Jupiter: Jupiter Merlin Weekly: NATO recovers its purpose – but what next?

However, at great expense to all, particularly Ukraine, NATO subsequently has come a long way in recovering its sense of purpose and some of its self-respect. Putin’s hope for a quick and easy win has been confounded by his (and to be fair, apart from the Ukrainians’ themselves, virtually everyone else’s) complete underestimation of the Ukrainian will and ability to resist and a significant overestimation of Russia’s military capability and leadership. But strategically, where Putin has palpably not only failed but achieved exactly the opposite of what he intended was his aim to push NATO back from his own border and have a geographic buffer, a no-man’s land, between the Alliance and Mother Russia. It was a pre-condition of his not invading Ukraine that none of the post-1993 new members of the Alliance (all of which were ex-Soviet states or former communist satellites of Moscow e.g. the Baltic States, Poland, Hungary, Romania etc) should be allowed to host any foreign NATO troops (known to Putin as trigger troops) or strategic weapons. Except for Hungary, those nations on NATO’s eastern flank are now the most committed of NATO’s members, the most hawkish in their approach to Putin and fully welcoming foreign NATO trigger troops as garrison forces and allowing their land and facilities to be used as forward bases for NATO air and naval operations (and it is a noteworthy and positive policy development that Germany’s relatively new and much the most effective defence minister for years, Boris Pistorius, has announced a 4,000-strong German brigade garrison force to be stationed in Lithuania). Further, the Alliance has been significantly bolstered and expanded by the agreed accession of formerly neutral Finland which has an 830-mile direct border with Russia, likely to be joined by Sweden if/when Turkey removes its veto objecting to Sweden’s support of Kurdish rights.

…along a still rocky path

But NATO’s has still been no easy journey, even this far. We have discussed many times in the past 18 months how, in this proxy war, NATO has been presented by President Zelensky with stepping-stones across the ideology and policy chasm as he arm-twists the Alliance collectively and member states individually for more practical help: training; military intelligence; small arms; medium and heavy artillery and ammunition; defensive anti-tank and anti-aircraft missiles; moving more aggressively towards armoured vehicles and main battle tanks and more recently to F-16 fighter jets; and now seeking US agreement for medium-range tactical missiles with which to attack targets deep inside Russia itself. There have been many disagreements and much political tension. And all the while, in what we have described as charity-shop warfare where Zelensky constantly has to beg for every single item of kit and relies totally on foreign benevolence, he is constrained by NATO heads of government having to maintain the political will and backing at home and their finding the financial funding amid the political cost-of-living crisis. In Europe, some, led by the UK, have been eager to help (indeed, under Boris the UK put real backbone and leadership behind the Alliance response, including gingering up the Americans); others, notably France, Germany, and Italy when under Mario Draghi, have been in a very different place at times facing accusations of outright appeasement towards Putin (we documented this fully ahead of the invasion in our extensive analysis “Anatomy of a Crisis” in February 2022).

While presenting a publicly nearly-united front, significant divisions remain underneath, notably about not only how to finish the war, but defining the ultimate goal; what constitutes a satisfactory outcome and what is the best means of bringing Putin to heel and/or to book.

Defence spending commitment: NATO’s delinquents remain much the majority

Today NATO finds itself once more at a political cross-roads. The war in Ukraine is now halfway through its second year, increasingly one of attrition and neither side seemingly able to make significant headway. It may yet escalate or present an enduring security threat to the West depending on what happens in Russia. But despite all this and the threats from China, Iran, North Korea and others, of the 31 members of NATO still only seven are meeting the minimum commitment to spend 2% of GDP on defence: America, the three Baltic States, Poland, Greece and the UK (and ours only gets there thanks to creative accounting including fully-loaded costs of pensions, military housing and the MoD overhead). At the forthcoming NATO summit in Vilnius, Lithuania, Secretary General Jens Stoltenberg is seeking to build a consensus for a new long-term spending target, in his own words seeking “an ambitious figure”, whatever that might be. He faces a considerable challenge. The list of habitual delinquents is long and enduring: if those lead-footed countries with squadrons of moths in their wallets (more than three quarters of the membership!) have failed to meet the minimum 2% target, what chance of them agreeing to a higher one, or even if they do are they willing to commit to achieving it? We ourselves think that 2.5% by 2030 is ‘ambitious’.

