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Investment quandary in a hostile world

The economic fallout from the political and military instabilities we now see in East Asia and Central Europe is the result of failures to properly manage the changing security environment.

These are not the usual forecasting failures.

(Read more: Ukraine will not give up Crimea: Acting foreign minister)

There has been nothing sudden and unpredictable about China's growing political clout as a result of its extraordinary economic development. That long and gradual process, starting in the late 1970s, was vigorously supported by American and European technological transfers and their open markets for exports produced by western joint-ventures in China.

Russia is a similar story, except that it got fewer joint-ventures and an unbalanced trade with the West, consisting of Russian energy and raw material exports and huge imports of European technology and consumer goods.

Unarmed Ukrainian troops bearing their regiment and the Ukrainian flags march to confront soldiers under Russian command occupying the Belbek airbase in Crimea on March 4, 2014 in Lubimovka, Ukraine.
Getty Images I Sean Gallup/Staff
Unarmed Ukrainian troops bearing their regiment and the Ukrainian flags march to confront soldiers under Russian command occupying the Belbek airbase in Crimea on March 4, 2014 in Lubimovka, Ukraine.

There was nothing intellectually impenetrable about the possibility that, at some point, these countries' economic development would lead to serious security challenges to the existing world order. Both countries have unresolved border issues and scores to settle of the dethroned superpowers.

If a management consultant looked at this as a problem in a corporate environment, the verdict would most likely be that those who now seem shocked by the strategic challenges posed by the resurging China and Russia are guilty of hubris and complacency – nice euphemisms the financial markets would simply label as "wrong calls."

But the people paying for that kind of public service may be less forgiving. Their mood would probably be aptly captured by Ibsen's famous line: "But, good Lord!--you can never pretend that it is right that the stupid folk should govern the clever ones …"

(Read more: Russia says sanctions will 'boomerang')

Lack of Russia experts?

To deflect the looming blame game, some influential U.S. media are already spinning the view that nobody is responsible for this. It's all back to the former U.S. Defense Secretary Donald Rumsfeld's (affectionately known as "Rummy") idea that "stuff happens." The argument of the moment is that more than four months of Ukraine's violent insurrection caught people out because "the U.S. does not have enough Russia specialists."

Clearly, a disingenuous claim if there ever was one.

The trouble is that Ukraine is just the latest in the line of potentially virulent flashpoints. What will happen to "frozen conflicts" that could flare-up in Georgia, Moldova and Nagorno-Karabakh (involving Armenia and Azerbaijan)?

And what will be the response to Russia's apparent desire to reunite the post-Soviet space through its Euro-Asian Community, where Russia, Kazakhstan and Belarus have already created a closely knit customs union? Armenia is now in accession talks, with other countries in the region not far behind.

The former U.S. Secretary of State Hillary Clinton warned that the U.S. opposes these Russian designs. At a press conference in Dublin, Ireland, on December 6, 2012 she said (only a few hours before meeting her Russian counterpart) that: "There is a move to re-Sovietize the region… But let's make no mistake about it. We know what the goal is and we are trying to figure out effective ways to slow down or prevent it." Ukraine definitely looks like a good test of that policy.

Sanctions are warfare by other means

A similar test continues in Asia. Washington's original "pivot to Asia," subsequently changed to "rebalancing to Asia," has been qualified as a move to counter China's growing economic and political importance in the Asia-Pacific. That was no news to Beijing; it knew all about it for quite some time, and it needed no particular message to understand the security implications of 60 percent of U.S. naval assets being positioned in its neighborhood.

(Read more: Greenspan: This is the only way to stop Putin)

That is the context in which the world is now facing the possibility of a much more serious military conflagration in East Asia than anything that could happen in Ukraine. Indeed, daily skirmishes in the South China Sea can easily ignite, through "accident" or "miscalculation," a Sino-Japanese war, drawing in the U.S. by virtue of its guarantees of Japan's security. And then picture this: A conflict between the two fiercely resentful powers with nuclear warheads on their intercontinental ballistic missiles.

Or think of an "accident" during North Korean missile launches and massive military drills in and around the Korean Peninsula.

It, therefore, sounds odd when voices of concern are now raised about this year's 12.2 percent increase in China's military spending. It seems like people are wondering what China is preparing for.

And it is even more surprising that, in spite of this, the "international community" expects China and Russia to cooperate in the political settlement of (a) the war-ravaged Syria, (b) the seemingly insoluble Arab-Israeli conflict, (c) Iran's suspected nuclear ambitions, (d) the volatile inter-Korean relations, (e) the post-NATO Afghanistan and (f) the factions-torn, proxy wars in the bombed out Iraq.

That is an explosive agenda for what Russians strangely call "partners" – people pretending that the guns they have pointed at each others' temples are full of blanks.

But countries spoiling for massive sanctions – as now seems to be the case -- are not firing blanks. To paraphrase the Prussian general von Clausewitz, sanctions, stock market and currency attacks are warfare by other means.

Investment implications

Investors have to realize that in that kind of hostile world Rummy's "stuff" can easily happen. And one does not have to be paranoid to think that Ibsen's earlier quoted line clearly alludes to such a possibility.

(Read more: Crimea votes to join Russia, Obama orders sanctions)

So, what are investors to do?

The safest first principle could be: Stay local as much as possible.

But watch the fallout from sanctions and martial games. If (admittedly a big "if") the reason prevails, your equity portfolio may still benefit from the expansionary monetary policies in the U.S., the euro area and China.

Blanket statement to stay away from fixed-income instruments may no longer apply for sanctions-distorted financial markets. In such a fragmented world, good quality bonds, if you can find any, could be part of a temporary flight to safety.

I also wish to repeat my positive outlook for gold. Having read so far, you might guess that my optimism about the yellow metal is based on growing geopolitical instabilities.

Energy prices could also shoot up. Ukraine has already practically defaulted on $1.89 billion it owes to Russia's Gazprom. The huge pipeline system running through Ukraine could soon be shut down to leave the Central Europe in a deep freeze, as was the case for 20 days in the early months of 2009.

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.

Follow the author on Twitter @msiglobal9

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