Wednesday, February 10, 2016

Meet Sergey Petrovsky, the Russian leader in southeast Ukraine who shot down MH17

If you have read much on the tragedy of Malaysian Airlines flight MH17, you likely have the impression that a consensus has formed among experts investigating the incident: that MH17 was shot down by southeast Ukrainian separatists, using an anti-aircraft missile launcher supplied by Russia. That is how most news media have reported the story.

But actually, active-duty Russian military officers shot down MH17. A colonel from the covert operations arm of Russia’s main military intelligence agency, the GRU, was with the anti-aircraft missile launcher and in charge of it, and a two-man crew of operators from Russia’s Air Defense Forces were with it the entire time it was in Ukraine.

This article lays out the evidence that a Russian GRU officer shot down MH17, most of which has been in the public domain for more than a year. Some of the evidence was included by the Dutch Safety Board in a video published on Youtube during the course of its investigation. That investigation ultimately confirmed that a Russian Buk-M air defense system shot down MH17, but it deferred to a separate criminal investigation by Dutch prosecutors to determine who was responsible.

The Dutch criminal investigation, which is continuing, undoubtedly has all the evidence referred to here. Ultimately, the most important question Dutch prosecutors will need to answer is how strongly they’re willing to lay the blame for the loss of 298 lives on the Russian state.

Understanding the events that led up to the MH17 tragedy will help to understand the nature of the conflict and how it is likely to develop. The personal story of the GRU colonel responsible for shooting down MH17 provides a vivid example of how the Kremlin controls southeast Ukraine, and of what sort of people are on the ground doing the job. 

Although the events are now more than 18 months in the past and much has since changed, the GRU colonel is almost certainly still one of the top Russian commanders on the ground in southeast Ukraine. He appears to also be the steward and custodian of the Ukrainian separatist “prime minister” who nominally controls most of Russian-occupied southeast Ukraine.

That Russia appears to be not even trying to cultivate a genuine pro-Russian local leadership that could potentially retain power without direct Russian military support suggests that Russia has no intention of withdrawing its forces from southeast Ukraine anytime soon. Perhaps the most important lesson of this investigation is that no genuine progress is being made towards a negotiated resolution of the conflict. That reading has recently been confirmed by Russia’s air strikes in northwest Syria, which make clear that the Russian president, Vladimir Putin, puts a low priority on getting western sanctions lifted.

Instead, the problem of the Russian occupation of southeast Ukraine is being left to the next US president, together with the problems of Russian annexation of Crimea and the Russian intervention in Syria. The passive and pacifist outgoing US president, Barak Obama, has taught Putin to expect almost anything he does to be accommodated with minimal confrontation. That’s a recipe for a shrill response from Putin and a deepening of the developing “new Cold War” as soon as he is more than minimally confronted.


The focus of this investigation is a senior GRU covert operations officer who goes by the name of Sergey Petrovsky.

There is more information about Petrovsky in the public domain than for any other Russian officer of his rank in southeast Ukraine, for three reasons. First, he was personally in charge of the air defense system that shot down Malaysian Airlines passenger jet MH17, which was delivered to him at the location from which it fired at MH17 three hours before MH17 was hit.

Second, until then, at least one of Petrovsky’s telephones was being monitored and recorded by Ukraine’s main intelligence agency, the SBU. Third, the next day, the SBU decided to expose its monitoring and publish the intercepted calls, in order to prove to the world Russia’s responsibility for the disaster.

Ironically, however, news media completely ignored the publication of Petrovsky’s intercepted calls. The SBU didn’t provide enough information to allow journalists to quickly grasp their meaning and importance. Instead, news reports from the day focused on less important but more easily understood conversations of other Russian officers in east Ukraine, which the SBU published at the same time. Since then, no news media has revisited the recordings to do a more thorough investigation. To the best of my knowledge, no professional news organization outside Ukraine and Russia has ever so much as mentioned Petrovsky.

Even in Russia and Ukraine very little has been written about Petrovsky, most of it by bloggers. Before an earlier version of this investigation was published in July 2015, the only detailed information written on Petrovsky was in a book on the MH17 tragedy by my old friend and former colleague, Jaroslav Koshiw. Our investigations were completely separate, except that I’m indebted to Koshiw for finding a 2003 interview of Petrovsky about his former job in Chechnya.

My investigation also draws on some of the more than 1,800 messages Petrovsky posted in 2014 and 2015 in a Russian chat room set up to promote Russian military intervention in Ukraine. I also refer to the excellent work of Bellingcat, an independent group of open-source investigators that has collected many photos and videos uploaded to the internet that corroborate and confirm the authenticity of Petrovsky’s intercepted phone calls.

Taken together, the evidence makes clear that Petrovsky is one of the top Russians on the ground in southeast Ukraine. But long before Petrovsky arrived in Ukraine, he was a GRU covert operations officer in Chechnya. His job there, of course, was not to instigate or support separatists. His job was to hunt down and kill them.


Petrovsky was interviewed in 2003 by Izvestiya, then an oligarch’s newspaper that often questioned the relatively new Putin administration. Putin had recently declared victory over Chechen separatists and was working on creating a loyalist Chechen administration. The Izvestiya journalist was there to expose that the fighting wasn’t really finished.

Somehow the journalist connected with Petrovsky while he was leading a military intelligence unit hunting down rebels in the Chechen highlands. Petrovsky then commanded a crew of six who drove around in an armored reconnaissance vehicle, a wheeled armored vehicle with artillery and sophisticated radio gear. Petrovsky identified himself to the journalist only as “Khmury,” a nickname he also used in his recent chat room posts. The 2003 interviewee and the writer of the 2014 and 2015 chat posts are unmistakably the same person.

Petrovsky said he got the nickname, which means “gloomy,” “because I don’t like to smile.” And he seethed with hatred for Chechens. When the journalist asked who he was fighting, Petrovsky let it rip. “With those who don’t want to live in Russia by our Russian laws, who don’t want to pray to our faith. The Chechens are an asinine nation. There are, of course, among them good people, but the majority are monsters. From time immemorial they lived by looting and killing. It’s in their blood. Even their own peasants they take for suckers. Who in Chechnya is a respected man? Those who get rich in Moscow, or who have hundreds of slaves, or to the bitter end run among the mountains with machine guns. Normal Chechens, the Russified ones, already fled from here.

Petrovsky said there were about 300 fighters in the valley he covered, which by then had too large a Russian presence for the rebels to risk any large-scale attacks. Asked how he would handle the situation if it were up to him, he said: “To begin with I’d destroy the entire local leadership. By any means. Shoot them or blow them up. I’d blame it on the Wahabbists, and then give Chechnya’s territory in parts to Ingushetia, Dagestan and Stavropol. There shouldn’t be any such place as Chechnya. It should be dissolved in Russia, and Chechens assimilated.”

Inside his armored vehicle Petrovsky had hung pictures of Vasily Margelov, a Soviet paratrooper commander in World War II and the invasion of Czechoslovakia, and Kurt Student, Hitler’s top paratrooper commander. “All paratroopers are brothers,” he said.

Petrovsky portrayed himself as a man driven by zealous nationalism and patriotism for the Soviet Union. Asked under what circumstances he could fight for another (not Russian) side, he answered: “Only for more money, and only these days. In Soviet times I wouldn’t have for anything. That was a society of social fairness. These days I don’t feel myself a citizen of my country. Rabble!”

“Khmury” said he attended a special forces military school in Kamenets-Podolsk, in western Ukraine. That suggests he might have been born and raised in Ukraine, though he obviously considers himself an ethnic Russian. In the published phone calls Petrovsky has a neutral accent, with no obvious Russian or Ukrainian markers.

Petrovsky went on to Moscow’s Frunze Military Academy, one of the Soviet Union’s top military schools. Probably around the same time he graduated, in his late 20s, the USSR split. Petrovsky evidently took Russian citizenship, as he became a career Russian military officer. According to his account to Izvestiya, he had been fighting there since 1995, with occasional vacations and breaks for further training. Petrovsky described himself as a “specialist in diversions.”

The journalist asked: if there’s no Russia, what was he fighting for? “Khmury” answered: “For the Russian people. For that little part that’s still preserved. For me, my soldiers are the Russian people.”

When the  journalist reminded “Khmury” that he thought most Russians are “rabble,” Khmury answered: “Give us hope in the future and we’ll crush them all.” The journalist suggested his own life was being threatened. And Petrovsky went back to ranting about Chechens. “They complain that their relatives are disappearing. But it’s not that simple. Normal people in Chechnya don’t disappear. Monsters are disappearing, who need to be destroyed and cleansed out.”

Asked if it was his team that was disappearing Chechens, Petrovsky claimed responsibility for half. Another 20%, he said, were killed by locals for cooperating, and 30% were killed in local squabbles.

