Dan Kutzke By | On July 14, 2014

I had the opportunity to travel to southern California for a couple of days in the last week of June for a due diligence meeting for a REIT program.  The workshop was very good, but the interesting story to share came from the ride back to the airport.  After a short, nice conversation with my fellow passenger, I had noticed that the driver had an interesting accent.  So I asked him where he was from; he answered Ukraine.  So I asked him the fateful question: Did he have any thoughts about what was going on in Ukraine these days? He gave us his answer over the remainder of the trip- about an hour!

Here was his background: he is the son of an army general from Ukraine and had been in the US since 1994.  I would estimate his age to be mid-forties, and he told us he had attended military academies in both Ukraine and in Russia.  He did not mention being married, or any other brothers or sisters.  He started by saying that he had friends on both sides of the conflict and saw himself as able to look at the broad picture.  He sees that Ukraine as a country has three choices: to make a go of it as an independent state, align with the European Union, or align with Russia.

He started with his thoughts of Ukraine being totally independent.  There were many advantages to being totally independent, but he had severe doubts that Ukraine could stand on its own.  We know of the severe economic strains that exist in Ukraine’s economy, but he feels that there is deep corruption in the government.  He did not think that the people could come together enough to be able to make it work at this time.

Next, he turned to an alliance with the European Union.  While there are a number of benefits with this, he did not feel that the people would be able to adapt easily to the different cultural and economic freedoms that are found in European countries.  They had been under the strict rule of government for too long.

He concluded that even though it was not ideal, the people can identify with the harsh treatment that is given to them by the Russians and have responded to it and coped with it in the past.  He did not have confidence that the people of Ukraine would be able to stand up on their own and would most likely be better off settling for the Russian way of life.  He did not agree with that for himself, but was resigned to believing that Ukraine would not be able to rise up out of the shadow of the Russians.

Much has happened in the last couple of weeks in Ukraine.  They have elected a new president that has an impressive background: a self-made businessman and a former member of the Ukraine Parliament.  He has received a positive response from the people and has reached out to numerous Western leaders.  At the end of June, a treaty between Ukraine and the European Union was signed, providing reforms to workers and monetary assistance.  This agreement was largely responsible for Russian military action to occupy Crimea and to encourage rebellion in eastern Ukraine.  Recent actions by the government have reestablished control of much of Eastern Ukraine and has begun to form stability in the region.

How will this affect the markets or the US?  While the situation is largely political, there are some economic pieces to the puzzle.  The Russians have shut off their pipelines of natural gas that go to Ukraine to pressure the Ukraine government into bending to the Russians.  The bigger message is that most of the gas in the pipelines is not used by the people of Ukraine but is passed through to Germany and other parts of Europe. We now have a game of stare down, as Russia relies heavily on the revenue from the natural gas and Europe needs the gas to stay warm in the winter.  Who will blink first?

Actually, I wonder if there is already some agreement behind the scenes to defuse the situation. Russia has removed much of its support for the rebels in Ukraine and is unusually quiet. The US and Europe have backed off of the demand to return Crimea (and the critical Russian naval base) to Ukraine. Perhaps cooler heads are prevailing and we will be able to work out of this spot.

I am not too worried about the markets reacting one way or another on the news from the region.  I think that the pipeline issue will quietly disappear and the focus will move somewhere else- like the Middle East. A prominent bond mutual fund is already buying bonds from Ukraine- buy when the price is low, right?

Finally, we hope that our driver was mistaken- that the people of Ukraine are ready for self-rule and all of the freedoms and responsibilities that go with it. They have taken many key steps, have promising leadership and many challenges ahead, but opportunity awaits.  We wish them well!