Crucial Connections: Finance and Hybrid Conflict

Elmar Hellendoorn

The massive use of financial sanctions against Russia has shown the importance of finance in the Western ‘hybrid’ toolbox. Also beyond sanctions, finance, hybrid conflict and geopolitics are deeply intertwined. Financial considerations can drive hybrid conflict strategies, financial trends caused Western vulnerabilities to such strategies, and more specifically, the financial system itself can be a target of diverse hybrid attacks.

Financially constrained or fiscally prudent powers may be more likely to focus on non-military or ‘hybrid’ strategies in international conflicts. Here, ‘hybrid conflict’ is understood when mostly non-military means are used to disrupt or manipulate the opponent in the short to medium term. Ways to build up more long-term positions of influence and control through the financial markets, are beyond the scope of this piece. Not only is the use of ‘hybrid’ tools generally less costly than military operations. Their use is also less likely to provoke a escalatory military response, thus keeping the costs of conflict financially more manageable. For example, a disinformation campaign against a NATO country may provoke some targeted financial sanctions in reaction, but it tends not to lead to a – significant – military reaction. A low-to-medium scale cyberattack can be hard to attribute, let alone to be deterred. Supporting (extremist) movements can somewhat destabilize a democracy, but for NATO or the EU it is difficult to prevent.

 

Post-Cold War interconnectedness

Post-Cold War hybrid strategies emerged in a context that was structurally changing. Of course, already during the Cold War – and before – both the Soviet-led Communist bloc and the US-led Western alliance, used a diverse set of political warfare instruments. This included psychological operations, political interference and coup d’états. However, in the 1990s and 2000s, Chinese and Russian strategic thinkers, as well as some Western ones, saw that in the post-Cold War the world was becoming much more interconnected due to financialization, globalization, and digitalization. Countries around the world quickly became more efficiency-driven and reliant upon information technology, and increased interdependence opened pathways for strategic exploitation, or ‘weaponized interdependence’.

 

China’s and Russia’s leadership were not convinced by the optimistic Western view that interdependence would make the world more secure. After the fall of the Berlin Wall, the United States was not only financially, but also diplomatically and militarily dominant. The devastation of the Iraqi forces during Operation Desert Storm and the Soviet collapse (both in 1991), confronted Beijing and Moscow with their relative military and diplomatic inferiority. Lacking adequate financial and technological capacities, they further developed asymmetric strategies to challenge the West. The most high profile exponents of the Chinese and Russian ‘hybrid’ strategic thinking were the respective ideas about ‘unrestricted’ and ‘non-linear’ warfare. Some Chinese and Russian strategists actually believed that the West was waging a war with non-military means, using among others color revolutions, cyber-attacks, media campaigns, and financial markets. Allegedly, already in the late 1980s, some KGB generals reckoned that the future conflict with the West would not be fought regular military battlefield, but through financial markets.

 

The West is now also facing financial constraints as well as Chinese technological parity if not superiority. As several European countries are already severely indebted, and they need to keep the cost of living affordable amidst expensive decarbonization projects and social programs, it is questionable whether higher European defense spending can be financially sustainable. As a result, Western countries may also seek to develop more impactful ‘hybrid’ tools, following in China’s and Russia’s footsteps. In fact, the massive Western use of financial sanctions can be seen as an effort to already do so.

 

Financialization, Fragilization, and Hybrid Threats

Financial trends, especially financialization, continue to be a major driver of the dominant efficiency-approach, which strategically fragilized Europe and the West, making the alliance more vulnerable to adversarial ‘hybrid’ conflict strategies.

 

Financialization is commonly understood as the increasing importance of financial motives, markets, institutions, and players. Financialization is a long-term process driven by multiple factors beyond the scope of this essay. A key consequence for businesses is that financial market dynamics, such as prices of stocks, bonds and futures have become more important in shaping corporate decision making than real supply and demand dynamics. In that environment, current or projected market valuations became a chief benchmark for an increasing number of Western companies and industries. Short-term profitability, cost-cutting and efficiency gains became a central theme, if not dogma, of business management. This trend also helped efficiency-focused management consultancy practices to proliferate.

