Notes From Underground

Last week we wrote about the need for Russia to create some mischief in the world. Lo and behold, we have two stories out of Moscow that could be unsettling to the politics and thus economics of the global economy.

First, Russia is still threatening to cut off of oil supplies that are delivered to Europe through the Ukrainian pipeline. This action is brought to the fore as Russia is unhappy with the Ukraine’s demands for higher transit fees on oil shipped from Russia to Europe via pipeline. The threat is not nearly as great as the disruption of natural gas, as the amount of oil is much less relative to natural gas. It seems that the Russians are only getting Europe’s attention as next month’s Ukrainian elections will limit Gazprom’s ability to act. The Kremlin is trying to prevent the election of Viktor Yuschenko, who the KGB poisoned in London, while supporting the present Ukrainian ruler, Yulia Tymoshenko. It seems that little action will take place as they don’t wish to provoke an anti-Russian vote, which would go to Yuschenko.

After the election, in the midst of the coldest part of winter, we will see how Russian energy demands are put in to action. If Tymoshenko loses, we can be sure that Russian belligerence to the Ukraine and Europe will increase. The primary concern for the Ukraine is the need for higher transit fees on energy to support a government budget that is in severe imbalance. Similar to the rest of Eastern Europe, the global downturn left the Ukrainian economy in tatters and they have already turned to the IMF for help. The Russians will remind Europe and the Ukraine that they are still a strong voice and their ability to disrupt the European economy is very great.

Second, out of Russia comes word that Prime Minister Putin raised the issue about restraining hot capital inflows into Russia.The vast amount of money that has flowed in has put upward pressure on the ROUBLE, which the Russian Central bank has attempted to stem by lowering interest rates several times this year. These rate cuts have not been successful in halting the ROUBLE‘s rise, forcing the central bank to buy dollars and adding to Moscow’s burgeoning foreign reserves. Putin hinted that the restrictions would not be like Brazil’s but would act to inhibit the inflow of funds. The potential action has not been implemented yet, but this is another move to restrain the flow of international capital at a time of great financial fragility.

In addition, the U.S. moved to create more trade friction as it announced tariffs on the imports of Chinese steel grating. The amount of steel affected is minimal, but it is one more action that is causing friction in the global system. We get the feeling that after the Copenhagen Summit, relations between the western powers and China are severely strained. Global equity markets,presently riding a wave of nirvana, are not prepared for events like exchange controls and other trade impediments. These uncertainties that continue to arise justifies our desire to maintain a bullish GOLD bias against all FIAT currencies.We are one misstep away from a major crisis.

Interestingly, we report that the FOOTSIE index closed above the Lehman debacle highs from September 15-22, 2008. It is the first major equity market able to do so. We are not sure why but it may be that the flexibility of the POUND has lent some support to the British economy. The depreciation of the POUND since the Lehman bankruptcy has been substantial. It has also given the BRITS a pricing advantage versus its European trading partners. Also, it has meant that British assets have become cheap on a relative currency based valuation. It supports our view that equity markets are riding high even as the threats to the global financial system continue to grow.

Just food for thought as we enter the new year.