Relations between Russia and NATO member nations have been molded and re-defined mostly for the better since the breakup of the Soviet Union and the end of the Cold War period. However, tension between the two blocs has re-emerged amid Western and Russian military manoeuvring in Eastern Europe and the Middle East. Some analysts believe the situation, if it is not defused, has the potential to cause further conflicts and serious impacts on key world markets including those in Europe and the U.S.
Background: A Legacy Of Suspicion
The backdrop for the situation was established at the end of WWII in 1945 when Russia and the Allies divided the territories under dispute during the war into an Eastern Bloc of controlled Communist economies under the coordination of Russia and a zone of autonomous free-market democracies across Western Europe.
Trade between the two regions suffered restrictions and was limited. In the ensuing period both Russia and the U.S. and its allies developed increasingly powerful and sophisticated nuclear weaponry that exacerbated distrust between the leadership of both sides and set the stage for the Cold War. In response to nuclear weapons testing by the Soviet Union and signs of Soviet interest in possible military expansion into Europe, the U.S and European nations in 1949 formed the North Atlantic Treaty Organisation (NATO).
The organisation's aim was to:
- Deter Soviet expansionism
- Prevent the revival of nationalist militarism in Europe through a North American presence on the continent
- Encourage European political integration
The NATO treaty's specific language, in Article 5, calls for mutual protection of members: "an armed attack against one or more of them… shall be considered an attack against them all." In the event of an attack, each ally is called upon to take "such action as it deems necessary, including the use of armed force."
The countries originally participating in NATO included:
- The Netherlands
- United Kingdom
- United States
The organisation was later expanded to include several more countries and totals 28 nations as of November 2016.
The other member countries, and the year they joined, are as follows:
- Greece and Turkey (1952)
- Germany (1955)
- Spain (1982)
- Czech Republic, Hungary and Poland (1999)
- Bulgaria, Estonia, Latvia, Lithuania, Romania, Slovakia and Slovenia (2004)
- Albania and Croatia (2009)
In response to the formation of NATO, the Soviet bloc in 1955 formed the Warsaw Pact, which included:
- East Germany
- Soviet Union
Following this and the escalation of tensions with the construction of the Berlin Wall in 1961, NATO adopted the strategic defense doctrine of "Massive Retaliation." Under the doctrine, if the Soviet Union attacked, NATO would respond with nuclear weapons. The intent of the doctrine was to deter any potential Soviet attack with the threat of a nuclear conflict. The policy also aimed to allow NATO members to focus on their domestic economic growth rather than heavy investment in large conventional military forces capable of repelling a Soviet advance.
In the 1960s, tensions were heightened between the West and the Soviet Union with the intensification of the Vietnam War and the Cuban Missile Crisis. During the latter, in 1962, U.S. President John Kennedy was forced to negotiate the withdrawal of a Soviet shipment of nuclear missiles to Cuba with Soviet Premier Nikita Khrushchev.
Following the Cuban Missile Crisis, President Kennedy sought to replace NATO's "Massive Retaliation" doctrine with a separate policy of "Flexible Response." It would allow for differing degrees of military or diplomatic response in the face of military aggressions from the Soviet bloc.
The tensions of the early 1960s then gave way to a period of stability in the late 1960s and 1970s known as détente. This was a relative balance of power between the Soviet bloc and NATO, and it served as a deterrent against aggressions from either of the sides. The relative stability was disrupted in 1979, however, when the Soviets invaded Afghanistan and deployed SS-20 Saber ballistic missiles in Warsaw Pact countries in Europe.
To counter the Soviet deployment, NATO allies deployed nuclear-capable Pershing II and ground-launched cruise missiles in Western Europe.
Following the emergence of Mikhail Gorbachev as Soviet Premier in 1985, the U.S. and the Soviet Union negotiated the Intermediate-Range Nuclear Forces (INF) Treaty in 1987. It eliminated nuclear and ground-launched ballistic and cruise missiles with intermediate ranges, and it's widely considered to have signaled the ending of the Cold War. target="_blank"
With heavy costs of its war in Afghanistan and a stronger economy in Western nations, the Soviet Union was handicapped by military spending and its domestic economic conditions deteriorated. This precipitated an internal demand for economic and democratic reform that eventually led to the dismantling of the Warsaw Pact bloc and the Iron Curtain in 1989. Nine of the 15 former Soviet Republics, including Russia, became members of the Commonwealth of Independent States. Following the dismantling of the Iron Curtain, Europe and NATO in the 1990s formed the Euro-Atlantic Partnership Council that included Eastern European and Central Asian partners.