Asked how he got over the difficulty of killing, Petrovsky said: “Hate helped.”

Petrovsky ended the interview with: “Okay, enough, I already told you enough for two Hague tribunals.” The journalist asked why he told it. Petrovsky answered: “I’m tired of the lawlessness. Maybe people will read the article and something will turn in their ugly brains. It can’t be this way. I haven’t gone completely crazy, but something important in me has been destroyed. I can kill a man like sticking two fingers. I don’t feel a thing.”


The next appearance of Petrovsky in the public record that I’m aware of was in April 2014, when the Russian military’s attention had shifted to Ukraine. That January, a pro-Russian Ukrainian president, Viktor Yanukovich, had fled to Russia to escape huge street protests that sacked his party headquarters in Kiev and were threatening to invade his presidential offices. That February, Russia began a covert intervention in Crimea, which quickly transformed into an overt annexation. Then in early April, groups of Russian paramilitaries and covert operations officers, supported by local separatists, began seizing central public buildings in a string of towns and cities in Ukraine’s southeastern Donbass region.

Igor Strelkov, a Russian who identified himself vaguely as a colonel in reserve, was taking responsibility for leading the operation. He had been promoting separatism and Russian intervention in Ukraine on the internet since early February, a couple weeks before the Crimea operation. He began by creating a chat room on the forums of, a web site designed for enthusiasts, collectors and re-enactors of Russian history that attracts many hard-line nationalists. By mid-April Strelkov was head of a brigade occupying the Donbass city of Slovyansk, and he was calling himself Defense Minister of the Donetsk People’s Republic.

On April 29, Petrovsky began writing comments in Strelkov’s chat room, using the handle “Plokhoy Soldat” (Bad Soldier) and an avatar that said “Khmury.” His first comment was a response to a post by Strelkov complaining that media commentators doubted he was capable of leading “reconstruction.” Petrovsky wrote: “Everyone should take care of their own business, a reconstructor: recon, a lieutenant: capturing Crimea, Slovyansk.”

Petrovsky posted frequently from then, establishing himself as a friend of Strelkov’s, a hater of the new Ukrainian government and a not always fully understanding admirer of Putin. During this period Petrovsky didn’t discuss any involvement in the Ukraine intervention. His chat profile identified his location as Rostov-on-Don, the nearest major Russian city to the Donbass. But Petrovsky had probably been deeply involved as one of the top leaders of the Russian operation in southeast Ukraine since it began in early April. It’s likely that Petrovsky was in Ukraine even before April, recruiting local separatists and preparing.

Petrovsky’s chat room posts were nothing like those of the thousands of enthusiastically pro-Putin commenters on mainstream internet sites that have come to be known as Putin’s “troll army.” Petrovsky wrote relatively honestly and realistically about Putin’s project in east Ukraine and the weak support it found among the local population. By late April the Ukrainian army was responding forcefully and the small numbers of Russian fighters and local supporters were pinned down and looking vulnerable.

In a May 2 post, Petrovsky wrote: “The question is, what next, if Russia doesn’t send in the army? And after all it won’t, we already understand that. The question is, why rouse the Donbass, give it hope. After all it’s not Crimea, here and now no more than 30 percent are for federalization or for joining Russia, let’s be realists. So a legitimate question arises: WHY rouse the people, give hope, send Strelkov (and after all we all perfectly understand that without support from the top his initiative would have gone to zilch), and then simply throw these people at the mercy?”

By “the people,” Petrovsky seems to have in mind the same concept of the Russian people he explained in the interview in Chechnya. He seems to mean the good (in his eyes) minority in the Donbass of Russians and Russified other nationalities who are loyal to Russia. It clearly doesn’t bother him that, by his own estimate, at least 70% of the residents of the Donbass oppose him.

In a follow-up post, Petrovsky explained why it made no sense for Putin to seize the Donbass and not take more of Ukraine: “Fine, let’s model the situation, purely abstractly. They sent in the [army], a month passes, and WHO will pay the salaries of budget workers? And what exactly comes next? In reality, Russia doesn’t need the Donbass without Ukraine.”

“The Donbass, if you remember your geography, was the largest region by territory in the USSR, bigger even than the Moscow region. There are 4.5 million people here, mainly mines and metallurgy. Any person even a tiny bit acquainted with economics understands that for metallurgy there have to be two ingredients nearby: coal and iron ore. If the Kryvbass [Ukraine’s central ore region] stays in Ukraine, no one’s going to bring ore from the Urals or coal to the Urals [where Russia’s steel industry is concentrated]. So what to do with 4.5 million people? It’s not Crimea, where there’s sea and they’re opening gaming zones and so on. The people need to either not be given hope, or follow through to the end. I’m talking about Putin.”

One of Petrovsky’s most interesting early posts was a half-hearted defense of Strelkov, whose military leadership abilities were being questioned by others on the forum after the Ukrainian army captured most of Slovyansk on May 2. Days earlier, on April 28, the EU had added Strelkov to a list of Russians under mild sanctions and identified him as a Russian GRU officer. Strelkov reacted by denying ties to the GRU. He has never specified in which armed force he is a reserve colonel.

Petrovsky in his post suggested that Strelkov was from a different special forces unit: the Alfa division of the FSB, the successor to the Soviet KGB and Russia’s main intelligence agency. Referring to Strelkov by his forum handle, Kotych, Petrovsky wrote: “Not to insult Kotych – he has always been an excellent ops man – but what was needed here was particularly a SPECIALIST and preferably of the corresponding profile, not from Alfa but from GRU special forces.” Petrovsky hadn’t yet been publicly identified as a GRU officer himself.

Over the next two months, the Ukrainian army kept Strelkov pinned down in Slovyansk while trying to encircle all the Russian and Russian-led forces in east Ukraine. This strategy created pockets of Ukrainian-held territory wedged between the Russian border and the Russian-held cities of Donetsk and Luhansk. Ukraine used cargo planes to ferry in fresh troops and evacuate the wounded from these isolated pockets, and fighter planes flew high-risk missions into the isolated Ukrainian-held zones to attack the Russian forces from behind.

It was for this battle, to prevent the encirclement of his forces in Donetsk and Luhansk, that Putin began sending in heavy armor and air-defense systems. Starting in June 2014, Ukrainian fighter jets and cargo planes found themselves seriously threatened. On June 14, a Ukrainian cargo plane was shot down while trying to reach the very southeast corner of Ukraine, known as Zelenopillya or Zelenopolye. Fourty soldiers and nine crew were killed. After that, Ukrainian planes flew higher whenever possible.

In July, Ukraine stepped up its offensive. Strelkov’s and some other Russian-led groups were chased out of Slovyansk and some other front-line towns, and the Ukrainian effort to complete the encirclement intensified. Putin fought back by moving increasing quantities of armor over the border and supplying more and better air defense systems.

Russia launched a major counter-attack on July 11, using a combination of more troops and equipment within Ukraine and heavy artillery guns positioned just inside Russia, which targeted Ukrainian army positions near the border. The counter-attack aimed to cut off and surround a group of Ukrainian forces that were holding Zelenopillya.

Ukraine employed fighter jets to help clear an escape path, but Russia had prepared for that by sending in a Buk-M. That was the context in which MH17 was shot down.


In the Russian operation to trap and destroy the Ukrainian troops in Zelenopillya, Petrovsky was field commander of the Russian and Russian-led forces making the pincer movement from the north. His battalion was positioned near Marynivka, or Marinovka in Russian, a Ukrainian village near the Russian-Ukrainian border and about 80 kilometers southeast of Donetsk (not to be confused with another Marynivka northwest of Donetsk).

Petrovsky’s group took a position from which Ukrainian forces couldn’t escape westward out of Zelenopillya without being exposed to attack from two sides: Petrovsky’s group from the north, and the artillery inside Russia from the south. The fighting was particularly brutal on July 16.

In an intercepted phone call (jump to 4:16) the next day, July 17, Petrovsky described the battle to another Russian GRU officer operating elsewhere in east Ukraine. Petrovsky also expressed relief that he had received a Buk-M, an advanced anti-aircraft system capable of shooting planes at higher altitudes and speeds than any system Russia had yet delivered into southeast Ukraine.

Note that my translations ignore gratuitous use of the Russian curse “blyad” (“whore”).

Petrovsky: Yes, Botsman, I’m listening.

Botsman (a nickname): Greetings, older brother, how are things?

Petrovsky: Greetings, well, not so good. We’re in Marinovka, so that’s why not so good, how to tell you. We’ll hold out.

Botsman: What’s the deal?

Petrovsky: Well, what do you think? They’re pounding with artillery constantly, only just now there’s a break.

