Defend Truth


Is the global cost of the war in Ukraine worth paying?


Natale Labia writes on the economy and finance. Partner and chief economist of a global investment firm, he writes in his personal capacity. MBA from Università Bocconi. Supports Juventus.

The minute Russia invaded Ukraine, the world changed forever. Everything after 24 February 2022 is different.

In 1919, after the Versailles conference and the most devastating military conflict seen till then, John Maynard Keynes penned what would become one of the most influential economic texts in history, The Economic Consequences of the Peace. Now, as Vladimir Putin seeks to obliterate not just the nation of Ukraine but also the entire edifice of world order, it is left to this generation of economists to determine what indeed are the economic consequences of this war.

It is too soon to know, precisely. We are currently enveloped in the fog of war. Only one thing is certain: the world has changed, forever. Everything after 24 February 2022 will be different to what it was before.

However, as we peer ahead into the most perilously uncertain year of our lives, at least for everyone born after 1945, we can at least surmise what the consequences will be.

First, we can consider what the effects on the economy will be from the most extensive package of sanctions ever levelled by Western governments against a major international economy and key commodity exporter. The most economically significant of these are the sanctions on Russia’s central bank, which have effectively frozen most if not quite all of its vast foreign exchange reserves, the third largest in the world.

At the end of January these were worth $630-billion, consisting of assets and deposits in the world’s major currencies, such as the dollar, euro and yuan, as well as about 2,300 tonnes of gold. These could have powered the Russian economy for about a year. Now they have been rendered useless.

Another set of sanctions excludes Russian financial institutions from Swift, the international cross-border money transfer system. This will make it harder, if not impossible, for those in Russia to send or receive foreign payments and effectively excludes Russia from the global financial system.

Russia is a major economy with linkages across financial markets. Out of Swift, liquidity in Russian assets evaporated in a blink. The immediate market impacts were a crash in the ruble and Russian sovereign debt. The ruble dropped 33% instantly on Monday as trading opened, after which the central bank doubled interest rates.

The Russian sovereign 10-year dollar eurobond yield doubled (bond yields move inversely to prices), although traders will be greeted by a red “Sanctions apply to this security” message on their Bloomberg screens if they attempt to buy or sell them. Ruble bonds are not trading, the stock market is still closed. The cost of swaps to insure against a Russian default have spiralled to 37% of the face value of the bonds.

The economic costs to Russian consumers, savers and borrowers have been ruinous and look set to worsen.

It is likely that Russian banks will struggle to remain capitalised and could well face runs, especially with a central bank denuded of its reserves. Queues of Russians drawing cash and exchanging rubles for foreign currency this week are a harbinger of tougher economic times to come.

The ensuing secondary-level effects of all this are more complicated as a number of Russian institutions and individuals are forced into making fire sales because of margin calls. Early examples are as varied as volatility in the share prices of Austrian banks and bankruptcy of the lessors of Aeroflot jet aircraft. A local example is that of the share price of paper manufacturer Mondi, which has substantial facilities in Russia. It is down 21% in the past week.

Second, it is fairly clear a critical effect of this war will be to make commodities dearer. The prices of gas, oil, nickel, palladium and indeed food have all risen substantially and look set to rise further. This will exacerbate already breakneck inflation as well as be a drag on growth, a confluence of economic realities best described as stagflation. Inflation resulting from higher input costs should not be confused with that of overheating economies; it is simply a tax on consumers and a source of rent for commodity exporters.

Given how important Russia and Ukraine are for global grain production, these effects will be particularly harshly felt in economies where food consists of a large percentage of daily spend, such as South Africa.

The two countries now at war were projected to export 60 million tonnes of grain in 2022, more than the EU and the US combined, according to S&P Global. All of these exports pass through terminals along the north shore of the Black Sea, which are now closed indefinitely. Wheat commodity prices are up around 25% this year to date, and volumes are down more than 90%.

