The often repeated refrain “we don’t want to be in another Cold War” is nonsense – we are in one. And Vladimir Putin is a much more dangerous opponent than dozy old Leonid Brezhnev. However the latest demonstration of this truth in Georgia is only a week old, so it’s worth reviewing its implications on the world economy.

There’s no question the political map has been redrawn. Winston Churchill wrote how “the dreary steeples of Fermanagh and Tyrone” disappeared from thought when the overwhelming crisis of World War I appeared, only to emerge again afterwards as the World War deluge subsided. This time around, it is the miserable minarets of Ramallah that have faded into insignificance as a more geo-strategically urgent danger appears to disturb the quiet Western August. We feel less disturbed about the imagined capabilities of a modestly funded rag-tag group of Islamic extremists when we are faced with the real and present threat of Russian military resurgence.

Although Vladimir Putin and his puppet President Dmitry Medvedev may believe that the map redrawing has been confined to Georgia, that is not what has happened. The stationing of a US missile defense force in Poland had been stalled because Poland had wanted a force of Patriot missiles to accompany it, in case of Russian aggression, which the US had refused, as it would antagonize the Russians. Now the missile defense installation will go ahead, accompanied by the Patriot missiles. The border between the EU and Russia has suddenly become a major barrier, across which mutually hostile forces gaze.

The reversion to a Cold War world has a number of economic implications. The United States and the EU (which post-Georgia is highly vulnerable to Russian energy blackmail) will need to spend considerably more on a defense buildup, to ensure they remain competitive with the Russian military machine. Since Russia has a population of only 140 million, its defense profile is likely to be fairly high-tech, unlike that of China, which has more or less unlimited manpower. Hence conventional defense spending will be most needed, with anti-guerilla equipment less relevant. The EU, having run its defenses down further, will need to rebuild exceptionally vigorously; the European political class has not yet recognized this.

Multilateral international trade agreements such as the late lamented Doha Round will continue to be impossible to arrange, while cross-border investment will be bedeviled by the successor to the COCOM (Coordinating Committee for Multilateral Export Controls) procedure – a much beefed up version of its feeble Wassenaar Arrangement successor — which will ensure that Russian companies will not be able to buy strategic Western assets. Investment in Russia is in any case both restricted and futile, so reciprocity will be maintained. Cross-border lending into the former Soviet Union will be limited and expensive, because of the political risks involved – the principal sufferer here will be Ukraine, which would like to reorient itself to the West but may not be able to.

China, India and Brazil, the other three of the BRIC quartet, will be more or less unaffected. China is economically so powerful and militarily so invulnerable, that it will be able to play both sides off against each other. Economically, it would benefit most by remaining on good terms with the West, but the temptation to make mischief by allying with Russia might have been irresistible had Putin not timed his invasion to coincide with China’s Olympics, a major affront to “face.” India and Brazil, large countries relatively remote from the conflict, will probably benefit, especially if it results in a reduction of the global foreign policy focus on Islam, an Indian vulnerability

The economic cures for Russian adventurism and Middle Eastern jihadism are the same: much lower oil prices. The inexorable rise in oil prices since 2002 has produced very little beneficial economic development that makes the lives of ordinary citizens better, in any major producer. Canada, already wealthy, and Brazil, moving beyond self-sufficiency as new discoveries are made, have benefited significantly from higher oil and commodity prices, but Venezuela, most of the Middle East, Nigeria and Russia have not, while huge amounts of resources have flowed into their corrupt governments. Thus the oil revenues have fed the poisonous miasmas of Latin American Guevaraism, Middle Eastern jihadism, African kleptocracy and Russian megalomania.

The global economic case for reducing oil prices to the long run production expansion cost of around $60 per barrel is clear-cut; the question is how to do it. At $60, tar sands remain economically viable provided they are controlled by competent oil companies, while offshore exploration also yields a very nice profit when it is successful.