In 2002, the NATO-Russia Council was established so that NATO member states could work with Russia on security issues of common interest.
2000-2016: An Evolving Relationship
In 1999, Russian President Boris Yeltsin appointed former KGB intelligence service officer Vladimir Putin as Prime Minister. Later that year, Yeltsin resigned and appointed Putin in his place as president. Putin was received by Western counterparts as a Russian defense and security hardliner who would reinforce resistance to Western encroachment on Russia's sphere of influence. 
Putin was re-elected through 2008 before serving again as prime minister, though he was re-elected president in 2012. Relations between Russia and the Western NATO alliance during Putin's tenure have been complex and tumultuous, with periods of warming and heightened tensions.
Despite some thawing of relations, the expansion of NATO into former Warsaw Pact countries Poland and the Czech Republic in the 1990s unsettled some nationalist members of the Russian government and parliament. That sentiment was also fanned by NATO involvement in the civil war in the former Yugoslavia.
Still, neither Yeltsin nor Putin entirely closed the possibility of warmer relations with NATO, and both entertained the possibility of Russia joining the organisation as a full member. The events of the early 2000s—Russia's fighting of separatist rebels in Chechnya and the September 2001 terror attacks in the U.S.—seemed to help further encourage a thawing of relations.
However, democratic revolutions in former Soviet states, including Georgia and Ukraine in 2003 and 2004, were blamed on intervention by the U.S. and fueled a resumption of distrust in Russia. The entrance of former Baltic states in NATO contributed to that sentiment.
After Putin returned as President in 2008, he had a more guarded and aggressive stance. The U.S. intervention in Iraq and Afghanistan in 2003 had helped raise global oil prices and stimulated Russia's economy by increasing investment and production in the country's vast oil sector. The influx of revenues brought by the situation helped restore Russia's investment in military capability and emboldened Putin to begin resisting and challenging positions taken by the U.S. and NATO.
Also in 2008, the U.S. and NATO allies protested when Russia invaded Georgia to take over the regions of South Ossetia and Abkhazia. And in the years since, the U.S. and Russia have differed over a number of incidents.
Russian troops in 2014 invaded and took control of the Crimea region of the Ukraine, which allows important access to the Black Sea and the Mediterranean Sea through the Turkish Straits. Russian separatists were also alleged to have shot down a civilian passenger aircraft traveling between the Netherlands and Malaysia.
Tension has also been heightened following Russian intervention in the Syrian civil war, with Russia siding in defense of Syrian President Bashar al-Assad against U.S. and European calls that he step down from power. This situation has been a particularly strong source of disagreement and potential conflict between the U.S. and NATO. Syria is considered strategic by Russia, because it has long provided Russian naval support at its port in Tartus and access to both Middle East trade and Mediterranean shipping. Further, a U.S. proposal to restrict the use of airspace in Syria raised concerns that the U.S. and the West could come into direct conflict with Russia as it tries to bomb rebel positions within the country.
One sore and lingering point of contention between Russia and NATO has been a long-standing U.S. proposal to position a missile defense system in Eastern Europe. The proposal was put forth as a defensive measure, but Russian government and military officials have looked upon it with suspicion. They see as a means of possibly disabling Russian offensive capability and upsetting the strategic balance of military power in the region.
The proposal was first made during the administration of U.S. President Ronald Reagan in the 1980s. But the initiative wasn't moved substantially forward until 2007, when NATO allies in Europe called for a system to protect the region. In reaction to the announcement, Russia announced that same year it would no longer comply with the 1990 Conventional Forces in Europe Treaty (CFE) which limited conventional military forces in the region.
In 2008, NATO began plans for deployment of missile defenses in Europe starting with a system that would be based in Poland and the Czech Republic. Russia reacted by announcing it would suspend its ties with NATO, and in an apparent response to Russian dissatisfaction, U.S. President Barack Obama announced a revision of plans for the NATO missile defense in 2009. The plans aimed to cancel the immediate deployment of land-based defenses in Poland and the Czech Republic, and instead deploy a mobile sea-based system called AEGIS. The plan also called for the deployment of additional sea and land-based missile defenses through 2020.
Concerns over the likelihood of a conflict increased in early and mid-2016, with the intensification of the conflict in Syria and NATO war exercises in Eastern Europe aimed at reinforcing the defense of the Baltic States. Significant troop buildups and manoeuvres were detected from both NATO and Russia, causing some analysts to speculate that both sides were preparing for an impending conflict.
