tension was building, but it was not until autumn that the crisis broke.

The third round of sanctions in the wake of the downing of MH17 bit deep. At the same moment, Janet Yellen’s Fed finally ended QE3, tightening credit conditions around the world. And then cooperation in OPEC broke down. Saudi Arabia ended its production restraint and oil prices collapsed. With or without sanctions, by the autumn of 2014 Russia would have been in serious financial difficulty. The combination of sanctions, Fed monetary tightening and a plunge in commodity prices was devastating. So devastating, in fact, that it has raised the question of whether this conjunction was entirely coincidental, or whether the United States and the Saudis were collaborating to launch a strike against Russia.⁶⁵

Oil politics are a rich field for conspiracy theory. There certainly are back channels between Washington and Riyadh. Secretary of State Kerry was in the gulf in the fall of 2014. The Saudis had every reason to act, if not over Ukraine then over Syria.⁶⁶ Along with Iran, Russia was the main backer of Assad’s die-hard regime. Saudi Arabia was its sworn enemy. There is no conclusive proof. Nor is a conspiracy necessary to explain these concurrent events. The oil market was under stress. America’s new fracking technology had opened up a new source of supply that was cheap and highly elastic. From the point of view of the Russian economy, in any case, the ultimate motivation was irrelevant. Oil prices plunged from $112 per barrel in June to around $60 per barrel by December 2014 and kept on falling. On top of sanctions and tightening credit conditions, it was a body blow.

In October the Russian central bank intervened heavily to prevent an immediate ruble collapse. But it needed to husband its reserves, and in November it exited the market. Starting at 33 to the dollar before the Ukraine crisis began, by December 1, 2014, the ruble had fallen to 49 against the dollar. This was terrifying for Russian corporate borrowers, who owed $35 billion in debt repayments by the end of the year. There was a scramble for survival. Rosneft, which had $10 billion to pay, was in the market hoovering up euros and dollars.⁶⁷ The strain on weaker Russian businesses was unbearable. In December, Trust Bank, a high street lender, and UTair, Russia’s third-largest airline, failed, and the central bank was forced to offer guarantees for the entire banking sector.⁶⁸ On the morning of Monday, December 15, the ruble began to plunge, ending the day down by 8 percent. That night, after a long evening of debate involving Putin himself, the central bank decided that it would hike interest rates from 6.5 percent to 17 percent. The announcement was made at one a.m. It was intended to reassure investors and punish speculators. It didn’t work. It was read not as reassurance but as a sign of panic. As markets opened on the morning of Russia’s “Black Tuesday,” December 16, the foreign exchange market went into free fall. By the end of the day the ruble had fallen to 80 against the dollar. The following day Sberbank came under concerted attack. A million of its customers received text messages from addresses outside Russia warning that the bank was about to be cut off altogether from external liquidity. On December 18, $6 billion were withdrawn. Over the following week the total came to $20 billion.⁶⁹^,⁷⁰ It was a spectacular bank run even by the standards of 2007–2008.

The oligarchs were once again exposed. Estimates vary, but the combination of the Ukraine imbroglio, the oil price shock and the December 2014 turmoil cost the twenty richest Russians between $62 billion and $73.4 billion.⁷¹ Once again Putin called in favors and demanded action. Measures were passed calling for the end to the offshore hoarding of wealth. An amnesty was offered to those who would bring their cash home. Meanwhile, the central bank attempted to get a grip on the situation with an increase in deposit insurance and the recapitalization of ailing banks. President Putin called for the authorities to abandon general principles of policy. They would need to be in “manual override” to see the country through. But there was one general principle that would not be abandoned. Russia did not want to ruin its reputation in the eyes of foreign investors by resorting to capital controls. Instead, to provide the necessary foreign exchange, the central bank ran down its reserves, which dipped as low as $388.5 billion on December 26. This cushioned the collapse of the ruble, but the pressure continued. The Western ratings agencies started by downgrading Gazprom. In January they lowered the rating of Rosneft, Transneft and Lukoil. Then the ruble slumped by 7 percent, giving up much of the ground it had recovered since the end of 2014.⁷² That, in turn, posed the question of the central bank’s reserves. What Russia was struggling to contain was something akin to the bank-sovereign doom loop that had menaced the eurozone until 2012. But what was now at stake was not just financial solvency but victory in a geopolitical tug of war.