NATO leadership: political dirty work at the crossroads

Stoltenberg himself is tour expired. Vilnius was supposed to be his valedictory meeting at the end of his term of office, a successor already elected. That has not happened and he has been asked to extend his term by more than a year to October 2024. Amid the usual round of political horse-trading as various heads of government whisper in dark corners to ensure some prospective candidates are quickly removed while others are pushed forward, deep vested interests are at play.

Presidents Macron and Biden have already vetoed the UK candidate, Defence Secretary Ben Wallace. Allegedly he personally has ruffled feathers in the Alliance in being too gung-ho in the prosecution of the war and being impolitic not only with the less committed but also the Americans; despite the UK being much the most effective supporter of Ukraine with the US, Wallace also undeniably suffered simply from being British. Biden’s personal antipathy towards a post-Brexit UK is palpable and, according to the Daily Telegraph his reaction against Wallace reflects Biden’s anger at being bounced by the UK (helped by Holland) into having to accept the F-16 jet training programme for Ukrainian pilots as a fait accompli. As for Macron, leaving aside Brexit, Wallace or any other British candidate would have been a non-starter because of the way France was kicked off the €47bn contract to build nuclear-powered submarines for Australia when the AUKUS Indo-Pacific defence pact was signed between Washington, London and Canberra. In politics there is no such thing as an action without a reaction.

As an aside, as a seasoned political operator Wallace both knows the game and plays it: at the end of June General Sir Patrick Sanders, Chief of the General Staff, declared in a speech at the Royal United Services Institute that Britian’s military capability was in a parlous state: “hollowed-out forces with clapped-out equipment”. In doing so he opened himself to the accusation of acting more in the spirit of a shop steward than the leader of the Army and within days it was announced that his would be a two-year appointment rather than the habitual three and ending in mid-2024. Whatever the assertions to the contrary from Wallace, it was clear that Sanders had been served the coup de grace on his career, particularly as he was seen as the likely next Chief of the Defence Staff. Sanders was naïve to think there would be no reaction from publicly embarrassing his political boss. However in speaking no less than the truth to politics, shooting the messenger does not make the message or the problem go away. Wallace might be seen as an effective supporter of Ukraine, however he has signally failed to attempt any reform of his department, its overheads and modus operandi, its decision-making process, the procurement mechanism etc which might make his budget much more efficient and begin to redress the critical deficiencies in numbers and effectiveness described by Sanders (and much the same can be said for the RAF and the Navy; as our retiring NATO Deputy Supreme Allied Commander Europe, General Sir Tim Radford also said a couple of weeks ago in the context of the UK’s ability to field meaningful fighting forces, “in terms of influence, the UK is only just hanging on by its finger tips in NATO”). The Americans have been pointing out the same to us for years.

But back to NATO finding a new chief. There is nothing to preclude an American being NATO Secretary General. However, because of the overwhelming weight of influence brought to bear by the US defence budget (the US accounts for 72% of all NATO spending) and its military capability, convention says that to retain political balance a non-American should have the post (in contrast, SACEUR, the supreme military head of NATO forces in Europe is always from the US). It is clear that Biden and Macron see a future leader coming “from the EU”. We put that in quotation marks because it has a double meaning: it could imply from an EU member state, or it could mean directly from the EU itself, i.e. Brussels. In this context, Biden is reportedly pushing for EU Commission President Ursula Von der Leyen to have the job. Biden’s is a calculation that an EU appointee would achieve two goals: 1) to get Europe to take greater responsibility for its own defence within the Alliance by meeting those minimum commitments on expenditure and 2) to help bring those EU leaders (Macron in particular but also Von der Leyen herself) back in the NATO fold who otherwise think that in matters of European defence, the EU should diverge from the US even to the extent of disintermediating America’s role. Macron, in collaboration with Von der Leyen, the architect of the recent protectionist pan-EU defence procurement programme, no doubt sees her potential appointment as another significant step towards a unified European defence force on the path to full European political integration.

