THE BIG REVEAL
Grigory Potemkin (1739-91) was a statesman who helped acquire new lands for the Russian Empire in what is now Ukraine, including annexing Crimea from the Ottomans in 1783. The eponymous Potemkin villages were allegedly built along the banks of Ukraine’s Dnieper to impress Catherine the Great en route to Crimea in 1787. Hastily erected to give the illusion of wealth, the villages were then dismantled and moved down river to repeat the process.
Appropriately, the story itself may be a fiction. Regardless, Potemkin has come to mean anything illusory and hollow, masking a more sobering reality.
Fittingly, Russia’s latest invasion of Ukraine has revealed many contemporary Potemkin façades.
ZEITENWENDE
German Chancellor Olaf Scholz called the invasion a Zeitenwende: an epochal tectonic shift.1
In truth, Europe’s largest war since 1945 is simply one indicator of a much larger Zeitenwende long underway: a shift away from the low inflation, low interest rate, low volatility, geopolitically stable era of recent decades towards a more inflation-prone and volatile world riven by long-term tectonic shifts. These include the continuing breakdown in world order, dominated by a Sino-US Cold War; the energy transition to Net Zero; mass ageing; the return of fiscally activist big governments; politicised central banks; increasing natural risk; and technological revolution.
But it was the return of World War II-scale battles to Europe which shattered lingering illusions that the post-Cold War era marked a decisive break with History. It has exposed Europe’s Potemkin armed forces, munitions stocks and defence-industrial bases.
Skinny supply chains and minimalist inventories aren’t fit for war: resilience requires the ability to take losses and keep fighting. To date, Russia is estimated to have lost up to 300 aircraft and thousands of armoured vehicles, to say nothing of 100,000 soldiers.2 Quantity can have a quality of its own: when the chips are down, inventory and industrial capacity count.
Ukraine is simultaneously the last war of the twentieth century, featuring artillery duels and trench warfare, and the first major war of the twenty first: drones, networked warfare and portable precision-guided missile systems are coming of age.
It also shows how America’s way of war is adapting. Exhausted by failures in Afghanistan and Iraq and wary of escalation with a nuclear superpower, Washington is using its defence-industrial base and unmatched surveillance and targeting capabilities to help others fight strategic conflicts. The US is only likely to commit its own forces directly as a last resort.
This is staggeringly cost-effective. For a modest percentage of the Pentagon’s annual budget, America has been able to destroy by proxy a significant portion of Russia’s conventional warfighting equipment in Ukraine.3
The lesson for other at-risk states is simple: invest in your own defence, or American support is not assured.
So, after decades of neglect, defence spending needs to rise. Germany has belatedly committed to NATO’s 2% of GDP defence spending target, plus a cool €100 billion catch-up cheque. Japan – eyeing China – announced its own defence budget hike from around 1% of GDP to 2%, whilst acquiring offensive Tomahawk cruise missiles. For a constitutionally pacifist state, this is a big deal.
FUEL ON THE FIRE
But higher defence spending is merely the appetiser on the bill for this new era. Russia’s cessation of gas flows to Europe catalysed the biggest global energy shock since the 1970s. Scholz’s government alone allocated more than €440 billion for energy support – about 12% of GDP.4 German inflation reached 11%, exceeding the 1974 peak of 8%.5
This highlights the mortal peril of relying on a potential adversary for your economic lifeblood, especially energy. Rapid supply diversification is now underway.
For some time, energy market dislocations have been a matter of when not if, courtesy of long-term underinvestment in supply. That was partly driven by naïve Net Zero plans – you can’t wish away the fact that the world is still over 80% dependent on fossil fuels and demand is growing.6 Supply shortages mean the shocks will keep coming. Investment needs to climb.
1 Scholz (27 Feb 2022 ), Bundestag speech 2 Wallace (20 Dec 2022), Statement to UK Parliament and Oryx (Feb 2022), oryxspioenkop.com 3 Oryx (Feb 2022), oryxspioenkop.com 4 Reuters 5 Destatis, Bundesbank, Refinitiv 6 BP Statistical Review of World Energy, 2022