In his first period as president, Putin’s legitimacy had been based in large part on a sustained recovery in living standards. That easy narrative was broken by the crisis of 2008. From 2014 onward economic expectations were further diminished. Over the winter of 2014–2015 GDP was falling by more than 10 percent per annum. It would not stabilize until the second half of 2015. For ordinary Russians the crisis of 2014–2015 was considerably worse than that of 2008–2009. Real wages fell more sharply and rebounded less vigorously. The Russia that emerged from the Ukraine clash was above all a nationalist regime whose citizens were called upon to pay whatever price was necessary for their nation’s reemergence on the global stage. It was tough, but it was a role that came easily. And, indeed, in some respects one might even say it was convenient.⁷³ As prime minister during the 2008 crisis Putin had thrown himself into hands-on domestic crisis fighting.⁷⁴ Since his return to the presidency in 2012, the Kremlin had been inciting nationalism to offset disappointing economic growth and disappointing poll ratings. Given the collapse in oil prices in 2014–2015, some campaign of nationalist incitement was only to be expected. The crisis in Ukraine was perfectly timed. Even with the economy languishing, Putin’s personal popularity surged from a low in 2013 in the mid-40s to a record 89 percent approval in June 2015.⁷⁵

Russia suffered, but if the economy was a weapon, it cut both ways. You could not damage Russia without damaging its neigbors. The much-feared emerging market crisis hit the post-Soviet world with a vengeance.⁷⁶ Between the end of 2013 and early 2015 the currencies of Kazakhstan, Azerbaijan and Belarus devalued by 50 percent against the dollar. The Kyrgyz, Moldovan and Tajik currencies lost between 30 and 35 percent of their value. Across Central Asia, the effect was to force sudden and sharp increases in interest rates and to place enormous pressure on the balance sheets of those banks and businesses that had globalized and borrowed abroad.⁷⁷ Meanwhile, family incomes were squeezed as remittances from migrant workers in Russia plunged.⁷⁸ In Tajikistan, the most remittance-dependent country of the world, where approximately one half of its working-age males earned their living in Russia, it threatened a catastrophic fall in household income and foreign exchange earnings. Kyrgyzstan, the world’s second-most remittance-dependent country, was also badly affected.⁷⁹

But if the crisis took its toll on the entire region, the epicenter of the shock was Ukraine. In the emergency bailout of April 2014, the IMF had started its estimate of Ukraine’s economic situation from an exchange rate of 12.5 hryvnia to the dollar. The IMF had called on Kiev to impose currency controls to prevent capital flight, while letting its currency float and allowing domestic prices to adjust to whatever level would ensure the viability of government-owned gas firms. If this program had been adopted, it would have squeezed both ordinary Ukrainians and wealthy Ukrainians, who would see their funds trapped in a depreciating currency. Instead, the Ukrainian central bank did the reverse.⁸⁰ It permitted billions of dollars to flee the Ukrainian banking system while using its precious exchange reserves to stem the decline in the exchange rate. While prices surged by 50 percent, the result was to favor the most wealthy Ukrainians, who swapped their assets into dollars at favorable exchange rates. All told $8 billion drained from the currency reserves. Whatever money was pumped into Ukraine simply bled out. With exchange reserves depleted to as little as $4.7 billion by February 2015, the central bank finally abandoned the exchange rate. As the European powers struggled to make diplomacy work and the hawks in Washington and at NATO headquarters were urging ramped-up military support, between February 5 and February 6 the currency plunged by 50 percent in twenty-four hours.⁸¹ Prices were adjusted on a daily basis, and to combat hoarding, a system of de facto rationing was introduced, which limited each consumer to buying fixed quantities of flour, oil, rice and buckwheat. Meanwhile, GDP fell by almost 18 percent year on year, making Ukraine’s debts progressively less and less sustainable.

With the battle in the Donbass ongoing, the government of the revolution of 2014, like its predecessor in 2004, was seeing its legitimacy evaporate in the face of insurmountable economic problems. To enable the new Ukrainian regime to survive, in the spring of 2015 there was no alternative to further foreign assistance. On March 11, 2015, the IMF recommitted itself to Ukraine, relaunching the agreement of the previous year, this time rated at $17.5 billion. It would be the cornerstone of a $40 billion four-year deal, supported by the EU. But this time, at last, the IMF acknowledged that there would have to be debt restructuring.