 

At the firm-level, the increased focus on efficiency has led to offshoring supply chains, outsourcing non-vital operations such as R&D, increased automation and digitization, which was accompanied by US-style management consultancies – which helped companies to become more efficient, boosting numbers in the short run. The overbearing focus on efficiency has made the West more vulnerable to many kinds of adversarial hybrid operations and ‘weaponization of everything’. Economic coercion has become much easier as Western industries offshored their supply chains, causing greater dependence on overseas production facilities and local suppliers in China and beyond.

Offshoring apparently helped companies to cut costs. But while Western industrial manufacturing base hollowed out, China’s strengthened. The offshoring of supply chains has also made especially Europe more dependent on secure sea lines of communication to  connect Europe’s ports to Asia’s. These run through multiple naval chokepoints, like the Red Sea and the Malacca Straits, which can be disrupted by proxy operations and piracy. The Houthi attacks near Yemen are an illustration thereof.

 

The finance-driven focus on efficiency-has also aided the emergence of cyber risks. Notwithstanding significant attention to cyber-security, Western companies and governments ever more automated and digitalized their processes, including those for vital infrastructure and other key operations. The move away from paper and analogue has also increased Western dependence on information technology companies, for, e.g. software, cloud services, and other ‘data solutions’, as well as for the hardware, ranging from smartphones to satellites and chips to cables. The Echelon and Snowden Affairs, as well as the concerns about Huawei’s 5G technology indicated that the pervasiveness of digitalization has made European governments and companies vulnerable to surveillance.

 

Together, financialization, globalization and digitization have increased the vulnerability of Western societies to hybrid campaigns aimed at political destabilization. This goes beyond ‘disinformation’: great parts of the European and American populace are disenchanted about the loss of stable work due to offshoring, the erosion of social welfare and the apparent dehumanization of government services, as well as a perceived loss of socio-cultural cohesion in the face of globalization and social media. This significant popular disenchantment is a fertile breeding ground for all kinds of political movements which can be manipulated from outside.

 

Attacking the Adversary’s Finances

Apparently, the more financialized states are, the more vulnerable their national security becomes to attacks on the financial systems on which they depend. For example, following an effective attack on a financial system, states’ ability to fund themself may be affected, people may lose their savings leading to social unrest, the economy may tank and key companies can collapse and come under foreign control. Even the international security context may quickly deteriorate as states do sometimes get violent in the wake of financial difficulties, like Argentina in 1982 and Rwanda in 1994, and most notably Germany in the 1930s.

 

Financial markets can be manipulated and attacked with numerous ‘hybrid’ operations, involving the full ‘DIMEFIL’ spectrum (diplomatic, intelligence, military, economic, financial, information, and legal instruments). Broadly speaking there are three main categories of attacks on financial markets: military and kinetic attacks, diverse non-kinetic operations, and financial operations as a league of their own.

 

Military attacks on the adversary’s finances occurred regularly in history. The greatest was perhaps the capture of the Spanish silver fleet by the Dutch Piet Hein in 1628. As Habsburg Spain had already gone bankrupt in 1627, the regular arrival of the Silver Fleet could have restored Spanish finances and saved Madrid’s despairing bankers in Genoa. Inspired by the Dutch actions, French corsairs, and English pirates, nineteenth-century French naval strategists envisaged how they could use their smaller navy to bring the British Empire to its knees: according to their logic smaller ships should raid British maritime shipping, causing a maritime insurance crisis in the City of London. Subsequently, facing huge financial losses, the City bankers would force London’s politicians to compromise with Paris – or they would have to sell their holdings of British government debt, forcing the British government into crisis.

 

All kinds of attacks

In the contemporary context, it is imaginable that again military operations will be targeted specifically to disrupt financial markets. For example, overseas, overland, and air trade routes can be attacked, leading to higher oil and gas prices, higher shipping insurance costs, and to disrupt the supply chains of specific companies which have large market cap – for example in chip manufacturing. The Houthi attacks in the Red Sea are one such example. A Chinese blockade of Taiwan could be another. And disrupting flight routes in the Middle East could nowadays effectively cut-off air traffic between Europe and Asia. In the short run, such actions could lead to financial chaos, or inflation and attrition in the longer run.

 

All kinds of direct attacks on financial systems can be imagined: these range from missile and drone attacks on key cloud servers, the cutting of undersea cables, other act of sabotage against financial infrastructure. Using a small electro-magnetic pulse (EMP) device in or near a financial sector could be highly disruptive. Also, state-sponsored terrorist attacks against bankers and key industrialists have been planned and executed in the 1980s and, allegedly, more recently again.