Botsman: Yeah I understood …

Petrovsky: We knocked out an airplane just now, a Sushka [a Sukhoy fighter jet]. And we already have a Buk-M, we received it. They’re trying to break out of Zelenopolye, but their only way out is past me. Yesterday we shot down two Sushki, today a second [sic]. Thank God, this morning the Buk-M arrived. So it got a bit lighter. But, of course, it’s pretty heavy.

Botsman: What can I say? If you need something, you call me, I’ll come right to you.

Petrovsky: Thanks, brother. But I’m planning to get out of here in a couple hours, it has kind of calmed down. In a couple hours I’m going to Donetsk. Because they sent to me there three more Gvozdiki [tanks with 120mm artillery guns]. I’m going to bring the Gvozdiki here, because it’s very heavy for us here now.

The Buk didn’t actually arrive to the area until around 1 pm on July 17. It was photographed and video recorded driving south from the town of Snizhne in the direction of Marynivka a little after then. A reporter from the Associated Press who just happened to be in Snizhne reported that he had seen the Buk in a brief dispatch that day. According to the reporter, the Buk moved through Snizhne at 1:05 p.m. The vehicle, which carried four 18-foot missiles, was in a convoy with two civilian cars.

At 4:20 pm on July 17, MH17 was shot down by the Buk from a position between Snizhne and Marynivka.

The tragedy occurred partly because few people knew that such sophisticated equipment was in southeast Ukraine. There have been many separatist movements covertly instigated by foreign powers, but the Russian-organized separatism in southeast Ukraine was the first such insurgency to feature anti-aircraft rockets capable of hitting passenger aircraft at cruising altitudes. The closest parallel to the Ukraine situation was in 2013, when Russia delivered several of the same model of air-defense systems to the Syrian government, which attempted to transfer them on to Hezbollah in Lebanon. Israel responded with an air raid into Syria and destroyed them.

When publishing the above conversation, the SBU didn’t specify one crucial detail: the time it was recorded. I believe it must have been recorded very soon after 4:20pm, and that it shows Petrovsky discussing how he and his unit used the Buk to shoot down what he thought was a Ukrainian Sukhoy fighter, but was actually MH17. There was no Sukhoy fighter, or any other plane besides MH17, shot down in east Ukraine that day.

In other words, the decision to fire at MH17 was almost certainly a mistake made in the fog of war. But it was a mistake made by professional Russian soldiers, not by the amateur Ukrainian separatist fighters who support them. Petrovsky almost certainly was the person who gave the order to fire at MH17, and the person who operated the controls and fired the missile at MH17 was also an active duty Russian military officer. Both of them were performing their assigned duties under a carefully established chain of command that led directly from the Russian president.


When the SBU published Petrovksy’s phone calls, the video identified him as Sergey Nikolayevich Petrovsky, born 1964, a GRU officer, with the nickname “Khmury.” Oddly enough, Petrovsky confirmed the identification.

His chat room post of July 18 said: “Well what, decadents, now thanks to the betrayal of certain representatives of Moscow who gave up my personal information, allow me to officially introduce myself: deputy minister of defense of the Donetsk People’s Republic for intelligence, colonel Petrovsky Sergey Nikolayevich, also known as Khmury, also known as truly yours Plokhoy Soldat.”

The Donetsk People’s Republic, known by its Russian acronym DNR, is one of two quasi-states that have been declared in southeast Ukraine.

It’s possible of course that Petrovsky’s chat room outburst was a ruse. Sergey Nikolayevich Petrovsky might be just another pseudonym. For what it’s worth (not much), the year of birth published by the SBU, 1964, doesn’t match the age of 36 that “Khmury” gave in the 2003 interview. But at least we have some name to personally identify Petrovsky, which is more than one usually has for a man of his profession. 

Petrovsky continued to post regularly on But he never discussed the Buk or MH17 in the chat room, and none of the other participants ever asked him about it. Apparently it’s the kind of forum where, when a member is accused in public of responsibility for the deaths of almost 300 people, his fellow forum participants know not to ask any questions.

Other intercepted phone calls published by the SBU show Petrovsky organizing the delivery of the Buk to Snizhne. They show that a two-man crew of Russian soldier operators arrived with the Buk from Russia, and pile on evidence that Petrovsky was in charge of the Buk while it was in Ukraine.

In this conversation (here at 1:35) Petrovsky speaks with an apparently local, Ukrainian-accented assistant nicknamed “Buryat” (the beet), who picked up the Buk-M from a Russian army group at the Russian border and delivered it to Donetsk.

Petrovsky: I’m listening, Buryatik.

Buryat: And where should I haul this beauty, Nikolayevich?

Petrovsky: Which? That one?

Buryat: Yeah, yeah. I brought it. I’m already in Donetsk.

Petrovsky: Is it the one I’m thinking of? The M, oy, BM, that one?

Buryat: Yeah, yeah, the Buk, the Buk.

Petrovsky: And it’s on the trailer?

Buryat: Yeah, it’s on it. It ought to be unloaded somewhere, to hide it.

Petrovsky: It’s with the crew?

Buryat: Yes, with the crew.

Petrovsky: Don’t hide it. It’s going there now. You understood where?

Buryat: I understood. Well, it ought to be unloaded just temporarily, so no one sees it.

The Dutch Safety Board included this conversation (here at 2:30) in a video it published in May 2015, which laid out much of what is known about the Buk’s route into and out of Ukraine and appealed to anyone with more information to get in contact. The Dutch Safety Board video didn’t identify Petrovsky, instead referring to him vaguely as “a separatist,” but did add the important detail of the exact time of the conversation, which was 9:08 am, July 17, 2014.

Corroborating the reference to a crew traveling with the Buk, local witnesses told journalists from BBC Panorama they had seen and heard the Buk crew, who had Russian accents and appeared to be soldiers. One eyewitness told the BBC the two-man crew who accompanied the Buk were “Well-disciplined, unlike the rebels, and not wearing the standard Ukrainian camouflage uniform sported by government and rebel troops alike. They had pure Russian accents. They say the letter ‘g’ differently to us.”

Bellingcat’s investigation showed that the particular Buk that was delivered to Snizhne came from a Russian military base in Kursk, north of Ukraine. It was recorded departing from there on June 23 together with a large convoy of military gear that was ostensibly heading to an exercise. Numerous photographs and videos posted to the internet show the convoy and several Buk units traveling between Kursk on June 23 and Millerovo, just east of Ukraine’s eastern border, on June 25.

Slightly after the conversation above, Petrovsky spoke again with “Buryat,” telling him where to take the Buk. This call reveals that Petrovsky initially expected to receive a set of two Buks, but there was a mix-up between the Russian army group that brought them to the border and Buryat. The Russians didn’t bring any trucks they were willing to lend, and Buryat brought only one truck. This conversation has been published only by the SBU (here at 2:11).

Petrovsky: Did you bring me one or two?

Buryat: One, one. Because there was a misunderstanding on their side. They didn’t send the truck over. They unloaded it and sent it over on its own power.

Petrovsky: It came on its own power, or on a truck?

Buryat: It crossed the border.

Petrovsky: And now you’re bringing it on the truck? Don’t go anywhere with it. I’ll tell you now where to take it. It’s going together with Vostok’s tanks.

Vostok was the name of a Donetsk-based group of fighters made up initially mainly of Ossetians and Chechens loyal to Chechen president Ramzan Kadyrov. Given his responsibility for keeping down Chechen rebels against Russia, it’s understandable why Kadyrov would feel obliged to lend troops to Putin’s operation. From his perspective, the Russian operation in Ukraine is quashing a Ukrainian rebellion against Russian, which if successful could theoretically encourage Chechens to rebel.

In the next pair of conversations, Petrovsky speaks to two more Ukrainian-accented drivers in Donetsk. He tells one called Sanych that the Buk will be joining a military column that Sanych’s group was planning to relocate. Petrovsky then calls another man and directs him to split off from the column and head to a place called Pervomaisk, and wait there. These conversations have also been published only by the SBU (here at 2:41 and 3:10).

Petrovsky: Sanych, and where … the deal is that your guys are driving also my Buk-M, it’s on a truck. Where to send it to join with the column?

Sanych: Just past the motel, don’t pass Gornostayevska.

Petrovsky: Right after the hotel, yeah?

Petrovsky: Listen to me carefully. Just after you pass the motel circle, call Bibliotekar, there will be waiting, you understood what, right?

(unknown): Yeah, yeah, yeah.

Petrovsky: Take along only those that returned, as many as you need as accompaniment. Understood?

(unknown): Yeah.

Petrovsky: The others leave behind here. Coming this way, there will be Pervomaisk nearby, look at a map.

(unknown): I got it.