Market Impacts: Sanctions
A particular economic consequence of the ongoing tensions between NATO and Russia has been the imposition of sanctions against the nation. These were imposed in 2014 following the Russian invasion and annexation of Crimea in March of that year, and their immediate impact has been the restriction of trade and investment in Russia.
The sanctions targeted Russia's state finances, energy and arms sectors:
- Russian state banks have been barred from raising long-term loans in the EU,
- Exports of equipment that can be used for military purposes have been banned, and
- The EU has barred the export of oil industry technology to Russia.
The sanctions affect three large Russian state oil firms in particular: Rosneft, Transneft and Gazprom Neft (an oil producing subsidiary of gas company Gazprom). Three industries, however, were excluded from sanctions: the gas industry, space technology and nuclear energy. Top Russian officials and entities have also had their assets frozen in Europe.
The sanctions were estimated to cost Russia more than US$100 billion in 2014 and 2015. And in response, Russia banned Western food imports. That move has backfired, though, and helped raise inflation in Russia to more than 17%.
Meanwhile, the sanctions also caused international investors to write down the value of Russian assets by around 10%. Overall, the sanctions were estimated to have depressed the Russian GDP by 1.5 percentage points. Russia's economy contracted by about 4% to around US$1.3 trillion in 2015 due to slumping oil prices and the impact of the sanctions.
Independent estimates have put the immediate cost of the sanctions to European and U.S. trade also at more than US$100 billion each. However, the two-way trade between the regions represents a smaller part of overall global trade for the U.S. and the European Union than it does for Russia. In addition to trade losses, there is also a risk that Russia could default on more than US$140 billion in debt held in foreign banks.
A Conflict? Impacts On Markets
Considering the advanced weaponry, the economic weight of the adversaries and the stakes involved, the outbreak of any military conflict between NATO and Russia would have serious, far-reaching, and potentially catastrophic effects on the world economy, markets and conditions for most people around the planet.
One immediate impact of a conflict in the Russian-European military theater would be on the price of oil and other key commodities such as metals. Russia is a significant producer of oil, and though its fuels trade has already been reduced, markets would see that dwindle even more. Further, as Russia has established a strategic presence in Syria, it would be in a position to threaten disruption of important Middle Eastern oil supplies.
The increased price of oil and fuel would likely have a knock-on effect on prices of other commodities, because rising transportation costs would push up the market value of various items. For similar reasons, food costs around the globe would rise, prompting accelerated inflation in most countries.
The outbreak of a conflict in Europe would likely prompt flows of money toward the U.S. economy, because the country is considered a safe haven for investment. The euro and the ruble—the currencies from regions at the center of the conflict—could be expected to weaken. Additionally, other currencies that are considered safe havens could draw investment, such as the New Zealand dollar, Canadian dollar, Japanese Yen and Singaporean dollar.
In addition to safe haven currencies, investors would flock to purchasing precious metals—gold, silver and platinum—that would in turn see historically high price levels.
A serious conflict would likely create volatility for equities prices around the globe. Shares of many European companies could be expected to be hit hard, especially those dealing in areas such as tourism and retail. However, some sectors around the globe could potentially profit, including energy and defense.
Interest Rates And Bond Markets
Periods of war create heavy demand for goods, inflation and borrowing, and they tend to drive up interest rates and bond yields in the U.S. At the same time, bond prices are likely to decline. However, increased flows of incoming foreign investment from abroad are likely to offset that trend.
An Opportunity for New Dialogue?
The election of U.S. president Donald Trump in November 2016 may provide an opportunity for revision and improvement of deteriorated NATO-Russia relations. During his presidential campaign, Trump suggested that he would be interested in working with the Russian government to defuse ongoing tensions between the U.S., its European allies and Russia. "If we got along well, that would be good," he said in the third debate of the presidential campaign.
Trump added that he believed the two countries could work together to try to resolve the long-running conflict in Syria that has exacerbated global tension. Russian President Vladimir Putin for his part has expressed satisfaction with Trump's election and a desire to work together to end the crisis in Russian-American relations.
The increase in tension seen between Russia and NATO in the last decade has emerged as a consequence of a complex relationship and series of events that developed over the past 70 years. The adversarial relationship is one of the most dangerous across the globe, but it could just as easily settle into a calm situation of uneventful stability. The brewing conflict has been exacerbated by disputes over Syria and longstanding disagreements over NATO and Russian defense arrangements in central Europe.
The emergence of actual military aggression by either side would result in severe negative impacts for global financial markets, and such a scenario has appeared to grow more likely. However, there may be an emerging possibility that tensions can be resolved with a fresh effort at negotiations by Trump's administration and renewed goodwill from the Russian government.
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Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…