Alternatively, many non-kinetic, non-financial ‘hybrid’ operations against financial markets are already being used. The use of false or disinformation, spreading of rumors to influence financial markets is probably as old as financials markets themselves.

 

Regarding cyber-attacks, the International Monetary Fund warned recently that “the risk of extreme losses from cyber incidents is increasing”. For example, in 2023, the market for US government debt was disrupted when a primary dealer bank was hit by a ransomware attack. Iran and North Korea have been linked to several cyber-financial attacks, not just on the US, but also on smaller countries. During the initial phase of the Ukraine War, Washington ordered Microsoft to switch off the operating system of an European, but Russian-funded, bank, causing its collapse. Such cyber-attacks could be more devastating in a time of already existing financial stress.

 

The third dimension of attacks on the financial system is the most ‘pure’ form, namely finance-based approaches. On the one hand, these are based on diplomatic and legal instruments, such as sanctions. On the other hand, they involve market operations, ranging from monetary policy instruments to private financial players ‘gaming’ the market. The use of sanctions and their relative effectiveness or ineffectiveness has been much discussed elsewhere. Still, financial sanctions can have very disruptive effect on markets.

 

The financial weapon

The potential of market based operations became clear to Chinese and Russian students of the 1997 Asian Financial Crisis. They saw in George Soros’ hedge fund operations during that crisis a form of ‘financial warfare’, which effectively brought down several governments, including Thailand’s and Indonesia’s. Prior, during the 1956 Suez Crisis, Washington organized a run on the British Pound, with which it forced London to stop its military intervention in Egypt. With monetary policy, including interest-rate changes, currency or debt-sell-offs, it might under the right circumstances be possible to organize a run on a country’s assets. In fact, as the 2008 Global Financial Crisis unfolded, Russia invaded Georgia. To weaken the potential US reaction, Moscow sought – in vain – Beijing’s assistance to jointly dump their holdings of US government-agency mortgage debt. Subsequently, concerns emerged that China might ‘weaponize’ or use its position as a massive holder and buyer of US Treasuries as well as Eurozone government bonds to gain diplomatic and strategic leverage.

 

Clearly, the above examples only scratch the surface of how one could attack a financial system. In all likelihood, maximum impact depends on the right timing – pre-existing financial instability – and the right mix of tools and operations. Also, as financial conditions and structures vary across countries, there is no one size fits-all approach.

 

As Western capitalists countries have grown highly dependent upon finance for their overall national security and international position, the financial system needs to be understood as an integral part of their approach to national security and geopolitics. Second, restoring Western vitality and resilience in times of strategic competition and hybrid conflict requires policy makers to address the sources of financialization, not the symptoms. Third, historical insights indicate that to maintain their position, Western powers have to be fiscally prudent and ensure that higher defense spending is structurally sustainable. As an offset-strategy, the West should seek to develop more effective political, hybrid and financial operations to win in this era of strategic competition.

 

It may now be evident that governments, financial players, and companies can be severely disrupted by hybrid attacks on the financial system. While that ‘so-what’-question is clear, the can-do’s can be harder to define. Some initial thoughts:

 

First, governments and financial players should identify which processes are vital to their financial operations, potentially ranging from computer systems to knowledge and funding. Subsequently, it is the question how redundancies can be built into those vital processes. Redundancy can also mean switching back to analogue communication, recruiting better in-house expertise, and having emergency funds.

 

Also, preparation and crisis planning is key. A well-timed hybrid attack on the financial system is likely to happen at a time of disruption and stress. At such times, it is essential to have pre-established lines of communication between all the key players, public and private. A physical crisis or financial war room could be ideal. Financial players could prepare this together with financial and national securities authorities, for example by game playing how a hybrid attack on the financial system could take place.

 

Furthermore, geopolitics and hybrid conflict need to be integrated in – financial – risk assessments. Financial authorities could consider doing geopolitical and hybrid warfare stress tests. For central banks that may add new scenarios in which they may have to act as a lender-of-last-resort. Big investors and lenders, like pension funds, asset managers, and commercial banks, also need prudential risk management strategies: that requires assessing the potential impact of geopolitical dynamics and hybrid conflict on their portfolios and balance sheets.

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