The writer is president of Queens’ College, Cambridge, and an adviser to Allianz and Gramercy
Due to the invasion of Ukraine, Russia is being disconnected from the global system, one economic and financial wire after another.
This will devastate the economy, once the world’s 11th largest and still a G20 member. Together with a crippled financial system, it will result in a depression undermining the wellbeing of generations of Russians.
What’s happening economically and financially in Russia and Ukraine won’t stay there. In addition to the tragic forced migration of millions of Ukrainians, there are consequences for the global economy and markets, both immediately and in the longer term.
By the time the spillovers and spillbacks have made their way through the world, we will have faced some of the toughest economic and financial challenges of the 1970s, 1980s, and 1990s. But there is one important difference: they will all have materialised at the same time.
Russia’s vulnerability to the west’s sanctions is visible in the collapse of its currency, queues outside banks, goods shortages, multiplying financial restrictions and so on. The resulting sharp contraction in gross domestic product will take years to reverse and will necessitate a costly transformation of how the economy operates internally and interacts externally.
The major implications for the rest of the world, while uneven across and within countries, are a combination of challenges we’ve seen before.
Due to disruptions in the availability of commodities from both Ukraine and Russia, as well as renewed supply chain breakdowns, the world faces big inflation in costs 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 dealing with self-inflicted damage to its inflation-fighting credibility. With that comes the likelihood of de-anchored inflationary expectations, the absence of good monetary policy options, and a stark choice for the Fed between enabling above-target inflation well into 2023 or pushing the economy into recession.
Like the 1980s, mounting payments arrears will be a feature of emerging markets. This will start with Russia and Ukraine, albeit for different reasons.
Increasingly, Russia will be both unwilling and unable to pay western bond creditors, banks and suppliers. In sharp contrast, Ukraine will attract considerable international financial assistance — but this will increasingly be conditional on the private sector sharing some of the funding burden by agreeing to a reduction in contractual claims on the country’s public sector.
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. Already, they are feeling the pain of elevated import prices, a stronger dollar, and higher borrowing costs.
Like the 1990s, when a surge in market yields caught many by surprise, we should also expect more financial market volatility.
Investors are slowly recognising that the “buy-the-dip” strategy for investing has been undermined. That approach had proved very profitable when supported by massive and predictable injections of liquidity by central banks. But it is now facing headwinds, with US monetary policymakers having no good policy alternatives. This comes when the price of many assets is significantly decoupled from fundamentals by the many years of central bank interventions.
Unlike the 1990s, however, investors should not expect a quick normalisation of Russia’s relationship with international capital markets and, with that, a recovery in its debt securities. This time will be messier and lengthier.
All this has three main implications for the global economy. Stagflation has gone from being a risk scenario to a baseline one. Recession is now the risk scenario. And there will be significant dispersion in individual baseline outcomes, ranging from a depression in Russia to a recession in the eurozone and stagflation in the US.
While 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 markets has changed, too — potentially with unsettling volatility and market malfunction.
It is a risk that, unlike in 2008-09, is of less relevance to banks and, therefore, the payments and settlement system. That’s the good news. But its morphing and migration to the non-bank sector still poses blowback risks for the real economy.
