The Fallout from Ukraine

It’s March 7th, 2022…and the world is holding its breath.  

A tangled web of powerful forces are all of a sudden bearing down on geopolitics, the global economy, financial markets – and our lives.

Old fears of a worldwide war are re-emerging after a 30 year absence.

Europe is in the midst of its first ground war since WWII. Inflation, which had likely begun to fade, will now push even higher. The world of relative peace and stability in which we have lived since the fall of the Soviet Union is at an end.  

Honestly, I was reluctant to write this.

It’s important during such times to remember a couple of important truths though:

Order eventually triumphs over chaos – and good usually triumphs over evil.  

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Current situation.

The West has so far been treading carefully. There is only limited direct military support being provided to Ukraine. There are no NATO boots on the ground. There isn’t a no-fly zone. Russian oil and gas aren’t currently being sanctioned. Some Russian citizens have been able to sidestep financial sanctions via Western-owned crypto exchanges and Chinese payments systems. Russia is also still in a position to lean on China for a variety of other forms of support (which remain readily available to them).

The Rubel and the Russian stock market have collapsed though – and Russia now faces its most severe economic downturn since 1998. They simply won’t be able to withstand the death-by-a-thousand-cuts of Western sanctions forever.

Putin’s goal still seems to be to turn at least part of Ukraine into a vassal state. He’s shown that he’s willing to pay an insanely high price to achieve it too. Just how high that price gets before it becomes unbearable remains to be seen, but it won’t be paid just by Putin, or even the people of Ukraine and Russia.

The cost of this war will be borne by all of us. And that cost is going up every day.

Even if Russia quits now, with Putin still in office, it’s unlikely that sanctions will be removed any time soon. Much of Ukraine’s infrastructure is in tatters. Tensions in Europe’s east would also remain high for the foreseeable future.

We may quickly be approaching a point of no return as NATO builds up forces in member states surrounding Ukraine – and the fighting inside Ukraine gets uglier.

Make no mistake, under these circumstances, a tiny spark could light a very big fire.

What’s currently being decided in Ukraine goes well beyond the fate of the two countries involved; what’s being decided is nothing less than the course of world history.

At the time of writing, NATO is moving additional forces into Europe. European nations are considering sanctioning Russian oil and gas. China has reaffirmed its ties with Russia, but promises to try and mediate. If anyone can make a mediation succeed at this point, its probably them.  

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Feeling it at home, wherever you are.

Aside from the humanitarian disaster and geopolitical crises quickly unfolding, the war in Ukraine means inflation.

Lots of it.

In fact, it will be enough to undermine the growth of the entire global economy.

Whenever oil prices rise like they have over recent days, a recession typically follows.

If there’s no quick end to hostilities, or worse yet, an escalation, you should expect a prolonged period of higher energy and food prices. Russia is not only the worlds second largest oil and gas producer, but its also a major producer of food and essential agricultural chemicals and fertilizer used in food production. Ukraine is the vital conduit through which Russian oil and gas flow into Europe and is an important food producer in its own right.

Even though Russian oil and gas exports have not yet been blocked exactly, oil is currently trading at well over $110/barrel (up from below $80 late last year).

The economic situation could quickly start to resemble the inflation and stagflation of the 1970’s, during which there was a shock to the supply of oil, surging prices, and tumbling economic growth. The difference then was that there hadn’t just been a global pandemic, which meant that governments and central banks had a lot more room to move.

Aside from energy, wheat is becoming a real problem. Unlike oil and gas, where there are longer term supply alternatives around the world, there’s really no such thing for wheat. This is a bigger risk to developing nations that are dependent of Russian imports to feed their people.

Whatever happens after this point, a global recession is now a real possibility before the end of 2022.

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Looking for an exit.

There are number of ways the current situation could come to an end. I’ll go from best to worst.

1. Putin quits: Putin could just decide that it’s all too coslty and find an acceptable way to back out (such as contenting himself with holding two breakaway provinces). He does seem intent on going all the way at this point, but it must be hurting him at home. Backing away completely would not be easy.

2. China brokers peace: China could use its status as Russia’s best and most important friend to leverage them into a peace deal. How much desire China truly has to bring this to an end remains to be seen, but it’s reasonable to assume that they could make it happen if they really wanted to. This is a real possibility.

3. Putin keeps fighting: Fighting continues until Putin destroys the current Ukrainian government. He’s unlikely to be able to occupy all of Ukraine though. Not for long anyway. In this scenario, fighting continues for some time and gradually slows as Ukrainian forces are overwhelmed. This too is a real possibility.

4. Something breaks: Fighting escalates and NATO becomes directly involved. If we reach this point, WWIII has basically started. Some major factions may align with Russia. Most will not. A major ground war erupts in Europe and some cities on both sides are all but wiped off the map. Vast cyber attacks undermine vital infrastructure in Russia, Europe, the US and elsewhere. The internet itself may be severely compromised. I’d like to think that this is a very low probability outcome, but every day fighting continues and NATO moves more forces into the region, the odds of it increase.  

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Investing through the crisis.

We significantly increased our cash position prior to the Russian invasion, which we continue to hold onto.  We also added to our hedging positions. We did not follow the pack into Bitcoin, which briefly surged on sanction-evasion hopes and then fell again (currently sitting at around $39,000, down from the all-time peak of $68,000 only 4 months ago).

We’re planning to sit still for now and assess events as they unfold. If Putin ends up being content just to hold the two breakaway provinces he recognized at the start of the invasion (Luhansk and Donetsk), we’re probably closer to the end of this than the beginning. Fingers crossed that this option is the winner.

There are plenty of longer term ramifications to weigh here, but our focus remains on short term developments. We’re looking for key events which will either exacerbate the current situation, or lead everyone to a way out of it.

All options remain on the table for now. This could all go away tomorrow. It could also turn into something with consequences that echo for generations to come.

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