Petrovsky: Locate yourself somewhere there in that area, bringing yours along, and those who stayed with you. Your task is to be reserve plus to defend that piece that you’re bringing, got it?

(unknown): Got it.

Petrovsky: The Gyurza (machine guns) bring along too. If there’s anything, I’m reachable. Okay?

(unknown): Okay.

As the Ukrainian blog Ukraine@war mapped out, Gornostayevska or Hornostayivska is the road in Donetsk where Vostok’s headquarters were located. The Buk was photographed for Paris Match that morning being driven on exactly that route towards Hornostayivska from the yard where the truck it was driven on is usually kept overnight.

There are many towns and villages in east Ukraine with names like “Pervomaisk” (it means First of May). Petrovsky is obviously referring to the village called Pervomaiske or Pervomaiskoye located just south of Snizhne. As Ukraine@war, Bellingcat and the Dutch Safety Board mapped out, the Buk and the truck carrying it were photographed and video-recorded several times along exactly that route.


The Dutch Safety Board’s video was most impressive for focusing on a Petrovsky conversation and some other of the most important evidence previously compiled by independent investigators. But it also introduced some new evidence: a few more conversations about the Buk that weren’t published by the SBU, but obviously were intercepted by the SBU and provided by it to the Dutch investigation.

These mainly provide further evidence, on top of Bellingcat’s research, that after the MH17 tragedy the Buk-M was hastily sent back across the Russian border. The hasty removal of the Buk from Ukraine shows an effort to conceal that it had been in Ukraine and implies an involvement by Russian officials senior to Petrovsky in the cover-up.

In one of these new conversations, recorded at 9:32 pm on the evening of July 17, an unidentified man who sounds like “Buryat” says he is still in Snizhne and discusses with another man the delivery of the Buk to the Russian border (here at 5:43).

The Dutch Safety Board also made a mistake of minor importance by understanding that a “fighter” who was to be driven back from the Buk’s drop-off point at the Russian border to Snizhne was one of the Buk’s crew. It would have been a very strange decision to send a Buk crew members back to Snizhne without the Buk, and I don’t hear anything in the recorded conversation that suggests it.

The Dutch Safety Board’s final report, published in October 2015, completely backed away from pursuing the people responsible for the tragedy. The report concluded that a Buk-M located in eastern Ukraine shot down MH17, but made no attempt at all to trace how the Buk got there, who was in charge of it, or how it was evacuated back to Russia. The report said it would be up to a separate criminal investigation by Dutch prosecutors to identify who was responsible for shooting down MH17. Those prosecutors have surely studied Petrovsky’s intercepted calls.

The crew of two air defense soldiers who accompanied the Buk into Ukraine have not been publicly identified. A Ukrainian independent investigator publicly identified one of the many Buk operators stationed at the Russian base in Kursk where the Buk used to shoot down MH17 is usually located (forward the video to 37:45). Bellingcat announced it had identified many of the Buk operators based at Kursk in a confidential report for the Dutch criminal investigation, but it hasn’t made the information public.

There is no direct evidence that Petrovsky gave the order to fire at MH17. We know only that he was in charge of the Buk at the time, as he had it delivered to his own location just three hours earlier. And we can hear him telling by phone how “we” used the Buk to shoot down a “Sushka.” There’s some small possibility that Petrovsky delegated responsibility for the Buk to one of the local rebels under his command, and told the Buk’s Russian crew to obey the Ukrainian’s orders. But that seems very unlikely. In any case, Petrovsky obviously bears responsibility for shooting down MH17 as the person who was in charge of the Buk while it was in Ukraine and who arranged its delivery to the location from which it was fired.

There is no satisfying explanation of how a passenger aircraft could have been mistaken for a Ukrainian military plane. Even with nothing more than a decent pair of eyeballs, it’s not hard to spot the difference between a Sukhoy fighter jet or the Antonov military cargo planes used by Ukraine and a Boeing 777 passenger plane. Boeing 777s are much bigger and fly much higher. The Buk-M missile launcher has a built-in radar that should have made identification easier. There were other passenger planes flying through the same area at about the same altitude on that same afternoon that weren’t fired on.

We have only a partial explanation of how the mistake might have happened. In another phone call intercepted by the SBU on the day of the tragedy and published on Youtube, another man identified by the SBU as a GRU officer, Igor Bezler, receives word from a man nicknamed Naimanets (“mercenary”) that a “bird” was flying his way. Bezler, who was located in Horlivka, 40 kilometers northeast of Donetsk, tells Naimanets to pass on the word. The SBU identified the call as having been made at 4:18 pm, making it clear that the “bird” was MH17.

Probably the information was then quickly relayed to Petrovsky or one of his men, on some phone or system the SBU wasn’t recording. Perhaps Petrovsky simply impulsively ordered the Buk crew to fire. Perhaps nobody thought to pay attention to the size or height in the sky of the plane.


After MH17, the Russian operation in and around Zelenopillya continued with a battle for control of Kozhevnya, a village near the Russian border about six kilometers southeast of the Marynivka where Petrovsky’s unit had been located the previous week. The battle figures in the standard Russian media biography of Alexander Zakharchenko, a Ukrainian separatist, who was reportedly promoted to the rank of major after being wounded in the hand on July 23 in fighting near Kozhevnya. Zakharchenko has admitted Kozhevnya was razed to the ground.

According to his public biography, Zakharchenko was at the time leader of the “Oplot” (“bulwark”) brigade. The close correspondence of times and locations makes it appear that the Oplot brigade nominally led by Zakharchenko and the brigade Petrovsky was leading in Marynivka the previous week are one and the same brigade.

According to Vladimir Socor of the Jamestown Foundation, Oplot originated in a pro-Yanukovich group of  “street fighters.” There are many similar groups in Ukraine, and during Yanukovich’s rule some were employed to attack anti-government protesters. The ranks of such groups are filled with low-status, uneducated young men, but it’s possible Zakharchenko was a leader.

Usually such groups are linked to a particular big business group, but it’s possible Oplot established Russian connections before Yanukovich was ousted, or even that Oplot was from its founding a covertly Russian-backed organization. According to Zakharchenko’s biography, he and Oplot were involved in the occupation of Donetsk city hall in early April, one of the first events of the Russian operation in southeast Ukraine.

In August 2014, Zakharchenko was promoted to the position of “prime minister” of the Donetsk People’s Republic, a position that until then was occupied by a Russian. Since the area of the DNR is bigger and more populous than that of its sister quasi-state around Luhansk, that makes Zakharchenko, who still holds the title, nominally the highest-ranking Ukrainian separatist official. It also makes him nominally senior to Petrovsky, who identifies himself as a mere deputy defense minister.

But Zakharchenko is a 39-year-old former mining electrician with no known military or political experience before 2014, other than his reported involvement in Oplot. Petrovsky is a seasoned GRU colonel and about 50 years old. So far, no journalist has gained enough access to the inner sanctums of the forces in control of southeast Ukraine to actually witness first-hand who tells whom what to do. But it’s obviously hard to swallow the official story that Zakharchenko is Petrovsky’s boss. Socor judged Zakharchenko to be “the most junior, least educated and least experienced” member of the DNR’s nominal leadership.

In an October 2014 chat room post, Petrovsky drew a distinction between the Oplot brigade, which he said was led exclusively by Zakharchenko, and another, unnamed and undescribed group that Petrovsky referred to as “mine.” In February 2015, Petrovsky was asked by a chat room admirer about the men providing security to Zakharchenko in this video, shot on location after a victory by Russian forces in January. Petrovsky confirmed: “That’s Zakharchenko’s guard, mine.”

In that post Petrovsky was clearly referring only to the guards around Zakharchenko, not the whole unit. The post suggests Petrovsky’s men accompany Zakharchenko everywhere he goes, which on one hand might be in keeping with Petrovsky’s role as deputy defense minister of intelligence, but on the other hand suggest that Petrovsky is a kind of steward and custodian, managing and keeping a close eye on Zakharchenko. The guards that Petrovsky calls “mine” are likely a group of Russian GRU special forces attached to Petrovsky.

Petrovsky’s recorded calls make clear that he was in command of the brigade that was operating near Marinyvka in July 2014, and not just of some other commander’s retinue of guards. I suspect Petrovsky is actually in charge of the Oplot military brigade, and Zakharchenko is merely one of Petrovsky’s earliest and most trusted local recruits. Zakharchenko appears to be in reality little more than a spokesman, who was given the “prime minister” position precisely because he has no real authority.


While Zakharchenko was moving into the “prime minister” position in August 2014, the Kremlin was further ramping up its intervention. After the losses in Zelenopillya, the Ukrainian army abandoned the effort to surround both Donetsk and Luhansk and attempted instead to surround just Donetsk. The Ukrainian army began taking town on a north-south line between the two Russian-held cities, threatening to cut supply lines from Russia to Donetsk.

