Economic impact of the Russia-Ukraine war
In today's newsletter we see the economic impact of a full-blown war between Russia and Ukraine.
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After the collapse of the Soviet Union in 1991, East European countries including the likes of Estonia, Poland and the Czech Republic, moved away from Russia’s Sphere of Influence and joined NATO. NATO happens to be a military alliance of several European and North American countries. The alliance is particularly formidable considering “an armed attack on one or more of the Parties is deemed to include an armed attack on the territory of any of the Parties in Europe or North America.”
So everybody retaliates.
And as NATO’s influence spread across East Europe, Russia found itself in an increasingly precarious position. Or as Vladimir Putin puts it — “ You promised us in the 1990s that [NATO] would not move an inch to the East. You cheated us shamelessly.”
Needless to say, after putting up with this “provocation” for so long, he now wants NATO to walk back — Remove the missiles and the defence systems stationed in East European countries and halt further expansion. Most notably, he doesn’t want NATO to welcome Ukraine to its fold — a country that borders Russia. NATO meanwhile doesn’t want to cede to these requests considering they believe any sovereign country should have the right to decide its own fate — including Ukraine.
So there was an impasse. An impasse that political leaders tried to resolve.
But alas, talks didn’t help. Diplomatic solutions couldn’t bear fruit. And tensions peaked as Russian President Vladimir Putin increasingly ramped up his rhetoric against Ukraine. At one point he even questioned its statehood — Asserting that Russia created Ukraine. What’s worse? He has also recognised the independence of Donetsk and Luhansk — two cities in Ukraine, partly controlled by Russian backed separatists and partly controlled by the Ukrainian government.
Political analysts now believe that Putin may have set the stage for a full-scale invasion of Eastern Ukraine. He may even choose to invade the whole country, but considering the human and economic cost involved, that proposition does seem a bit unlikely — at least for now.
So there’s the status quo.
And while Western leaders have condemned Putin’s actions so far, they aren't willing to send in their own troops to fight on Ukraine’s behalf. Instead, they've promised to pursue sanctions. Sanctions will likely deal a crippling blow to Russia’s economy.
But before we deal with that, let’s talk about the war itself. The cost of war is steep. Russia won’t just pay for supplies and operations today. They will have to do so in perpetuity.
Take, for instance, the US war on terror. Their government committed close to $6 Trillion dollars on post-war efforts since 9/11. This includes all the money spent mobilising resources in Iraq, Syria, Afghanistan and all future obligations that accrue out of such war efforts — including interest costs (on borrowed money) and post-war care for veterans. And if Russia’s objective here is to invade people who aren’t sympathetic to their cause, then the costs will only add up.
Second, Russia will also have to deal with the sanctions. Think of sanctions as financial restrictions imposed on Russia and agents operating out of Russia. For instance, the European Union and the US are likely to impose heavy restrictions on Russia’s ability to borrow from investors in Europe. Without borrowed money, it can become extremely hard to wage a prolonged military campaign. The US will also impose similar sanctions and ban key Russian businessmen from the country. They’ll freeze their assets and target businesses in Russia — Making it hard for them to operate across the world.
But here’s something interesting. These measures won’t just hurt Russia. There will also be some collateral damage back in the US and the European Union. Take, for instance, the sanctions imposed on Rusal (Russian aluminium giant) back in 2018. After only a few months, the US had to roll back sanctions because of the unexpected fallout in the aluminium market.
As a Reuters report notes —
U.S. sanctions on Rusal imposed in April 2018 — and lifted in early 2019 — created major disruption for firms in the transport, construction and packaging industries. The resulting scramble for aluminium saw prices jump 30% in just a few days.
And this isn’t a one-off either. Right now Germany has decided to halt the final approval to operate Nord Stream 2 — a 1,200 km pipeline running under the Baltic sea— transporting natural gas from Russia to Germany. The pipeline is ready. Gazprom has invested about €5 bn and the likes of Shell and ENGIE (oil and gas companies in the West) have put up the rest. All they need is the go-ahead — a final seal of approval to transport natural gas from Russia to the European Union. However, with the sanctions in place, that may not happen. And if it doesn’t happen, Europe will have to source gas from elsewhere, which will likely lift oil prices for everyone.
A sudden rise in oil prices could affect multiple industries. Prices could soar and inflation could become a key concern — not just in Russia, the US and the EU, but everywhere. And this should probably explain why the markets have been jittery. This isn’t an isolated event. This affects all of us.
And finally, one other thing. We talked about Nord Stream 2, but what about other pipelines? Isn't Russia already pumping gas to the European Union?
Yes, they are. And it's business as usual on this front. The only difference — some of these older pipelines run through land — Russian land, Ukrainian land and German land. And Ukraine doesn’t want any disruptions here. If anything they're worried that the Nord Stream 2 may reduce Russia's dependence on Ukrainian co-operation.
And that brings us to today.
*It should be evident by now that this crisis isn’t just about geo-politics. It’s about economics, money and shared financial interests. But like most things, economics is a fleeting enterprise. You make some money today. You lose some tomorrow. But the human costs will be immeasurable. You can't just look past the bloodshed and the misery this war will beckon if Russia chooses to invade Ukraine and subjugate its people. People who by the way have no role to play in any of this. Ukraine isn't allied with NATO yet. And despite Russia's repeated assertions, they haven't been the aggressors. They've restrained themselves. As one Twitter user put it, "Putin saying that Ukraine is attacking Russia is like me saying someone’s cheek is pummeling my fist."
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