Global Markets and Economy Can’t Escape War in Ukraine

(Bloomberg Opinion) -- “If your life still feels normal, ask if you are doing the right things… .”

Scotland’s First Minister Nicola Sturgeon made this observation about fighting Covid-19, but it also provides a useful lens to assess economic and market reactions to Russia’s invasion of Ukraine and what may come next.

Tragically, life has been upended for those who were living in a peaceful Ukraine only a few days ago. Now their country is under intense military attack and creeping occupation. Many fear for their lives. Others have become refugees.

Sadly, none of this is likely to change soon, notwithstanding the numerous acts of courageous resistance that have inspired people around the world. If anything, Russia may be tempted to intensify its attacks, going full out to secure control of a good part of Ukraine; and the more it does so, the harder it will be to contain and reverse the significant damage on the ground.

The longer and fiercer Russia attacks Ukraine, the more the West will be pulled into responding, albeit avoiding direct military confrontation. An initial wave of sanctions on Russia started to give way over the weekend to more powerful ones, including the exclusion of certain Russian banks from the SWIFT international payments system and sanctions on the central bank.

By going after Russia’s international payments capabilities, the West is targeting a nerve center of economic activity. If applied comprehensively, these latest measures have the potential to cripple the Russian economy. But they also involve spillovers and spillbacks that will impact the global economy and its payments system.

As the West matches Russia’s aggression by ratcheting up its own measures, which I suspect is likely, it will have to navigate a host of consequences that go well beyond Russia, which will suffer the principal damage.

Growth will slow and inflation will increase worldwide. Companies with business in Russia are likely to face mounting arrears, as will creditors holding financial claims on Russian entities. Those relying on imports from Russia will suffer supply disruptions. And efforts to build alternative payments system, albeit partial at best, will get a boost from countries suspicious about the Western-dominated system in operation since World War II.

While the implications for the global economy and creditor-debtor relations are consequential, they take time to play out. As such, life may still feel normal in some quarters. But this is unlikely to persist if both Russia and the West are pulled ever deeper into conflict.

As for financial markets, given how they ended the week, one could be excused for wondering whether investors and traders are even aware of the deepening invasion of Ukraine. European and U.S. stock markets more than recovered what was a sharp but short selloff. Oil prices are no longer trading above $100 a barrel. Emerging-market bonds shrugged off the contagion from the crisis.

Such seemingly “normal” markets can be attributed to several factors, including some combination of low valuation, hope that central banks will be dissuaded from tightening monetary policy too much and long-term behavioral conditioning to buy the dip. Yet such normality will not be able to persist long if the situation in Ukraine worsens, if sanctions cripple the Russian economy, if arrears and debt restructurings mount, and if the economic and financial spillovers to the rest of the world are not contained.

Unless investors are confident that all four of these things will not happen, they would be well advised to take heed of Ms. Sturgeon’s observation.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is president of Queens’ College, Cambridge; chief economic adviser at Allianz SE, the parent company of Pimco where he served as CEO and co-CIO; and chair of Gramercy Fund Management. His books include "The Only Game in Town" and "When Markets Collide."

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