Putin reacted by for the first time sending in regular Russian army troops, with lots of heavy armor, thinly disguised as “volunteers.” The Ukrainian army suffered heavy losses, and in September the Ukrainian president, Petro Poroshenko, was convinced to submit to the first of two Minsk ceasefire agreements, which essentially permitted indefinite Russian control over much of southeast Ukraine.

The introduction of regular Russian army units changed the structure of Russian chains of command in southeast Ukraine. Russian paramilitary units, who were the leading fighting groups of the operation before August 2014, have since been little seen, and some have departed. Most of the Chechens and Ossetians of the former Vostok brigade have left. Although the Russian government still denies it has troops and armor in Ukraine, their presence has been extensively documented by Bellingcat and others.

The SBU in July 2015 named five generals and one colonel from the regular Russian armed forces that it said were operating as commanders of mixed Russian and separatist forces in Ukraine. While the arrival of Russian regular armed forces groups must to some extent have reduced Petrovsky’s importance, he clearly hasn’t been shunted aside, judging from his role as Zakharchenko’s custodian.

Petrovsky has hinted, very obliquely, that another of his roles is to remove Ukrainian leaders who step out of line.

The one time he discussed this in the chat room was in reference not to himself, but to another DNR official, Igor Bezler, and “defense intelligence staff.” Bezler has also been identified by the SBU as a GRU officer, though in his case there is no supporting evidence in the public domain.

In September 2014, a story spread on the internet that several leaders of the DNR and its sister quasi-state, the Luhansk People’s Republic, had decided to unite into a new state called “Novorossiya” (New Russia). Photos of documents circulated showing the appointment of a new military leader, “General Ivan Anatolievich Korsun,” who had never been heard of before.

Petrovsky then wrote in a chat room post that Bezler and “some defense intelligence staff” had detained Korsun in a “successful and carefully planned-ahead special operation.” Petrovsky was probably joking about Korsun. Most Ukrainian journalists and bloggers who followed the story came to the conclusion it was all a ruse and Korsun was a fictional character.

But Petrovsky was probably being honest about the job of a Russian military intelligence operative in occupied east Ukraine. If the “prime minister” were ever to fell too far out of line, the job of removing him would presumably fall to Petrovsky.


The fact that nominal authority in southeast Ukraine has been given to someone of such low status as Zakharchenko makes clear that Russia has no intention of genuinely implementing the Minsk agreement. Genuine implementation would include a full withdrawal of Russian armed forces. Without Russian military support, Zakharchenko would lose power almost immediately to the former Donbass elite, who fled the region in the wake of the Russian invasion.

Some of those exiled Donbass elites retain some of their traditional loyalty to Russia, but since the occupation most have nothing but fear and hatred for Vladimir Putin and his regime. Their desire for autonomy from Kiev would be chastened by worry that Putin could exploit any conflict they might have with Kiev to re-invade.

The same former elite could also return to power, through elections, if Ukraine were to retake control of southeast Ukraine by force. In other words, unless Russia cultivates a powerful local leadership able to command respect without direct Russian military backing, implementing the Minsk agreements would have practically the same long-term result for Putin as a surrender to the Ukrainian army. The Minsk process has stabilized the conflict, but it has not achieved any progress towards demilitarization or resolution.

If the next US president is as passive towards Russia as Barak Obama, which is unlikely, Putin could perhaps push for western support for a disingenuous implementation of Minsk. An ideal scenario for Putin would be western governments pressuring Kiev to grant constitutional autonomy to southeast Ukraine without any withdrawal of the Russian military. France and Italy and some other European governments would probably support it.

But if Putin were seriously pursuing that kind of scenario, it wouldn’t make much sense for him to be bombing Aleppo, which deprives his strongest supporters in Europe of any argument in his favor. It seems clear that Putin doesn’t really care much about getting sanctions lifted. Bear in mind that the only sanctions he could plausibly get lifted without any real military withdrawal from Ukraine are those of the EU, and current EU sanctions on Russia have little economic power. US sanctions are more powerful but would be much harder to get lifted.

Instead Russia seems to be satisfied with an indefinite military occupation of southeast Ukraine and an indefinite continuation of small-scale fighting along the long de facto border between Russian- and Ukrainian-controlled territories. Russia’s strategy appears to be one of attrition, in which the purpose of the fighting is not to gain territory but to cause various kinds of damage to Ukraine and wear down support for pro-Western politicians. Russia used a similar strategy with great success against the government of Mikheil Saakashvili in Georgia. One of the most important elements of the strategy is to ensure that the security in Ukraine is considered too risky for large-scale western private investment.

The next big event on the horizon in the southeast Ukraine story is the election of the next US president. Hillary Clinton, by far the most likely winner, is promising to take a significantly harder line with Putin. The Republican challengers, all long-shots, range from taking a very hard line with Putin (Marco Rubio) to about the same stance as Clinton (Jeb Bush, Ted Cruz), while the unpredictable and hot-headed Donald Trump professes to admire Putin, but it seems unlikely he would keep that opinion.

Obama has been exceptionally accommodating of Putin, and Putin has become accustomed to that. Whoever the next US president is, much more direct confrontation with Putin is practically inevitable. Putin is likely to become shrill and overtly threatening as soon as he is confronted, or even just not accommodated.

My prediction is that the relationship between the US and Russia from 2017 till the end of Putin’s rule will be as bad as or worse than it was for most of the Cold War. The official investigation of the MH17 tragedy will play some role. Keep an eye on it.

Monday, September 21, 2015

The great Syrian trek across a disintegrating union

I don’t much like writing about  the economics of human tragedy, but the great import of events in Europe compels me. The European Union has never looked so fragile.

The news is mainly about the conflicts between Germany and its eastern neighbors: Hungary, the Czech and Slovak republics, Poland and the Baltic states. Most of the latter are making themselves look very mean and petty, refusing to offer sanctuary to more than token numbers of Syrian refugees, even though most would probably soon leave for Germany or Sweden anyway.

Germany is threatening to cut off EU funding to any states that don’t carry their share of the refugee burden. The eastern states are questioning whether Germany has any legal standing to make such a threat. If no one backs down, the very heart of the EU, its budget, could fail. The EU is after all an association of independent states, with no real powers of compulsion.

Another key component of the European project, the right to travel freely across Europe, is being rolled back. A number of states, including Germany, have reinstated checks at their borders with other members of the Schengen Zone. Another European treaty called the Dublin agreement, which governs the handling of refugees and asylum-seekers, has all but died.

Meanwhile, a lot of people are acting unbothered. The Greeks have re-elected Alexis Tsipras, making clear they want a government that will do the absolute minimum required of it to stay in the Euro Area after the maximum protest and resistance. The €13b of bailout funds Greece has received so far was only enough to roll over Greece’s debts through the end of this year, not even including the arrears Tsipras ran up during the crisis he manufactured in June and July. He is still being kept on a very short string. A fresh crisis could erupt any time from early next year.

Then there are the Catalans, who are seriously considering leaving Spain, even though that would automatically remove them from the EU. And the UK, where an “out” vote in the promised referendum on EU membership, probably in 2017, is looking ever more likely.

Is the EU about to fall apart? It’s time to step back and take stock.

Some background on the Schengen and Dublin agreements

There hasn’t yet been any real collapse of the Schengen Zone. The right of Schengen Zone residents and legal visitors to freely cross national borders within the zone is not being challenged.

Explicit national border checks within the zone are a new and alarming trend. But there has always been some amount of de facto national border checks within the Schengen Zone. If you’ve traveled much by train in Europe, you’ve probably seen police walking through just after a border crossing checking the documents of passengers who look neither well-off nor European.

The Dublin agreement does appear to be dying, but it has been falling slowly apart for a long time. This is the treaty that requires applicants for asylum to apply in the first EU country they enter, and allows EU countries to deport asylum seekers who entered the EU through another country to that first country of EU entry.

The point of the agreement was to force each EU country to take responsibility for securing its own borders (if any) with non-EU members, and to prevent ineligible people from abusing the benefits given to asylum applicants by applying in one EU country after another.

The agreement failed because it assumed all EU countries would treat asylum applicants with the same humane standards, but did nothing to ensure they all would. And because it offered no guarantees to countries on the front line of a refugee crisis that other EU states would share the burden.

The worst problem was Greece. To be fair, even before the Syrian crisis, Greece would have needed help from the rest of the EU to handle all the refugees and asylum seekers who enter the EU via its territory. People fleeing Iraq, Afghanistan, Libya and East Africa also tend to come that way.

