An interesting article on two fronts. First, a good summation of the history of the economic order since WWII. Second, the factors that are fundamentally changing in that order and how it may effect investments.
The world is responding to Russia’s invasion of Ukraine by taking a step back from globalization. What might that mean for financial markets?
"The world’s capital markets are currently going through a period of rapid adjustment. Inflation rates are high, interest rates are rising, bond prices are falling, and the equity markets are correcting. What is going on? Some contributing factors have been well documented: lingering post pandemic lethargy, accommodative monetary and fiscal policy, and an economic demand shock that only exacerbated an already shaky supply chain situation.
These factors seemed to be slowly resolving themselves, though, until an event with the potential to have an even deeper and more enduring impact on the global economy occurred. We are now experiencing a substantial transformation, or what is sometimes characterized as a sea change, in the global capital markets. Put simply, the world appears to be responding to Russia’s invasion of Ukraine by taking a step back from globalization."
Now for the history:
"As World War II was coming to an end, U.S. leaders assessed the devastation and came to the following conclusions:[5]
- The U.S. emerged from the war as “the” global superpower, but it had no desire to become an empire.
- The U.S. had a golden opportunity to “reboot” the economic order of the world. Having the only relevant deep-water navy to survive the war, it alone was able to install a global free trade system, and anyone who partnered with the U.S. could sell goods and services to anyone else in the system without concern.
- Any country that wanted to participate in this free trade system would have to let Americans direct national security policies (think NATO).
Based on these conclusions, the U.S. brought their allies together at a ski resort in Bretton Woods, New Hampshire, and imposed this fundamentally new global economic system. America’s allies were relieved and quickly accepted what came to be known as the Bretton Woods Accord.[6] They did so because they recognized that the U.S. was not pursuing empire status, but instead was proposing a solution that would benefit most stakeholders. The thought behind all of this was that if countries could access economic growth through a free trade system that encouraged cooperation and business competition, nation state wars would become a thing of the past. Nothing secures American national security better than a world at peace as a result of economic interconnectedness."
Putin's invasion broke this system. Now "pariah" nations will be cut out of the global free trade system. Russia is the test case.
"On April 13, Secretary of the Treasury Janet Yellen presented an important speech at the Atlantic Council.[9]
“Yellen described a new world order that is dominated by countries that play by the same rules. Countries that choose not to play by the rules will be treated as pariahs by the abiders. By invading Ukraine in an unprovoked war by choice, Russia has turned itself into a pariah nation among the “unified coalition of sanctioning countries” (UCSC). This league of rules-based countries “imposed an unprecedented suite of financial sanctions and export controls on Russia.” Yellen declared: “We, the sanctioning countries, are saying to Russia that, having flaunted the rules, norms, and values that underpin the international economy, we will no longer extend to you the privilege of trading or investing with us.”[10]"
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Indeed, this sea change is already viewed through numerous tectonic geopolitical shifts:[13]
- Many global leaders have condemned Russia as a rogue nuclear power.
- Switzerland took uncharacteristic, non-neutral actions by sanctioning Russia.
- Germany and Japan, with U.S. blessing, are building up their military capabilities.
- Even nations hostile to U.S. dominance such as China, Iran, and North Korea are seemingly distancing themselves from Putin.[14]
- NATO is strengthened as member countries began (or promised to begin) paying their annual 2% of economic output into NATO efforts. In fact, for the first time, even neutral European countries such as Sweden and Finland have expressed interest in joining NATO, which would have been unthinkable just months prior.[15]
- The European Union (EU) has strengthened as well, due to its unified response to Russia’s aggression.
- EU and non-EU European countries have concluded that relying on Russia for a portion of their energy needs most likely is not prudent.
What are the potential implications of this sea change from an economic and investment standpoint?
- The UCSC will have better prospects. Conversely, countries outside of the UCSC, or that are at risk of being outside of the UCSC, will have bleaker prospects.
- As the U.S. is leading the UCSC response and its economy is more insular than other countries (i.e., self-sufficient, given its economic dominance based on domestic consumption), it stands to be an economic leader in the new environment.
- The world’s efforts to move from carbon- based energy sources (coal, oil, gas, and liquid natural gas) to renewable sources will decrease in intensity. The urgency toward replacing traditional energy sources with renewables will take a pause as traditional supply systems are solidified. Nuclear energy may stage a comeback.
- Even so, oil production globally will decrease as the sanctions targeting Russia, along with multi-national energy company departures (taking with them their technology, knowledge, and experience) begin to bite what is currently the third largest global energy producer. This will be supportive of high and higher oil prices.
- The UCSC will focus on building and maintaining an uncompromised energy system (one not beholden to potential enemies).
- Globalization was deflationary. Stepping back from globalization is inflationary.
- “Re-shoring” or “friend-shoring” of global supply chains (factories and energy systems) to trusted countries is also likely to have inflationary implications if it involves a move to countries with higher input costs than the departing countries.
- Russia and Ukraine produce a quarter of the world’s wheat and export it primarily to the Middle East and Africa. Disruptions in this supply chain could lead to increased instability in these areas of the globe. The last time wheat was scarce, it helped to bring about the Arab Spring, characterized by a series of anti-government protests, uprisings, and armed rebellions that spread across much of the Arab world in the early 2010s.[16]
- Russia and Ukraine are large producers of fertilizers for the world. Reduced access to fertilizers has huge implication for world food production and, by extension, for food inflation."