OhVER The The intensity of geopolitical risk has become a constant feature of world politics over the past decade, yet the world economy and financial markets have stopped it. From the rivalry between China and America to the rise of populist regimes in Latin America and the tensions in the Middle East, firms and investors have continued, judging by the economic consequences.
Russia’s aggression in Ukraine is likely to break this pattern, as it will isolate the world’s 11th largest economy and one of its largest producers. The immediate global effects will be some disruption to financial markets due to high inflation, low growth and deep sanctions. Further weakening will be the long-term consequences of the globalized supply chain and integrated financial market system that has dominated the world economy since the collapse of the Soviet Union in 1991.
Start with commodity shock. In addition to being a major supplier of gas to Europe, Russia is the world’s largest oil producer and a major supplier of industrial metals such as nickel, aluminum and palladium. Russia and Ukraine are both major wheat exporters, while Russia and Belarus (a Russian proxy) are large in the case of potash, an input of fertilizer. The prices of these products have gone up this year and may go up further now. Amid reports of explosions across Ukraine, on the morning of February 24, Brent oil prices exceeded $ 100 a barrel, and European gas prices rose 30%.
Product supply can be damaged in two ways. Destruction of physical infrastructure such as pipelines or Black Sea ports can disrupt their delivery. Alternatively, deep sanctions on Russia’s commodity complex could prevent Western consumers from buying from it. Until now, both sides have been wary of the trade in energy and commodities, which continued throughout the Cold War. Sanctions did not deter Crimea BP, From investing in ExxonMobil or Shell Russia, when in 2018 the American fines on the Russian metal company Rusal were short-lived. Germany’s decision to mumble the Nord Stream 2 gas pipeline on 22 February was largely symbolic because it still does not carry gas west from Russia.
Yet the possibility of Western restrictions on Russia’s natural resources industry now reduces global supply. Russia may retaliate by deliberately blocking price increases. The United States could lean on Saudi Arabia to increase oil production and persuade its domestic shale firms to increase output.
The second push relates to technology and the global financial system. Although trade in natural resources is an area of interdependence between the West and Russia, the balance of economic power in finance and technology is more one-sided. The United States could thus impose stricter Huawei-style sanctions on Russian technology companies, restricting their access to state-of-the-art semiconductors and software, and blacklisting Russia’s two largest banks, Sberbank and Blackberry. VTBOr want to separate from Russia Swift Messaging system used for transboundary bank transfers.
Technological measures will act as a pull on Russia’s growth over time and will annoy its customers. Banking restrictions will bite immediately, leading to a funding crisis and disrupting financial flows in and out of the country. Russia has specifically sought to keep its economy away from it: since the invasion of Crimea in 2014, its share of the dollar has fallen and it has created foreign exchange reserves. Still, it will hurt. Russia will lean towards China for its financial needs. Already trade between the two countries has been kept away from Western sanctions, with only 33% of Russian payments from China now being in dollars, down from 97% in 2014.
Russia seems to have relatively little exposure to Western banks. Nevertheless, no major economies have been isolated from the global financial system since the modern era of globalization began in the 1990s, and the risk of a transition across the market, albeit seemingly small, cannot be ruled out.
What does all this mean for the world economy? Russia is facing a serious but severe economic crisis because its financial system is isolated. There is potential for high inflation for the global economy as natural resource prices rise, exacerbating the dilemma faced by central banks, and the potential dullness of corporate investment due to declining confidence due to the gloomy market.
The long-term effects will accelerate the division of the world into economic blocs. Russia will be forced to lean eastwards, relying more on trade and financial ties with China. More politicians and organizations in the West will ask that a key principle of globalization – which you should trade with all, not just your geopolitical allies – is still valid, not only for Russia but also for other dictators. China will look at Western sanctions on Russia and conclude that its self-determination needs to be strengthened. Ukraine’s aggression may not be the cause of the global economic crisis today, but it will change the way the world economy works over the next few decades. 3
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This article was published in the Finance and Economics section of the print edition under the title “Economic Fall”