But rather than press that case, Greece simply refused to invest in its capacity to offer asylum. In effect it discouraged asylum-seekers by treating them horribly. For migrants to Europe, Greece became a particularly perilous transit country, where they had to avoid leaving evidence they had been there. If they applied for asylum in another EU country and were found to have transited Greece, they would be deported back to Greece and usually on to Turkey.

Then in 2011, a landmark case was won in the European Court of Human Rights on behalf of one of the unlucky asylum applicants who was found to have crossed Greece and deported back there. The court ruled that it would be abusive to continue deporting asylum-seekers to Greece.

By then Greece was in crisis, so no serious pressure was put on it to improve its asylum capacity. And that’s where things still stood when the Syrian refugee crisis exploded.

This explains why most of the refugees are transiting across Greece and not applying for asylum there, unless they’re detained by Greek police and given no choice.

This also helps explain Macedonia’s anger at the large numbers of refugees crossing its border from Greece. Macedonian authorities’ violence towards transiting refugees was obviously horribly wrong, but it’s also horribly wrong that the refugees are being sent from Greece to tramp by foot over the Balkans.

If the EU system were operating as it should, Syrian refugees would be able to apply for asylum in Greece, without having to cross the former Yugoslavia, as they’ve been doing by the hundreds of thousands, at considerable risk to their own lives and especially those of their children.

And this background also helps explain Hungary’s paranoid reaction to the Syrian refugee crisis. Until recently, Hungary had tried to extend relatively humane conditions to asylum seekers, far better at least than in Greece. Thus, the Dublin agreement still applies to Hungary.

According to it, any asylum seekers who transit from Serbia across Hungary to anywhere else in the EU can and should be deported back to Hungary. Germany recently announced it would stop deportations under the Dublin agreement, and others are likely to follow. But the move was belated, after Hungary had already fenced its border with Serbia.

Too little planning, too late

EU countries are now trying belatedly to agree on burden-sharing. But that’s a lot more difficult when the issue is so direct and tangible.

The crisis has exposed important historical differences between the former Western Europe and Eastern Europe. Much has been made since the 1980s of the deeper common cultures of Mitteleuropa, and for good reasons. But other, unshared histories also matter.

The former communist countries were not colonizers. So their people feel no moral responsibility for the fragility and brutality of the regimes that came after colonialism. Except Hungary, the former communist countries were imperial subjects not imperialists. They are fiercely proud of having come through imperialism with civil society and democratic culture intact, and they credit that to their national cultures.

People in former communist countries are not accustomed, neither in good senses nor bad senses, to large-scale immigration. By bad senses I mean mainly how people in the former Western Europe accept as inevitable the existence of their immigrant slums and put them out of their minds. People from the former Eastern Europe don’t have any such slums in their cities, and they are terrified by them.

Even within the societies of Western Europe, liberals sympathetic to refugees are far from holding secure majorities. Few liberals dare to speak honestly and openly about the scale of the refugee influx, fearing that would only strengthen the hands of xenophobes.

Seriously, how will so many people be integrated into European societies? The apparent unwillingness to discuss that is death to whatever hopes there could be of calming down and communicating with the people of former communist Central and Eastern Europe.

I don’t have any exclusive information, but it’s not hard to work out a few basic realities.

1) There is no end in sight to war in Syria and Sunni Iraq. Anyone who thinks Russia might team up with the United States to end the war is fooling themselves. Russia on the contrary will prolong the war by defending Bashar al-Assad from the pro-Western rebels of northwest Syria. Russia will let the US continue to struggle to contain Islamic State.

2) Around half of Syria’s 22 million people have been displaced from their former homes. Most are still inside Syria, and it’s not clear how many of those intend to leave, or will decide later that they want to leave. Millions more are in neighboring countries, mostly in camps in Turkey and Jordan. All of those are highly likely to want to migrate to Europe.

3) The main factors in these people’s decisions will be: a) the cost of travel to Europe, b) the risk of being turned back, c) the risk to life, and d) the degree of attachment to and hopes for return to Syria. Those appear to me to add up to an undiminishing stream of refugees for the foreseeable future, as stories of success filter back, attachment and hopes are worn down, and earlier immigrants send money home to bring their relatives. Then there’s Iraq, Afghanistan, Libya, East Africa. I would assume Europe will receive at least three million refugees over the next five years, possibly as much as twice that.

4) As long as EU countries offer varying amounts of support to refugees, refugees will go where support is the best, which is currently Sweden and Germany. No system of distributing refugees among countries can work unless benefits and treatment are seen to be equal, or the countries that offer better benefits are willing to harshly and systematically deport refugees back to their assigned countries. It would make no sense for Germany to have a big fight with eastern countries to force them to take refugees, only to allow those refugees to use the eastern countries as a staging ground for immigration to Germany.

5) The past failures of Arab immigration to Europe were both cultural and economic. Especially in France, neither the locals nor the immigrants tried very hard to integrate with each other, and politics favored protecting native jobs while paying immigrants to sit at home in ghettos.

Summing all that up, I’d say there’s no reason why the refugee crisis must destroy the EU. Germany with its relatively liberalized economy is best prepared to employ large numbers of immigrants. But the lack of concrete plans being made even in Germany should be deeply alarming. Unless Europeans start honestly facing up to what’s happening and discussing in all seriousness how they’re going to handle it, there will be more and angrier fighting over it, locally and internationally, and the EU itself could be mortally wounded.

Monday, September 7, 2015

China’s pace of spending reserves is extraordinary

The arm of Chinese government that manages foreign-exchange reserves has just released its count of where they stood at the end of August, which is down by nearly $94b from the end of July. Here’s Bloomberg and here’s the Chinese data.

And the actual pace at which China is spending reserves was even faster than that. The dollar significantly weakened during August: the DXY index fell by 1.6%. That should have increased the dollar value of China’s FX reserves, by nearly $20b if about one-third of them were in non-dollar assets. So it looks like China actually spent at least $110b of reserves in August.

Since China is so big, and has such a big stockpile of FX reserves, $110b in a month might seem like not such a big number. It is. China’s GDP was about $10.6 trillion in the four quarters ending in June, or a bit less than $900b in an average month. That means that in August China spent down its FX reserves at a pace of around 12% of GDP. That’s a very big volume of demand for foreign currency that’s not being met by market sellers.

By comparison, Russia spent $31b of FX reserves in December 2014 at the peak of its selling, a pace of about 17% of its (pre-devaluation) GDP. The ruble ended up losing half its value.

Obviously such comparisons aren’t direct, and Russia is in a much worse situation. But a devaluation of more than 10% in China seems to be the most likely outcome now.

Thursday, August 27, 2015

Why Global Trade Is Struggling

A lot of people for a long time have been predicting it, and a lot of people are eager for it to come, or at least think they are. As the data continues to worsen, it’s only a matter of time till the mainstream media picks up on the story.

The day has come!  It’s the end of globalization!

By the most common definition of recession, global merchandise trade is already in one. Volumes of internationally traded goods shrank by 0.5% in the second quarter, after shrinking 1.5% in the first, according to the Dutch government’s World Trade Monitor. Those are equivalent to 2.1% and 5.9% annualized paces.

This hardly compares to the fall and winter of 2008-2009, when global trade in goods shrank by 7.2% and another 10.9% in two consecutive quarters. Volumes of traded goods were still up by 1.1% in the second quarter of 2015 versus the second quarter of 2014.

Also, these numbers don’t include trade in services. International business process outsourcing is still booming, and international tourism is doing fine.

Still, there’s no doubt global trade is struggling. Judging from the recent drops in commodities prices, nobody is expecting trade growth to bounce back anytime soon, not even to the 2.6% pace it averaged in 2012 to 2014. A return to the long-run average of 7% annual global trade growth that prevailed until 2007 seems more far-fetched than ever.

Emerging Markets In Crisis

This is far from the end of globalization. But it is a crisis, and one that could last a while.

The problem is in emerging markets, which had been leading global trade growth since the 2008-2009 crisis. Imports by low and middle-income countries accounted for 71% of the growth of global merchandise trade between 2008 and 2013, though even by the end of that period their imports were only 31% of global merchandise trade. Those figures are by dollar value and are calculated from World Bank data.
Trade among emerging markets was especially strong. Imports by low and middle-income countries from other low and middle-income countries accounted for a third of global merchandise trade growth from 2008 to 2013, even though by the end of that period they still accounted for only a tenth of global merchandise trade.

When countries punch so far over their weight, they tend to tire quickly. Put another way, the catch-up process for emerging markets is inevitably cyclical.

Above all, trade growth in 2008-2013 was driven by a frenetic pace of building in China. Housing, retail space, offices, industrial plants and infrastructure were all built as quickly as possible, financed from foreign investment and booming exports. That drove up prices of imported raw materials, especially oil and ores, but China was able to keep up by continually boosting its exports, especially to its raw materials suppliers.