It is not impossible to imagine contagion spreading to a full emerging markets financial crisis, of the sort that Russia defaulting in 1998 triggered and which led to a 37% depreciation in the value of the South African rand. Post-Covid, emerging markets were already fragile going into this crisis. The timing could not have been worse.

Third, the war’s effect on financial markets is best guessed at by considering what happened in the last period of stagflation of the mid- to late 1970s.

From 1972 to 1980, a period of eight years, which included the Arab-Israeli War, the advent of OPEC and the Iranian revolution, the S&P500 decreased 13%. Investors should not be surprised if the next eight years exhibit similar returns. Caught between the Scylla of inflation and the Charybdis of growth grinding to a halt, central banks such as the US Federal Reserve might seek to postpone their rate-hiking schedules to cushion the blow to the economy. Emerging market central banks such as South Africa’s Reserve Bank face an even more perilous set of circumstances as input prices soar.

Finally, and more generally, the global financial system must prepare for a new chapter of geopolitical decoupling.

Financial markets have become a new field of battle and are now the place to defend liberal values and renew old alliances. As Russia is excluded from the global financial architecture and becomes a predatory commodity-fuelled pariah state, it will be pushed into the clutches of an ascendent China. Russia’s invasion of Ukraine is therefore a key turning point that will have lasting international consequences. The future will consist of two international financial systems; one backed by the dollar, the other by the renminbi.

China may be no fan of the war against Ukraine but there is no doubting the opportunity it presents for buying excess Russian oil and gas diverted from Europe, as well as Russian arms. “China is our strategic cushion,” Sergei Karaganov, a political scientist at Moscow’s Council on Foreign and Defense Policy, told Nikkei Asia recently. “We know that, in any difficult situation, we can lean on it for military, political and economic support.”

China clearly sees Moscow as part of a new Beijing-led order, of which Moscow is patently aware. It is surely no coincidence that Putin waited for the Beijing Winter Olympics to finish before ordering his tanks to advance on Kyiv.

Meanwhile, faced with a brutal, nuclear- armed aggressor, Europe and the US are being forced to unite in a way not seen since the darkest days of the Cold War. Judging by the extraordinary speed in levelling sanctions against Russia and supplying Ukraine directly with weapons, this may prove to be the formative moment that the EU assumes the semblances of a federal state.

Where this leaves South Africa is deeply, and extremely worryingly, uncertain. There is no doubting the deep ties of parts of the ANC to forces in Russia. The confused, contradictory and noncommittal response of the Ramaphosa administration to this unwinding geopolitical and humanitarian catastrophe is at once embarrassing and concerning, and an indication of the government’s allegiance to Russia, a result of deep historical linkages.

Furthermore, events of the past few weeks have made the ANC conference at the end of the year and the machinations of the Radical Economic Transformation (RET) faction exponentially more critical and concerning.

The links of senior ANC protagonists such as David Mabuza and Ace Magashule to Russia are no secret. Mabuza spent a month in Russia in August getting treatment, allegedly for the effects of a 2015 poisoning. Russia may be working on ensuring an RET faction victory in December to give it a bulwark in southern Africa, which if it happens will position the country firmly in the autocratically militant sphere of Russia and China. South Africa’s free market and constitutional democracy itself are at risk.

The costs of the invasion of Ukraine are real and unavoidable, and will be felt by everyone. From warming an apartment in Berlin to feeding a family in Johannesburg or running a factory in the Midwest of the US, effects will be profound.

Our leaders must explain why these are costs that must be borne as part of the global effort to defend what so many are dying to protect: our freedom and democracy, for us and our children. It is beyond the realms of economics to assert that this is a price worth paying. DM168

This story first appeared in our weekly Daily Maverick 168 newspaper which is available for R25 at Pick n Pay, Exclusive Books and airport bookstores. For your nearest stockist, please click here.


Comments - Please in order to comment.

  • Craig B says:

    This Moscow assumption is all assuming the world keeps buying from China. That will also be re evaluated by the 141 countries if the world which is a good thing more jobs at home.

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