The Von der Leyen conundrum

But Von der Leyen is a divisive character. As a former German defence minister for five years from 2014-19, she was widely derided as embarrassingly inadequate (remember on her watch German troops taking part in a NATO exercise armed with broom handles instead of rifles?); she was judged by both colleagues and political opponents in Berlin as having been asleep at the wheel while Germany’s defence capability, already weak, declined markedly further as Germany consistently and significantly failed to meet the 2% of GDP minimum NATO threshold on defence spending. Further, she was a long-standing senior minister in Chancellor Merkel’s government actively colluding with Putin in the development of the Nord Stream 2 gas pipeline.

Latterly, leading the EU Commission where Von der Leyen was the compromise candidate when she was proposed (defined more by who she wasn’t than who she was), the supranational European financial response to the pandemic and its politically motivated vacillation over the vaccines programme (over which she took personal control) showed Brussels’ leadership at its worst: obstructive, obtuse, technocrat and lacking all urgency. Much the same could be said for its response to the Ukrainian crisis. While Von der Leyen herself has been publicly robust in her views on Russia’s aggression, she never managed to create an EU-wide consensus on how to deal with Putin; her support for Ukraine’s EU membership remains equivocal, conditional on Ukraine proving that it has stamped out corruption. With Macron, she also stands accused earlier this year of temporarily withholding munitions to Ukraine until the EU’s self-interested defence procurement strategy was implemented.

She will find support for her candidacy in both Poland and Hungary difficult to come by. The internecine hostilities between Brussels and the current administrations in Warsaw and Budapest are well documented. Both countries are regularly threatened with Article 7 and the withdrawal of voting rights. Both are still under sanction and disbarred from benefiting from the EU’s €750bn pandemic recovery fund. In August of 2022, facing significant economic pressure from more than 4m displaced Ukrainians being offered sanctuary in Poland and yet still finding itself on the EU naughty step, albeit with zero chance of success the Warsaw government made clear that were Von der Leyen’s attitude not to improve, it would take steps to have her removed as EU Commission President.

In being presented as the lead candidate in an otherwise now seemingly absent field, it is her historic and current shortcomings in Brussels that would present the biggest challenge for her to overcome in her potential position as head of NATO. The UK is aligned with the US in wanting Putin defeated (though even that definition of ‘defeated’ is imprecise: not in a position to do to any other country what Russia has done to Ukraine? Or thrown out of Ukraine and whether to include ejection from the Crimea? Or does ‘defeated’ mean Putin being thrown out of the Kremlin too and his government replaced? Answers on a postcard). Within the EU and countries who are also members of NATO, there is a significant divergence of attitudes about how to deal with Russia. The Frontier countries are unequivocal: they are closely aligned with the UK/US and want the Russian threat to themselves to be removed (the exception is problematic Hungary where Viktor Orban remains stubbornly supportive of Putin despite Hungarian membership of NATO). They are at odds with France and Germany (less so Italy now under Georgia Meloni) whose natural inclination is still not to see Putin in a position of ultimate humiliation or total defeat; in the jargon, Putin must be allowed to ‘off-ramp’, any outcome from the conflict should be face-saving for him and his regime.

With Biden and Macron behind her, Von der Leyen has strong support. But she is no shoo-in. However, for those opposing her (and Rishi Sunak is being put under pressure from irate backbenchers to do so), the fundamental problem remains: if not her, and not Wallace, then who? Much the most persuasive means of vetoing one candidate is to propose a better alternative. There are no credible names that are immediately obvious.