That growth model has been unraveling since 2014. One reason was that Chinese households became reluctant to invest further in housing. I don’t have good data, but based on anecdotal reports, it appears that a large portion of middle- and upper-class Chinese families already hold apartments for investment, and a large portion of those are empty. As apartment prices in most cities have stopped rising, owners of empty apartments are taking losses as their apartments age and depreciate, which is a powerful warning to potential buyers.

Another reason global trade is struggling is the fracking boom in the United States, which by driving down the price of oil hit the incomes of the raw-materials producers that had been most rapidly increasing their imports from China. Steel and iron ore prices crashed as construction industries contracted in Russia, the Middle East and other raw materials exporters, adding to the slow-down of construction growth in China.

Emerging market currencies devalued, even those of materials-importing manufacturers. The dollar value of emerging markets imports didn’t grow at all in 2014, and both values and volumes have been dropping this year.

The next chart is of merchandise trade volumes, again from the World Trade Monitor. It shows how emerging markets, the red line, led global trade growth for many years, and how sharply their demand for imports has recently collapsed.

A Developed-Economy Recovery Isn’t Enough


Meanwhile, the United States has reverted to its former status as the biggest driver of global trade demand, at least this year. Import volumes were up 7.4% year-on-year in the first half, according to the Dutch data. A much-touted “re-shoring” trend has been overwhelmed: US manufacturing employment has been flat this year after a modest partial recovery in 2010-2014.

But the US demand growth looks like a one-off that stems directly from the fracking boom. As oil prices and oil import volumes have dropped, the dollar has appreciated, and Americans have reallocated much of their extra wealth to more imports. Latin America has been the biggest beneficiary, with its export volumes up 9.6% year-on-year in the first half of 2015.

But oil prices can’t fall much further. And as you’ve surely noticed, many consumer goods markets in the US are already saturated with imports. By my best estimate, close to half the value of manufactured or processed goods consumed in the US is imported. According to the BEA’s input-output tables, $4.4 trillion worth of manufactured or processed goods were consumed in the US in 2013 by non-manufacturers, not including logistics and trade mark-ups. That year $2.3 trillion worth of goods were imported, of which some obscure but small fraction was re-exported.

Europe has been more or less pulling its weight in global trade since last year. The Euro Area has increased its merchandise imports at an average pace of just over 2.5% a year since the beginning of 2014. But that pace is also unlikely to accelerate. With its numerous highly integrated economies, Europe’s goods markets are already very saturated with imports. International trade within the European Union accounts for about a fifth of global international trade.

Like the name of my blog says, the world economy is already globalized. I believe there’s still much more to come, especially in global trade of services. And of course, any globalized supply chain has at least as much natural potential for growth from improvements in quality and efficiency as any domestic supply chain. But global trade growth will no longer be driven by developed economies substituting imported goods for domestic products.

Trade among emerging markets is now the biggest potential driver of global trade growth. But that growth will be cyclical, and right now we are in a weak stage of that cycle.

Only when emerging markets are growing rapidly can the pace of global trade growth exceed the pace of global GDP growth. When emerging markets are in crisis, global trade will stagnate, even if developed economies are strong.

Monday, August 24, 2015

A Few China Charts To Ponder

Writing about the Chinese economy can be daunting, not only because it’s so big. China is just plain extraordinary. Things in China work differently from elsewhere, sometimes astonishingly so. Predicting how such an unusual place will change is close to impossible.

But change is certainly in the air. The news of the moment is capital flight, which is believed to be accelerating. Not long ago China was a very difficult place from which to export capital. Lately all sorts of formal and informal holes have been opening up in the old system of capital controls. Chinese money brokers boast they can turn your yuan in China into dollars in a foreign bank account in about an hour.

Nomura’s chief China economist, Yang Zhao, estimates that $100b was sent or pulled out of China in the first three weeks of August, on top of $90b in July. That’s according to the Daily Telegraph’s summary of his private research. Much if not most of the departing money represents Chinese investors paying off dollar financing and liquidating long positions in the yuan or commodities.

The trigger for this exodus was a mere 3% drop in the value of the yuan, a scale of devaluation that anywhere else would have been taken in stride. But the Chinese currency market is so carefully managed that a 3% move wasn’t just shocking. It was understood to represent the tip of an iceberg of market pressure.

And indeed the yuan has been under growing pressure for about a year. The central bank’s decision to hold the yuan stable against the strengthening dollar resulted in a costly appreciation against most of China’s trade partners. With export growth slowing, that has been difficult to defend. As of the end of June, the central bank’s foreign exchange reserves had shrunk by about $340b over the past 12 months. Probably about half of that was devaluation of non-dollar assets, and the rest was spent intervening in currency markets to prop up the yuan.

Now the central bank is believed to be spending FX reserves much more rapidly, as it struggles to prevent further depreciation. The pace and scale of its intervention is likely more than $10b a week.

That’s the background in which I present the next three charts. I don’t mean them to provoke alarm or to spread a sense of doom. Remember, China is different.

One way China is especially different is its very large volume of bank deposits. As of the end of June, China’s M2 money supply, which includes circulating currency and bank deposits, came to $21.5 trillion. M2 is defined somewhat differently in different places, so international comparisons aren’t exact. But if taken at face value, China has about 75% more M2 than the United States, although the US economy is still about two-thirds bigger than China’s.

What this chart shows is a sizable portion of the world’s wealth moving into Chinese bank deposits. That has happened partly thanks to the considerable wealth-generating power of China’s export-oriented industry, and partly because in China other kinds of financial assets are less developed. Bank deposits in China substitute for any kinds of public and private savings, insurance and safety nets one finds in advanced economies.

Those $21.5 trillion worth of Chinese deposits and currency also represent the opposite side to commercial bank and central bank assets. The largest and most important part of those are commercial bank loans, which in China are largely state controlled and often used as a kind of quasi-fiscal stimulus. China had $15.2 trillion worth of bank loans outstanding at the end of June, compared to $12.9 trillion at Euro Area banks and just $8.3 trillion of bank loans in the US, where bonds are favored over loans in corporate finance.

In other words, the value of deposits in Chinese banks is backed mainly by the loans those banks made to finance China’s urbanization and industrialization.

The next chart puts the difference between China and major advanced economies in starker terms. Instead of comparing the outstanding stocks of M2 across economies, this chart compares the flows of new M2 being created, relative to GDP.

And here you can clearly see how different China is.

Remember all the talk about the vast sizes of advanced-economy quantitative easing programs? You might be able to see those here, barely. Major advanced economies have been adding M2 at paces that usually hover around 5% or less of GDP, broken mainly by a surge of M2 creation in the Euro Area before the 2008-2009 crisis. But even that didn’t come close to the pace of 15%-40% of GDP at which China has been adding M2. Remember, most of that M2 creation in China is through commercial bank lending.

The good news is: the loans tied to this M2 growth have by and large worked, despite some that haven’t. Chinese exports grew from about $320 billion in 1999 to $2.2 trillion in 2014. That’s according to the import data of China’s trade partners, so there’s no question of fudging. Even after accounting for dollar inflation, that still represents an almost quintupling of exports over 15 years, or an average growth pace of about 11% a year. That couldn’t have happened if loans were rampantly misspent.

The other good news is that Chinese people and companies seem to mostly trust that their deposits will be made good. One of the main distinguishing features of an undeveloped country is lack of popular trust in bank deposits. The least developed countries of the world typically have M2 to GDP ratios of less than 25%, and if they attempt to grow M2 too rapidly, most of it turns quickly into circulating banknotes and drives inflation.

The Chinese people’s willingness to hold bank deposits is evident in the fact that M2 reached 204% of GDP at the end of June. That compares to 184% in Japan, 98% in the Euro Area, and 68% in the United States. When people are willing to hold increasing volumes of bank deposits as savings, that sterilizes liquidity and allows banks to boost lending without driving a lot of inflation.

The bad news is: the supply of bank deposits in China is nonetheless probably too high. There appears to be a large pent-up demand in China for alternative financial assets in which to save. The high-flying, short-lived equity bubble of last November to June can be seen as one symptom of that pent-up demand. The same can be said of the over-investment in residential apartments that prevailed until last year, leaving a glut of unoccupied flats held for investment.

The current wave of capital flight could be another symptom of pent-up dissatisfaction with deposits. After all, even one-year time deposits earn only about 1%-1.5% in real terms. A 3% devaluation and a perceived threat of more are serious reasons to reconsider trying to save that way. However unusual China is, it can’t get around that it’s still a developing country without the rule of law and other liberal traditions that underlie popular trust in bank deposits in advanced economies.

