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The return of geopolitical risks

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From the end of the Cold War until the mid-1980s, investors have pushed international tensions to the background. The fall of the Soviet Union and China’s gradual transition to a market economy and globalization reinforced their idea that geopolitics now had little effect on corporate value. The attacks of September 11, 2001 created a financial shock, mainly because of its proximity to Wall Street. However, over time the stock market fallout has been relatively weak. Companies and investors then felt that the economic consequences would be contained, and took a relative interest in the conflict between China and America, the rise of populist leaders in Latin America or tensions in the Middle East. Thus, neither the differences with Iran nor the trade war between China and the United States led to real shifts in the markets.

The isolation of the 11y International Economy

With the invasion of Ukraine, this scheme can be smashed on the grounds that it may isolate the eleventh economy in the world which is also one of the largest producers of raw materials. Never, since 1945, apart from state wars resulting from the break-up of Yugoslavia, there has been a war involving two internationally recognized European states, given that Russia is a member of the United Nations Security Council. You have to go back to the worst years of the Cold War to get the same level of stress.

This crisis is exceeded by the number of deaths caused in 1948 by the siege of Berlin or those related to the construction of the same city wall in 1961 and the subsequent Cuban missile crisis in 1962. These various events have led or reinforced the division of the world. The economic repercussions were certainly less significant than those that an invasion of Ukraine would generate.

The immediate global repercussions will be higher inflation, weaker growth, and some turmoil in financial markets with tougher penalties. The long-term repercussions will be a further weakening of the system of globalized supply chains and integrated financial markets that have dominated the global economy since the collapse of the Soviet Union in 1991.

Oil, gas, nickel, aluminum, palladium, wheat, potash…

Since the second oil shock, Western countries have not faced such a sudden rise in the prices of energy, raw materials and agricultural products. The barrel of oil certainly saw big increases in 2007 and 2014, but they spread over time. The energy shock of 2022 signals the morale that pits Russia against one another, that is, one of the three largest oil and gas producers in the world. Russia is also a major supplier of industrial metals such as nickel, aluminum, and palladium. Both Russia and Ukraine are major exporters of wheat, while Russia and Belarus are notable producers of potash, an essential component of agriculture.

The price of a barrel of Brent oil exceeded $100 as soon as the Russian intervention began and the price of gas in Europe rose by 30%. Many European countries, starting with Germany, are highly dependent on Russian gas. It would be very difficult to manage the shutdown of supply with the risk of shortages as a result. The supply of raw materials can be challenged in two ways. Deliveries could be halted if physical infrastructure such as gas pipelines or Black Sea ports are destroyed. They can also be questioned about sanctions and counter-sanctions.

So far, both sides have been reluctant to militarize the energy and raw materials trade that also continued throughout the Cold War. Sanctions after the invasion of Crimea did not prevent the signing of gas and oil contracts. ExxonMobil or Shell’s decision to leave Russia is the first. Germany’s shutdown of the Nord Stream 2 gas pipeline on February 22 is symbolic because it was not in good shape.

If the West is exposed to energy risks, Russia in terms of technology

Western sanctions, even if they do not lead to a ban on gas and oil purchases, could eventually overburden production due to the difficulties that Russia will have in modernizing its equipment. The latter can also retaliate by favoring clients whose states have not condemned him. Westerners hope that the Arab states will partly compensate for Russia. For now, these states are hesitant. For years, they have made agreements with Russia that allow them to regulate the price of oil. They do not wish to create a crisis with this country which is certainly not a member of OPEC but is linked to its work. In addition, the price hike is making up for the shortfall that occurred during the health crisis.

If the West is exposed to energy risks, then Russia in terms of technology. The United States could impose sanctions similar to those of Huawei on Russian technology companies. This could limit their access to semiconductors and advanced software. They also have the option to cut off internet access. Some companies in the digital field such as Apple or Google have already reduced their services to Russia.

Impact of Financial Sanctions

Western countries rely on financial sanctions to put Russia in trouble. However, this country can count on large foreign exchange reserves and sovereign wealth funds. She has a few months or even a year of margins. However, with inflation and the depreciation of the ruble, the accumulated reserves tend to evaporate rapidly. The desire of Westerners is to reduce the financial flows entering and leaving the country as much as possible. To deal with this risk, Russia has sought since 2014 to isolate its economy from the dollar zone. The share of its trade denominated in US currency has declined over the past five years. Russia will have to look more to China for its financial needs. If in 2014 97% of exchanges between these two countries were carried out in dollars, then this rate was only 33% in 2021. The decision to exclude several Russian banks from the SWIFT network may slow down financial flows and trades. SWIFT for Society Worldwide Interbank Financial Telecommunication is a company founded in Belgium that operates an international system for the secure transmission of bank data. This system allows financial institutions to securely exchange data regarding inter-bank transactions. These contacts are especially necessary to push imports.

There are two countries currently excluded from the network, North Korea and Iran. For several years, China has been implementing its own system to protect the exchange of financial data. Russia can join. Russian banks can also pass through Indian institutions linked to SWIFT by an independent transmission system. The danger of a generalized ban on access to SWIFT is the emergence of competing regimes and the removal of dollars from the global economy.

The economic weight of the West is only 45% of global GDP

A few days after the outbreak of the Ukrainian crisis, the consequences for the global economy are already numerous. Russia is facing an unprecedented economic and financial shock, as its currency has lost more than 30% of its value and raised its key rates to 20%. While the sanctions are significant, they do not immediately jeopardize the Russian economy. It complicates the regulation of flows but does not prevent them. The economic weight of the West was lower in 2022 than it was in 1973. At that time, more than two-thirds of GDP was generated by the United States, Western Europe, and Japan. Today, their weight in global GDP is less than 45%.

For the world economy, the Ukrainian crisis is above all an additional source of inflation, which exacerbates the dilemma facing central banks. Should they quickly raise their key prices while risking destroying growth already damaged by the Russian invasion or accepting rising inflation?

In the long run, this crisis may accelerate the division of the world into several economic blocs. Russia will have to swing a little eastward, relying more on trade and financial ties with China. In the West, in the name of economic sovereignty and the protection of national interests, protectionism can once again be legitimized. China may be tempted to protect itself from potential Western sanctions by favoring self-sufficiency.

The invasion of Ukraine may not cause a global economic crisis today, but it could mark a turning point in the course of the global economy for decades to come.

  • Philip Krevel specializes in macroeconomic issues. The founder of Economic Studies and Strategies, Lorello Ecodata, also runs Cercle de l’Epargne, a studies and information center dedicated to savings and retirement in addition to being an economist.

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