The economic end-scenarios of Russo-Ukrainian war

From bad to worse

On the 21 February, I published a short Twitter thread, where I went through the (economic) worst-case scenario for the looming Russo-Ukrainian war. It was a rather precise account of what was about to hit, also implying that we have been following the worst-case scenario thus far.

In March, we published our economic end-scenarios for the Russo-Ukrainian war. We can now conclude that we have not been following the ‘good scenario’ (quick ceasefire; we were also hoping for). Instead, we have been following the combination of the ‘consensus’ (we considered the most likely) and the ‘bad’ (escalation) scenarios.

Our scenarios have been rather accurate, and thus I decided to publish them here so that you could get a decent picture where we are heading.

We are also in a process of updating the Stages of the Collapse special report from December 2019. The updated stages will be published as a special report of the Q-Review series next month.

But now, the scenarios. This is unaltered text from the March Q-Review report.

The ‘consensus’ scenario

This scenario follows not just our own analysis, but also the narrative of some other institutions and analysts from a variety of public sources.[1] We believe that even in the case of a ceasefire, we would not see a rapid and complete retreat of Russian forces. This is because, as mentioned above, it has been a goal of President Putin to establish a land corridor to the Crimean Peninsula. He’s unlikely to yield on that. What this means that we would probably be facing a prolonged crisis between the two nations.

This would keep some pressure on commodity and energy prices for months to come, which has already provoked increasing inflation pressures, but price volatility also threatens global trade and a globalized economy in a more direct way. Commodity traders and logistic houses have been in a serious bind due to extraordinarily volatile commodity and freight prices. On March 8th, in a worrying and highly exceptional move, the main trade body of commodity traders and utilities in Europe, the European Federation of Energy Traders, pleaded for help from governments, the European Investment Bank, the ECB and the Bank of England due to “intolerable cash-liquidity pressure”.

The pressure is already visible in the bond markets where, for example, the bond prices of Trafigura, a commodity trading and logistics  giant, were in near free-fall in mid-March. This poses a serious threat to not just the world economy but societies across the globe, as everyone can imagine what would happen if global trade simply freezes. This is a remote possibility we have been warning about in our ‘systemic crisis’ scenario since December of 2018, but which now seems disturbingly possible.  In it, we speculated that the meltdown of global financial systems leads to collapse of derivatives trading through which, in one example, commodity traders hedge against freight risks. 

Our globalized economies would suddenly face an abrupt shortage of a large variety of food, necessities and factors of production. In a worst-case scenario, economies would simply collapse and revert back to the era before the first wave of globalization (early 19th century). We would face a reshuffling of our economies on an unimaginable scale. However, we consider that governments and official institutions will act to stop this from happening—simply because the alternative is so horrifying.

Moreover, exclusion of Russian banks from the SWIFT system and the “ring-fencing” of the Bank of Russia would probably be maintained as long as Russian troops remain on Ukrainian soil.  Thus, we would probably not return to normal anytime soon. What could this lead to next?

First of all, many sanctions would probably remain in place for some time however the conflict results. We would likely see upward pressure on prices across several asset classes, which could become broad and persistent. This would probably lead to a faster hiking cycle by central banks. The economy and the financial markets would eventually be unable to cope with a combination of rising rates and receding levels of artificial central bank liquidity as a result of tapering and balance sheet run-off by central banks. We would thus see economies falling into recession later in the year.

Asset and credit markets would turn very volatile and eventually crash. Banking problems would emerge due to rising rates and likely Russian defaults. We would head into an asset market crash and corporate bond crisis in the U.S. and to a banking and sovereign debt crises in the Eurozone (see below). It should also be noted that meddling with and even “weaponizing” the global financial and economic architecture, such as the SWIFT system, central bank transactions, and limits to trade, are likely to have many unintended, negative, unforeseen, and potentially long-lasting consequences.

What we aim to establish in this scenario, which we consider most likely, is that the shock that has hit as a result of war and sanctions will reverberate in the world economy just as the recent shock of the coronavirus pandemic and lockdowns did. They weakened European banks notably and produced increased inflation. In 2020, the weakness of the world economy was, again, masked by an enormous spending spree of debt stimulus and central bank credit issued through programs of quantitative easing QE.

Now those measures are in retreat. Everything that the war has put in motion may thus be enough to start the ‘multifaceted’ economic crisis we have been warning about for a year. Thus, the “consensus” and the “bad” scenario entwine such that while the “bad” scenario would be extremely detrimental for the world economy, the war may already have put forces in motion that will eventually push it into recession—or worse. So, we may be already heading into crisis, even though most do not fully understand it yet. That’s why the economic consequences of the “bad” scenario should also be carefully understood.

The bad scenario (escalation)

In the ‘bad’ scenario, the war drags on and eventually mutates into a very destructive guerrilla war which may include other nations as well. However, we are not forecasting World War III or any similar end-of-the-world scenario and will concentrate on economic outcomes.

If the war eventually drags on it would have serious effects on global food and energy prices, supply chains and naturally on the financial system. Wheat and other food exports from Ukraine would cease entirely, which would send global food prices skyrocketing. Disruptions in the production and exports of, e.g., semi-finished iron, potash, nickel and neon-gas would wreak havoc in the global manufacturing sector.

Other commodity prices would also rise, and supply chain issues would return—with a vengeance (there are already indications of this). Inflation pressures would start to build, dramatically, and inflation would reach double digits in 2-3 months and stay there. This would force central banks to implement emergency rate rises and to halt all bond purchase programs. Uncertainty and volatility in the financial markets could increase significantly.

Inflation in Russia would reach figures not seen since the breakup of the Soviet Union (hyperinflation). Russian banks would start to implode, leading to wide-spread knock-on losses, especially for already-weak Italian and French banks. As already mentioned, Russia currently has $150 billion worth of foreign-denominated debt. Just prior to the war the debt was investment-grade, which means that it was suitable to be held by conservative investors, like pension funds. A Russian default would thus produce a massive shock to the global financial system. 

Russia’s default and rising interest rates would hammer households and corporations on both sides of the Atlantic. A banking crisis would engulf Europe and a sovereign debt crisis would re-emerge in a massive way.  Italy would fall into a political crisis, almost certainly default and leave the euro. Greece, Portugal and Spain would follow—and then the eurozone finally fragments. And as the euro unravels, the world faces a currency crisis of epic proportions.

The banking crisis would quickly spread to the U.S. Fire sales in the junk bond markets would commence and spread to credit markets more broadly. There would be a corporate debt crisis, and the U.S. would, most likely, enter a deep economic recession or major depression.

Moreover, if Russian banks are completely barred from SWIFT, Russia would probably create disruptions in gas and oil exports, as a retaliatory measure. It would also become very difficult for western countries to pay for imports from Russia, which would, most likely, create unseen havoc in the global financial system and trade. In this instance, the economic worst-case scenario imaginable, i.e., the collapse of global trade and the world economy, described above, could actually happen.

As a result, the world economy would contract severely, and nations would succumb into a never-before-seen economic malaise with serious rioting and utter chaos. We do consider this scenario to be rather unlikely, at the time of writing at least.