IV

In 2014, the comprehensive crisis, both geopolitical and financial, that had threatened the post-Soviet sphere in 2008 had arrived and the verdict it delivered on the hegemony of the United States and its alliance system was ambiguous, to say the least. A popular upheaval had swung Ukraine forcibly toward Europe. The Association Agreement eagerly signed by President Poroshenko in June 2014 was finally ratified in July 2017. The West had not let Ukraine sink. But neither had it saved it from crisis. Ukraine’s financial position remained precarious. The debt restructuring deal that was eventually done in August 2015 satisfied the IMF’s demand for private sector involvement in formal terms. But, in fact, it imposed minimal losses on the hedge funds that had gobbled up Ukraine’s distressed debt. It bought Ukraine only the slightest amount of debt relief, cutting its debts from $71 billion to $67 billion, while Ukraine’s GDP continued to plunge.⁸² The viability of the package would depend on the unpredictable course of domestic reform and the intensity of the confrontation with Russia, which neither the United States nor Europe had mustered the resources or political will to decisively repel. As far as Russia was concerned, even in combination with the oil price shock, the sanctions were painful but not decisive. By the spring of 2015 Putin’s regime had regained its grip. If and when oil prices began to stabilize, Moscow’s position would recover. Sanctions would soon prove deeply unpopular within the EU. To general amazement, Russia would find prominent sympathizers even in the United States. While it bided its time, Moscow could cause trouble in the Middle East, it could fish in troubled waters in the United States and it could look for new strategic partners farther afield.

In the cold war the interplay among Washington, Beijing and Moscow had been crucial in shifting the balance of power. In principle, a resurgent China could pick and choose. It had no particular reason to prefer Putin. But in the spring of 2014 in the East Asian arena, tensions between Japan and China were rising to a dangerous level. Washington gave notice that it meant to stand behind its strategic pivot. It would not countenance China’s assertion of rights in the South China Sea. But for America to take a strong line in Asia while at the same time confronting Russia in Europe had its price. It offered Russia an opportunity and Putin seized it. In the spring of 2014, as the seriousness of Russia’s confrontation with the West became clear, the Moscow leadership resolved on a strategic approach to China.⁸³ China would provide Russia with support against the West. If the United States and the EU were determined to oppose Russia in economic terms, it would find markets in China and sources of capital in Shanghai and Hong Kong. China, for its part facing resistance in the South China Sea, could build a Eurasian land route via Russia and Central Europe. The EU had shown no interest in joining America’s “de facto containment alliance” in Asia. Russia would provide the bridge. A start was made in May 2014 with the signing of a $400 billion, thirty-year Sino-Russian gas deal.⁸⁴

Though the strategic logic was strong, in practice, Moscow found that doing business with China was fraught with difficulty. The Chinese were tough negotiators. Russia’s hard-pressed oligarchs were reluctant to commit to long-term deals when they were not negotiating from a position of strength. Laying the necessary infrastructure eastward was monumentally expensive and Russia’s elite were leery of opening up Siberia to ever greater Chinese influence. Gas diplomacy in an age in which prices for fossil fuels were gyrating was a volatile business. But for both Moscow and Beijing, the point went beyond economics. It was about redefining the balance of power and affirming multipolarity. It would not be the incumbent hegemon that would shape the twenty-first-century order but the rising power of Asia and its allies. In so doing, Moscow and Beijing were also giving a new ending to the twentieth century.⁸⁵ The symbolism of guest lists at the anniversary celebrations for victory in World War II in 2015 was hard to ignore. Seventy years after that struggle, in which China, Russia, the United States, Britain and France had been united against the Axis, a new relationship was being constructed between China and Russia, a relationship that had the potential to reshape Eurasia. In Moscow on May 9 and Beijing on September 3, Xi Jinping and Vladimir Putin were each other’s guests of honor at spectacular commemorative ceremonies. Obama, Cameron, Hollande and Merkel gave their excuses.⁸⁶ In the spring of 2015 the one Western leader who would look to the former allies of World War II for support would be the embattled left-wing prime minister of Greece.