The top news story this week is the increasing escalation of the crisis in Ukraine, with Russia moving troops into two rebellious areas that have tried to buck the government in Kyiv since 2014. This has sent ripples through world financial markets as the uncertainty over what will happen next intensifies. With this in mind, I want to walk you through the spectrum of possible outcomes for the crisis and then look at their likely effects on financial markets.
What could happen?
Possibilities range from Russia staying where it is and pushing Ukraine to acknowledge two breakaway regions as either independent territory or part of Russia, to a full-scale invasion with Russia installing a puppet government in Kyiv and rattling its saber at the Baltic republics and Poland. Each step in that range creates a bigger shockwave in geopolitics and has greater power to shift global economic realities. If those are the possibilities, what are the probabilities? The most probable situation, so far as I can tell, is somewhere between where we are right now and a large enough Russian intervention to provoke a regime change without directly toppling the government through conquest. Those actions will prompt harsh economic sanctions and attempts to isolate Russia diplomatically but wouldn’t head into direct NATO military intervention.
What would be the effects?
In the event of economic sanctions and diplomatic isolation, most of the effects here in the US would be indirect because the US and Russia have little direct trade. However, the EU, which is our largest trading partner when taken as a whole, has a strong direct trade relationship with Russia and would likely see a hit to its economic growth. With growth already sluggish at best in Europe, this would be a significant hit to their economies. The knock-on effect of that is diminished demand for US goods and services, making a minor drag on our economy here in the US. We could also see a rise in prices for petroleum products and natural gas, two of Russia’s most important exports. That would further the ongoing worries about inflation here in the US.
What’s the Upshot?
Right now, all the most probable scenarios lead to a negative shift in the US economy, but nothing that changes the fundamental economic situation. We’re likely to see a furthering of current trends rather than a shift in what those trends are. Instead, I think the biggest impact of the current situation in Ukraine are its implications in the ongoing story of the US reacting to China’s bid for superpower status.
Is that a Panda or a Dragon in the room?
Unlike Russia, China and the US have a massive trade relationship and any sanctions between us would have significant direct impacts on both countries’ economies. Additionally, the US and China have an ongoing geopolitical issue with the status of Taiwan, which China considers a rebellious province, but which the US considers a de facto independent state. China is watching what happens in Ukraine with great interest to see how far the US will go to curtail Russian aggression. While the situation in Ukraine isn’t a perfect analogue (Taiwan isn’t recognized officially by the US or any international body, unlike Ukraine) it’s the closest China will get to a preview of what might happen if it takes definitive moves to invade Taiwan and bring it back under Chinese control.
It's all part of the broader picture
To summarize, the impact of the current situation in Ukraine is likely to have indirect negative effects on US economic fundamentals, but just as, if not more, importantly it also has implications for the larger world geopolitical situation and in particular our relationship with an increasingly powerful and assertive China. In the future, I’ll be writing a primer on China to help you all better understand this important actor on the world stage, but for now I hope this helps shed some light on what’s currently in the news and how it will affect your financial portfolios.
If you’d like to talk more about the implications of geopolitics on your portfolio, get in touch. Otherwise, stay safe and healthy, and I’ll be in touch again soon.