The difficulty in reducing oil prices to this level is two-fold. Demand, particularly from the rapidly industrializing countries of China and India, is rising at rates well above the historical trend. Conversely new supplies have been subject to political obstacles both in the West and in many Third World countries, incapable of developing complex new resource pools themselves but ideologically rigidly apposed to allowing the oil majors in to develop them on their behalf.

There are a number of steps that the United States and other Western countries could take to reduce oil prices to $60 a barrel over a 12-18 month period.

• First, interest rates could be increased to levels at which they are sharply positive in real terms, say 9-10% on the US Federal Funds target compared to the current 2%. Much of the surge in oil usage has been due to excessively global low interest rates, which have caused Chinese demand in particular to grow excessively quickly, causing inflation but also an upsurge in Chinese demand for energy. Higher interest rates will deflate demand for Chinese exports, which will reduce the overheating in the Chinese economy. A similar rise in interest rates within China, facilitated by high interest rates elsewhere, will affect Chinese demand directly. We do not need a sharp contraction in the Chinese economy to reduce global demand for oil, simply a reduction in the pace at which demand is growing.
• Second, restrictions on oil development should be abolished, except for environmental controls that would be imposed for any activity of similar environmental impact. In this context, the actions of US politicians are a true disgrace. To impose a Presidential ban on offshore drilling in 1990, when all other countries with significant offshore reserves were drilling, and countries such as Britain and Norway were meeting the majority of their needs from offshore sources, was egregious enough, though typical of the vacillating and time-serving President George H.W. Bush.

However to maintain the ban until 2008, for 7½ years of the term of the nominally Republican president George W. Bush, for the first six of which the Republicans controlled Congress, at a time of rocketing oil prices, was truly disgraceful. It was especially a disgrace as after September 2001 Bush declared a national emergency and conducted a military campaign expensive both in money and lives, in the world’s major oil-producing region. Lifting the drilling ban was an obvious step in reducing US dependency on the volatile Middle East. Had the ban, and that on drilling in that Arctic National Wildlife Reserve (again with appropriate environmental controls) been lifted in 2001, as they could and should have been, the US could be producing substantial quantities of offshore and Alaskan North Slope oil today and thereby depressing global oil prices.

• Finally, taxes should be imposed on US gasoline to bring its price up to European levels, thereby reducing consumption. The taxes could be justified on environmental grounds, and the money raised should either be remitted in other tax cuts or spent on the military buildup that seems likely to be necessary. The real purpose of these taxes would not be environmental, nor to finance public expenditure; they would simply reduce US oil consumption and provide another downward pressure on oil prices.

With these three measures in place, and a measure of help from other oil consuming countries such as the EU, China and India (in particular, abolishing any consumption subsidies) the global supply-demand pattern for oil would be changed by that 2-3% necessary to bring prices down to around $60 a barrel at which exploration and unconventional oil sources remain sufficiently attractive to be worth exploiting.

At that point several nice things would happen. Russia’s export income would be halved, so its ability to finance a massive military buildup would be decimated. Meanwhile, its people would come to realize what a fraud the Putin/Medvedev regime has been; it has failed to provide more than a temporary lift to the living standards of the Russian people, but has instead engaged in kleptocracy and massive empire-building, funded by unearned oil revenues. Even BP and Shell might benefit, as Russia came to realize that their expertise was valuable in developing new oil resources with the maximum efficiency.

Hugo Chavez of Venezuela would also suffer devastating financial stringency, would be unable to continue financing the export of his petty revolutions, and would soon be forced out by the Venezuelan populace, who would come to realize that, bad as were the traditional corrupt “democratic” rulers of Venezuela, Chavez has made things infinitely worse. Iran too would feel the pinch; it might or might not continue developing nuclear weapons, but its limited democratic mechanisms would soon produce a less hostile and frightening government.

It took Presidents Harry Truman through Ronald Reagan nearly half a century to figure out how to win the first Cold War. With will and competence, this one should be much quicker and easier.

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)