No Game of Chicken in Ukraine
At first glance, the conflict over Ukraine looks like a game of chicken, where two cars rush against each other and the loser is the one swerving to the side to avoid everyone’s demise. Looking more closely at the situation, however, provides a different picture.
We often use a game theory framework to help analyze geopolitical conflicts, and in doing so, identify the major players and objectives. A player’s endowment power, coalition power, and level of risk tolerance add up to its net influence in the game, while salience measures how important the outcome is for each player.
Who Wants What?
From the standpoint of Russian President Vladimir Putin, the West has gradually been moving into Russia’s backyard while Russia has mostly stood idly by, only occasionally fighting back to secure the safety of Russian nationals in Georgia and Ukraine.
The West sees Russia as the aggressor and is threatening sanctions, which would likely be either insignificant or improbable. Insignificant sanctions include restricting exports, restricting Russian bond purchases, and targeting individuals in Putin’s circle. None of these tactics have proved to hurt Putin or threaten his administration in the past. More severe restrictions include blocking the Nord Stream 2 pipeline and expelling Russian banks from the SWIFT network or dollar clearing. These would be politically feasible only in the case of an aggressive Russian move because they would also hurt Western allies to some degree.
Issue 1: NATO Membership
We believe an aggressive Russian move is unlikely in the near term, because Russia and the West have a key shared interest in how far to take this conflict. Neither side wants a military confrontation nor for Ukraine to become a NATO member. Both U.S. and European politicians know it would be chaotic to let Ukraine into the alliance, because allowing Ukraine into NATO would impose on the entirety of the alliance an obligation to get involved in a country that was encroached upon by Russia only a few short years ago. So, U.S. and European politicians will take any opportunity to punt that decision to their respective successors in office.
Importantly, the West also may want to avoid dealing with the diplomatic fallout of completely shutting the door to a Ukrainian NATO membership.
Both sides need to sound tough while avoiding any commitment on either side.
The Russian administration understands all this. However, both sides need to sound tough while avoiding any commitment on either side.
The only player that wants to see the Ukraine entering NATO is Ukraine itself, and that does nothing to sway the outcome of this conflict, because Ukraine is closer to a pawn in this game than one of the influential players (much as it was in the early days of the 2014 conflict before the Crimean invasion).
Issue 2: Political Planning
While any grand escalation is unlikely, in our view, investors should not expect the conflict to end anytime soon.
In our view, U.S. President Joe Biden benefits from the confrontation because it provides him with an opportunity to act as a statesman in the face of falling approval ratings. With problems at home, there is no such thing as a conflict with an enemy. Many Americans blame the Biden administration for increases in their cost of living, and this needs to be forgotten to increase the odds of a favorable outcome for the Democrats in the midterm elections later this year. We believe the longer and closer to the elections that the Russian conflict drags out, the better.
We believe the longer and closer to the elections that the Russian conflict drags out, the better.
In our opinion, Putin faces no threat of being voted out in an upcoming election, but before the conflict over Ukraine became the central focus in Russian geopolitics, the West was pressing Putin over his handling of opposition leader Alexei Navalny. Now forgotten by many Western observers, Navalny was jailed and labeled a terrorist by the Russian government early last year upon his return from Germany, where he was recovering from a poisoning, ostensibly at the hands of Russian agents. His jailing was a blatant suppression of any semblance of political freedom in Russia and an uncomfortable development for Western governments. Fortunately for both Russia and the United States, the Ukrainian conflict is now grabbing the headlines.
Coordination, not Chicken
The conclusion is that what may look like a game of chicken between Russia and the West is instead a game of coordination, where Russian and Western governments are groping toward the ultimate prize—a level of conflict that serves their needs while not moving so close to violence that a small mishap could land them in direct military conflict.
An Eye on Markets
As far as markets are concerned, a Russian equity market rebound to its previous highs may still be a way off as investor worries will likely persist while the conflict continues. While we believe investors would be wise to brace for potential additional Russian market declines, those who maintain a long-term view should be able to ride out, or even take advantage of, these periodic pullbacks.
Lastly, the incentives to find compromise in this situation suggest that current Russian market volatilities are unsustainably high and should revert to more normal levels as market participants realize that the incentives involved in this game are not aligned with war. We believe there remain plenty of opportunities to avoid a head-on collision in this ongoing game of coordination.
Lotta Moberg, Ph.D., CFA, is an analyst on William Blair’s Dynamic Allocation Strategies team.