Markets are selling off in response to the downing of a Malaysian airliner being shot down by missile fire over Ukrainian territory with 295 souls on board. This is obviously a significant turning point regarding the civil war in Ukraine, which has now become a proxy war between the West and Putin’s Russia. For investors, however, the real question is, how will this escalating conflict affect international markets?
It has been obvious now for months that we are experiencing a one-way market. That is, a market that goes straight up. Throughout history, when you see such irrational exuberance thriving with equity investors, the bubble is usually popped by some type of black swan event. The Ukrainian war, if you can call it that, could possibly be this type of catalyst. The proof-in-the-pudding is how Putin responds to the shootdown and the escalation of economic sanctions by the Obama administration against Russia.
The United States has imposed greater sanctions on Russian energy companies and banks, preventing them from obtaining long-term funding from the West. The Kremlin will obviously not take these sanctions lying down. There will be a response, and it will be targeted primarily against U.S. companies.
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Russia is also aggressively targeting Europe to pull certain countries out of the U.S. orbit, Germany in particular. American spying against its ally has created an opening for Putin to drive a wedge between NATO allies. European companies have more to lose and are loath to increase sanctions against Moscow. America is in a better position and not so reliant on Russian business. European companies could face earnings compression from the Russian response, and this will directly affect equity and corporate debt markets.
The other elephant in the room is the European natural gas supply. Europe gets thirty percent of its gas from Russia. Much of that gas is transited in pipelines that cross through Ukraine. Ukraine owes Russia billions in back payments for gas, and Russia has increased the price it wants Ukraine to pay as payback for signing a trade agreement with the European Union. At the moment, Russia has shut off gas delivery to Ukraine until the bill for past deliveries is paid. However, Ukraine is siphoning off gas to shore up its underground storage stocks for the upcoming winter.
Will Russia cut off gas altogether, transiting Ukrainian territory and therefore impact European business and manufacturing? Russia is actively attempting to construct the South Stream pipeline that avoids Ukrainian territory. However, there have been delays due to political concerns and Russia’s actions in Ukraine. The bottom line is that Europe remains vulnerable to a natural gas supply shock, especially if we have another brutal winter.
The final major implication of the Ukraine War will be the fall of the USD as a reserve and trading currency globally. The effect of the American economic sanctions on Russia will be to push Russia further into the arms of the Chinese, which Russian president Putin hinted at recently. This alliance will most certainly include the removal of the USD in bilateral Russian and Chinese trade. This is a stated goal of the Chinese as well. Russian and China, as well as other nations, have been hoarding gold. This is obviously an attempt to place their wealth in a vehicle that will hold its value.
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The American penchant for spending much more than it earns is fomenting this effort to remove the USd as a global reserve currency. This will have a devastating impact on the American economy over time in the form of higher interest rates and higher debt service payments. The recent establishment of a BRIC fund to alleviate financial pressures in the developing nations is a harbinger of things to come. The world does not like to be under the foot of the USD, and this will change sooner than later. All in all, the impact of the Ukrainian War will be negative for the capital markets. Investors can profit if they read the tea leaves of events to come concerning changes in the global trade settlement structure.