The other bad news is: China’s bullish lend-and-grow strategy might not be working anymore. Many people have tried to call its expiry date before and been proved wrong, so I wouldn’t be too certain. But it does appear that large sectors of China’s industry are hitting a wall of overcapacity.

That’s most clearly reflected in the fact that nominal GDP growth, especially in US dollar terms, has slowed much more rapidly than real GDP growth. Nominal GDP growth in the first half of 2015 was just 6.5%, less than real GDP growth. That means output volume gains are driving down prices.

One of the biggest problems for China is that most of its fastest-growing export markets were its suppliers of raw materials. They have been hard hit by big drops in prices for those materials, and many are devaluing their currencies and sharply reducing imports.

Friday, July 17, 2015

Greece Is Still Trapped, Act Three

And so Greece’s parliament has endorsed the first stage of the deal struck last weekend when its prime minister, Alexis Tsipras, completely caved in to an exasperated Angela Merkel.

He is now on a shorter leash than ever, forced to take the lead role in carrying out a stricter Troika reform program than the one initially proposed to him back in February.

As I’ve been explaining since late January when Tsipras first came to power, Greece is trapped by simple economic reality. The Greek government had zero primary surplus in 2014, which means that even if it defaulted on all its debts, including to Greek banks, it would still have no room to fund fiscal stimulus.

The only way Greece could get such room would be to quit the euro and accept a large devaluation of all Greek financial assets, including deposits in Greek banks. That’s a political non-starter in Greece: only a minority of Tsipras’ Syriza coalition and a couple small far-right parties are willing to go there.

It will be interesting to see how long Tsipras can last in this situation. He appears to be under no near-term threat in parliament. An accommodation appears to have been reached for now in which the centrist opposition will support the reform program while the farthest-left and far-right corners of Tsipras’ ruling coalition will cast symbolic protest votes against reforms but not do anything to bring down Tsipras or his government. The farthest-left factions lost minister and deputy minister positions. The far right kept the defense ministry.

Tsipras’ resounding victory in the July 5 referendum has proven that he is skilled at channeling the public mood into support for himself. The fact that he won the referendum completely dishonestly, by urging Greeks to vote for an anti-austerity option that he knew didn’t exist, doesn’t seem to have cost him much in Greek domestic politics, at least not yet.

Meanwhile European political leaders are hurriedly working on rolling over Greece’s €2b of overdue debts to the IMF and another €3.8b of principal and interest due mainly to Euro Area central banks on Monday. The European Central Bank’s governing council has reportedly added €900m to Greece’s “emergency liquidity assistance” allowance, the lifeline that was keeping Greek banks liquid until the council stopped approving increases in late June. Greek banks are expected to open on Monday, though I don’t think €900m is nearly enough to enable the Greek government to lift all of the protections it has granted to Greek banks from their depositors.

Understanding the meaning of “debt relief” in IMFese

As I wrote back on July 2 when the IMF first published its report saying Greece needs “debt relief,” the meaning of those words is being widely misunderstood. Gradually more and more journalists have been figuring it out, but there’s still a lot of confusion around, so it’s worth clarifying this point a little further.

The IMF was not saying that Greece needed a write-down. What the IMF said was that Greece needed extensions of the maturities of its official debts that fall due after 2018, plus another €52b of official loans. That breaks down to: €30b to roll over the debts that fall due by the end of 2018; €20b to clear arrears, rebuild run-down cash balances, and replace bank bailout reserves that the EU seized in February after Greece threatened to default; and €2b to roll a portion of interest due before 2019 into more long-term official debt. The crucial point to understand here is that the IMF considers new official lending to be a kind of debt relief, because it’s long-term and low-interest.

With all that, the IMF opined, Greece could probably sustain its debts without any more official lending after 2018. That was a very optimistic projection. Few people really believe Greece won’t need another EU-IMF lending program in 2018, to continue rolling over its various other kinds of debts as they come due into long-term, low-interest official debts.

But the IMF’s rules say that before it lends it must ensure that the recipient country will be able to sustain its debts after the lending stops. And there is no political will right now to commit to lending to Greece past 2018. So the IMF needed to meet a high standard of sustainability that assumes Greece won’t have any more access to official lending after 2018.

The need for €52b of new lending and maturity extensions of official debt due after 2018 was the IMF’s opinion three weeks ago (the report was written a week before it was published). On July 14 the IMF published an update dramatically increasing its estimate of Greece’s financing needs from €52b to €85b, and saying Greece needed either maturity extension with “a very dramatic extension with grace periods [of deferred interest] of, say, 30 years on the entire stock of European debt, including new assistance” or “explicit annual transfers to the Greek budget or deep upfront haircuts.”

The latter two options are obviously politically unpalatable. So the IMF is really calling for the first of those options: extensions of maturities and grace periods of deferred interest on Greece’s debts to the EU.

How could Greece’s financing needs have grown by €33b in three weeks, you ask? The IMF says, “the events of the past two weeks — the closure of banks and imposition of capital controls — are extracting a heavy toll on the banking system and the economy, leading to a further significant deterioration in debt sustainability.”

The IMF probably also took an opportunity to climb down from over-optimistic nominal growth forecasts built in to the three-week-old report. The experience of not being paid on time tends to push creditors to revisit such things. The IMF is undoubtedly maintaining the high hurdle that Greece’s debts must be plausibly sustainable without any further official lending after 2018.

The IMF is also apparently not taking into account the new reform program’s section on privatization, which calls for Greece to raise €50b and put half of it towards repaying debt. That would imply €25b less financing needs, though the program document doesn’t say how soon Greece would raise so much money. Anyway €50b is a wistful fantasy, which could only come true if things go so well in Greece that it won’t need the money.

A clarification of Greece’s fiscal position

Most media covering Greece have reported that the new reform program represents a deepening of fiscal austerity.  Dan Davies has written a popular blog post arguing the opposite, that actually Greece is being given room for fiscal stimulus. So who’s right?

The mainstream view here is much closer to being correct. The deal is fiscally austere. Greece had zero primary surplus last year, and the new program calls for that to tighten to 1% of GDP this year and to 3.5% of GDP from 2018 on. Unless you believe there are growth forces at work in Greece that will greatly improve the fiscal position without any change in tax or spending policy, that is a big fiscal tightening.

On the other hand the deal is not any more fiscally austere than the one offered to Greece in June. When I say the new program is much stricter, I mean its regimen of supply-side reforms. The fiscal numbers are exactly the same. And they’re much easier than the fiscal path Greece committed to under its 2012-2015 bailout program. The latter called for Greece to tighten to a 4.5% of GDP primary surplus from 2016 on.

What the media have missed is that Greece has actually already severely tightened its fiscal position in the first half of 2015. Remember that Greece kept current on its debts until the last day of June, and its repayment schedule is not light. Greece hasn’t been able to raise any new private financing since last year, and has only been able to roll over debts owed to Greek banks and other captive local creditors.

The only way Greece could make its debt payments was by sharply tightening its fiscal position. And it did so in a completely ad hoc manner, by running up arrears or just not making budgeted expenditures. As the table below shows, Greece’s state budget (the core central government) ran a primary surplus of 3.1% of GDP in the first half of 2015. That’s probably about equal to an overall primary surplus of 2.6% of GDP, judging from the fact that Greece’s core central government ran an 0.5% of GDP primary surplus in 2014 while the IMF calculated a zero overall primary surplus.

Note that my calculations rely on Greek government data, but I don’t use the Greek government’s own count of its state budget primary surplus, which wrongly counts privatization receipts and refunds of previously paid interest as primary income. The IMF consolidates all central and local government entities and makes other adjustments.

So this is the valid point that Davies could have made: relative to the severe austerity that has prevailed so far this year, a 1% of GDP primary surplus target for this year does represent something like a fiscal stimulus. It means Greece is allowed to run a primary deficit of around 0.6% of GDP in the second half. Actually Greece is likely to endure another couple months of severe austerity and then enjoy a rush of public spending in the fourth quarter.

But Davies’ actual argument is all wrong. He thinks Greece will enjoy fiscal stimulus because the primary surplus of 1% of GDP minus interest costs he estimates at 3% to 4% of GDP leaves an overall deficit of at least 2% of GDP. But fiscal stimulus is a negative change in the fiscal position, not a negative level. For fiscal stimulus Greece would need to be able to spend more and/or collect less revenue than it did last year. And no one is offering to lend Greece enough money to do that.

Besides, Greece’s actual interest costs are around 2.5% of GDP, net of expected refunds but including deferred interest, and about 1.6% of GDP in terms of cash paid net of refunds. And payment of interest to foreigners, in cash or not, is never a fiscal stimulus.