The writer is president of Queens’ College, Cambridge and an advisor to Allianz and Gramercy.
Due to the invasion of Ukraine, Russia is disconnected from the world system, one economic and financial thread after another.
It will devastate the economy, once the 11th in the world and still a member of the G20. Combined with a crippled financial system, it will lead to a depression that will compromise the well-being of generations of Russians.
What is happening economically and financially in Russia and Ukraine will not stay there. Besides the tragic forced migration of millions of Ukrainians, there are consequences for the global economy and markets, both immediate and longer term.
When the fallout and fallout has made its way around the world, we will have faced some of the most difficult economic and financial challenges of the 1970s, 1980s and 1990s. But there is an important difference: they will all have materialized. at the same time.
Russia’s vulnerability to Western sanctions is visible in the collapse of its currency, queues outside banks, shortages of goods, increasing financial restrictions, etc. The resulting sharp contraction in gross domestic product will take years to reverse and will require a costly transformation of the way the economy works internally and interacts with the outside.
The main implications for the rest of the world, although uneven from country to country and within countries, are a combination of challenges we have seen before.
Due to disruptions in the availability of raw materials from Ukraine and Russia, as well as further disruptions in the supply chain, the world is facing high cost inflation reminiscent of the oil shock of the 1970s.
Also similar to the 1970s, the US Federal Reserve, the world’s most powerful central bank, is already facing self-inflicted damage to its inflation-fighting credibility. This comes with the likelihood of unanchored inflation expectations, the absence of good monetary policy options, and a stark choice for the Fed between allowing above-target inflation through 2023 or pushing the economy. in the recession.
As in the 1980s, rising payment arrears will be a feature of emerging markets. It will start with Russia and Ukraine, although for different reasons.
Increasingly, Russia will be both unwilling and unable to pay Western bondholders, banks and suppliers. In contrast, Ukraine will attract considerable international financial assistance, but this will increasingly be conditional on the private sector sharing some of the financial burden by agreeing to a reduction in contractual claims on the public sector of the country.
This mix of default and restructuring is likely to spread to other emerging economies, including some particularly fragile commodity importers in Africa, Asia and Latin America. They are already feeling the pain of high import prices, a stronger dollar and higher borrowing costs.
As in the 1990s, when a surge in market returns took many by surprise, we should also expect greater volatility in financial markets.
Investors are slowly recognizing that the buy-the-dip investment strategy has been undermined. This approach has proven to be very profitable when supported by massive and predictable liquidity injections by central banks. But he now faces headwinds as U.S. monetary policymakers lack good policy alternatives. This occurs when the price of many assets is significantly decoupled from fundamentals by many years of central bank interventions.
Unlike the 1990s, however, investors should not expect a rapid normalization of Russia’s relations with international capital markets and, with that, a recovery in its debt securities. This time will be more complicated and longer.
All of this has three main implications for the global economy. Stagflation has moved from a risky scenario to a reference scenario. Recession is now the risky scenario. And there will be significant dispersion in individual benchmark results, ranging from a depression in Russia to a recession in the Eurozone and stagflation in the United States.
While the differentiation will also be visible in market performance, this will come after a period of contagion for some as global financial conditions tighten. The major risk scenario for the markets has also changed – potentially with unsettling volatility and market dysfunction.
This is a risk which, unlike 2008-09, concerns less the banks and, consequently, the payment and settlement system. That’s the good news. But its transformation and migration to the non-banking sector still presents risks of backfire for the real economy.