Natural Consequences – Russia and Ukraine

The response to date that western countries have had to Russia’s invasion have been appropriately measured, and it would appear that President Zelensky and Ukraine will continue to be well-supported by a surprisingly cohesive set of European and US economic sanctions joined by Japan and a number of other western-oriented countries, big and small.  Pressure is sufficiently high, though, that there is a distinct chance hostilities break out between Russia and NATO in the coming weeks. One misstep or perceived transgression magnified by social media can tip the scales, most especially since there appears to be no off-ramp for Putin’s aggressive strategy.  A course reversal could only start to happen with regime and/or political strategy change in Russia. This cannot be anticipated in the near term but may become more possible the worse the Russian economy performs and the worse the pictures of devastation to people and property in Ukraine look to a European worldview that has been upended.

Inflation was already elevated and against this geopolitical backdrop it is going to get substantially worse.  Supply chain logistics are going to get a good deal more disrupted.  Some very important and lesser-known industrial commodities produced in Ukraine and Russia are going to be in short supply and many agricultural commodities that the Ukraine is well known for are going to suffer significant shortages. It is difficult to think of a sector or company anywhere that isn’t going to find life more difficult in the next three to six months, and we think the world has not yet properly appreciated the impact of the above disruptions and shortages.

The Federal Reserve bank is going to be confronted by the nightmare scenario of stagflation in the midst of geopolitical uncertainty the likes of which the world has not seen since World War II. This uncertainty has many threads, but foremost is determining the trajectory of how countries deal with their industrial policy and economic security balanced against social and environmental considerations without ceding power to bad actors in commodity-rich or offshored production locales in key sectors such as energy, food, key industrial commodities, microchips, pharmaceutical products etc.  The US has the ability to mitigate and perhaps reduce the inflationary pressures in some energy sectors, for example in promoting oil exploration, fracking, or shale oil extraction, though other movements to build up strategic reserves in certain commodities could prove disastrous if not properly managed.

All this leads to the inevitable discussion about a bi-polar world consisting of the US/Europe on one side and China inextricably linked to Russia on the other.  It is increasingly important for us to understand clearly which of the other countries around the world are going to fall into which camp as old historical alignment pressures resurface and are re-assessed on a real-time basis.  The US will need to think about its role in the new world landscape and how it can persuade emerging countries to align with it rather than with China/Russia.  Russia is now a clearly weaker and junior party in its partnership with China and may even be vulnerable to what is now China’s status as its largest customer.  China was already driving many countries towards the West through its bullying behavior but post Ukraine this now becomes a much more existential issue with a sharp point. Japan’s quick support for sanctions on Russia give a sense of things to come.

Jonathan Binder is CIO at Consilium Investment Management