NATO’s immediate challenge: EuropeFinding a tenable line among 31 disparate countries with only the membership of the Alliance in common but each with its own national agendas and foreign policies is a political challenge for any head of NATO. Immediately relating to the current conflict, matters directly concerning Ukraine include three major policy decisions all of which will be debated at Vilnius:

1. Ukraine’s admission to NATO: countries led by the UK are pressing for Ukraine to be admitted to the Alliance as soon as possible. The US is reluctant while a fifth of Ukraine is still occupied by a combatant Russia. If Ukraine were to be adopted while the conflict is current, then logically NATO would be directly at war with Russia, something it is determined to avoid. It would be perverse for Ukraine not to be a member of the Alliance in future given the military and financial support it has had; but equally adopting it now would allow the Russians to interpret NATO’s action as an act of war. Note that the adoption of a new member can only be by unanimous consent.
2. Nuclear attack: what constitutes a nuclear attack? Here, when referring to Russia, this week’s developments of nuclear sabre-rattling must include Belarus under the mercurial and volatile Alexsandr Lukashenko, Putin’s proxy; he seems to think he has direct control over Russian missiles stationed on his territory. Russia’s use of tactical or strategic nuclear weapons against a NATO country would be an obvious attack, automatically invoking Article 5 (an attack on one is an attack on all). Russia using nuclear weapons against Ukraine would not constitute an attack on NATO; however, the US and the UK as co-signatories of the 1994 Budapest Memorandum giving assurances of Ukrainian sovereignty (clearly worth less than a handful of beans when put to the test) but offering explicit guarantees in the case of a nuclear attack, would be bound by treaty to intervene directly; question: where would that leave the rest of NATO in relation to Article 5? Raised recently and more probable than an attack using nuclear weapons, what would be the effect of Russia using conventional weapons to attack or destroy the nuclear power station at Zaporizhzhia with the potential for catastrophic fall-out across a wide geographic area? Some have suggested that an attack on a civilian nuclear installation, even if in Ukraine and not military, would constitute an Article 5 event. That is a very big call.
3. Wargaming a government collapse in Russia: although thwarted, the recent confusing and comedic events surrounding the Wagner Group rebellion and the attempted but abandoned mutinous march on Moscow illustrate the possibility that forces inside Russia might oust Putin. Until recently NATO had apparently undertaken very little wargaming of the consequences of a government collapse and a political vacuum in the world’s biggest country spanning two continents from the Baltic to the Pacific. The White House and the Pentagon are now on the case but a response if or when needed requires a full consensus.

It is that last point which leads into the broader leadership challenges for NATO and whomever is its new Secretary General next year. NATO is explicitly a defensive alliance: a mutual protection society to guarantee its members’ interests and security. But what in a dynamic context are the boundaries of that word ‘defensive’? Let us consider a possible political implosion in Russia and Putin’s presidency terminated. The resulting domestic political vacuum would inevitably be filled. There is the possibility it might be by progressives keen to make peace with the West. On the other hand, it could well be by forces even more malicious than we have experienced with Putin. What then might be the consequences for the security of those flank countries in Eastern Europe were Russia to rebuild its military capability and presumably learn important lessons from all that failed in Ukraine? They would need significantly shoring up.

History says that out-of-area, a NATO policy consensus is difficult.

But the greater indirect challenge to the security of the Alliance is what would happen further afield. To a greater or lesser extent depending on the capital concerned and who is in power, Moscow retains significant geopolitical influence over the Russian Federation countries and the old Soviet Republics. But others are seeking leverage too, notably China and Iran, not to mention India and Pakistan in their own national interests. All the aforementioned are nuclear powers (Iran’s might not be fully developed but it is close). Instability in Russia could easily destabilise the entire periphery of its borders from the Caucasus across the whole of central Asia. Things could unravel alarmingly quickly.

These are among some of the most sensitive areas on the planet whether through political or religious tensions, or because they are on the route of China’s One Belt One Road, or they are home to the rare earth minerals and elements critical in the manufacture of semiconductors and the technology upon which we are all going to rely as the world transitions to carbon net-zero over the next quarter of a century. Control over major infrastructure development zones and routes and those physical resources (including water) confers significant geopolitical leverage. China also has a keen interest in Siberia (the eastern part of which it used to own), awash with oil and gas and ownership of which would at a stroke make China self-sufficient in energy. How should the West and NATO respond in such a situation?

Through AUKUS and outside NATO, the US, the UK and Australia have jointly tilted their strategic emphasis towards the Indo-Pacific region, both to take advantage of the trade opportunities, but also to keep the growing influence of China in check. Within Europe, NATO members such as France, Germany and Italy take a very different view in dealing with China with an actively open dialogue which self-interestedly and cynically General Secretary Xi Jinping is prepared to entertain when the terms are in his favour. They run the risk of repeating the mistakes with Putin: that colluding with him they think deludedly that Xi can be persuaded to adopt western values.

China is playing hardball. The recent trip by the US Secretary of State Anthony Blinken to attempt to re-set post-Covid US-Sino relations was a failure. He was effectively told to mind his own business, particularly with regards to Taiwan and China’s territorial infringements in the South China Sea. Rightly or wrongly, China now sees itself as an equal with the US as a global superpower, even if in terms of nuclear capability it lags far behind.

Afghanistan: the reminder of when NATO gets it all wrong 

At 31 members, in terms of keeping them heading roughly in the same direction, leading NATO is already akin to herding cats. Which brings us back to the introduction: Afghanistan shows what happens when key players fail to cooperate and choose to go their own way; events rapidly spiral out of control.

The global tectonic plates are always in motion, occasionally producing a seismic thud such as Ukraine. Times like this force a redefining of NATO’s outlook; when it has to decide whether it actively shapes global events by heading them off (which includes a firm commitment to defence spending: our foes respect strength not weakness), or whether events control the Alliance and it is left to scratch around in the dust afterwards, as in the case of Kabul airport, literally picking up the pieces. That is a test of true leadership; let it not be found wanting a second time.

The investment case: the tendency towards TBD

Why should this be relevant to investors? We have made this case many times before and it bears repeating. Geopolitics are usually contextual to investors; economic and financial matters are the normal preoccupation. If markets find geopolitics difficult to understand, they find them even more difficult to quantify; they tend to park the problem until an event actually hits them and runs them over (as amply demonstrated at the time of the invasion which was clearly anticipated but almost entirely discounted as unlikely to happen; subsequent volatility, particularly in bonds, demonstrates that investors have struggled to make sense of the significant economic consequences since). The further the outlook, the more the tendency to file the subject as TBD: To Be Determined, or, more prosaically, Too Bleeding Difficult.

As only too evidently illustrated, periodic exogenous shocks such as a pandemic or a seismic geopolitical event such as a major conflict can and do have a direct and potentially enduring effect both on economics and investors’ appreciation of risk. Some, such as pandemics cannot be forecast. But others can be anticipated. As we have described above, particularly as we enter the new era in which three centuries of society being powered by hydrocarbons is replaced by alternative fuels in three decades, competition for advantage, security of supply chains and control of assets will intensify. Possibly it may result in open conflict. It certainly has direct implications for future macro-economic conditions, commodity prices, currencies, bond yields and equities, all of which are interlinked. The new era presents many investment opportunities but instability also creates greater risk. That’s why the evolution of such organisations as NATO is important in maintaining and promoting not only political but economic stability and safety. But they are only as strong as their weakest link. Fostering and maintaining security and stability are about political will and leadership. Vilnius on 11/12 July and subsequent NATO meetings need to demonstrate that.

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.

Alastair Irvine, Investment Director

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