The Russia-Ukraine War Immediately Disrupted Supply Chains
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Geopolitical struggles impact investment outcomes
Geopolitical pressures might appear to be very slow moving, with little immediate impact on capital markets. That view seemed justified up until around a decade ago. The reality is that like climate change, great power rivalries resulting in escalating geopolitical pressures have now become immediate, direct and global in reach, but uneven in their intensity. Geopolitical considerations influence investment returns both directly and indirectly via their impact on policy direction in the affected countries.
In turn, policy direction sets the trajectory for economic development. Governments have historically tried to protect their economies from the “penalty” of offending big trade partners. Increasingly, this approach feels outdated and unsustainable. The acceptance of the new situation is evident in government policy—sanctions, trade barriers, tariffs and reducing cultural and diplomatic links—making it harder to transfer capital and restricting the movement of people between countries. These measures all constrain private sector companies and end up limiting earnings growth potential. Geopolitical imperatives trump economic logic.
For most of the last 40 years, investors have enjoyed a giant convergence trade. It was a convergence of economic policy direction, which led to a convergence of generally lower inflation and interest rates—generating higher trend economic growth rates—primarily through increasingly freewheeling globalization and free trade. The trigger for this benign cycle was in a generalized geopolitical view that the Cold War was over for good, and most could benefit. We did not question the long-term sustainability of this wonderland, because we believed that even long-standing ethnic/territorial resentments could be appeased by economic growth
Historical context provides the motivation
Coming on the heels of the pandemic, and as global supply chains struggled to cope with a re-opening in most countries, the Russia-Ukraine war immediately disrupted supply chains, spiked inflation, and drove many vulnerable countries to the brink of starvation.
For the Kremlin, there is no doubt that Russia has always been destined to be a great power. Children are taught this all through school, and the message is so persistent that it has become part of the cultural identity. It rankles the Russian government that it is not automatically seated at a top table with China and the United States in deciding how the world will be run. It rankles the current leadership, particularly because it is composed of siloviki,2 people with a security services background. Putin has been explicit at various times, most notably at the Munich security conference of 2007, where he laid out his rejection of the United States led “rules-based order” and his aim to restore Russia’s hegemony over the countries of the old Soviet Union. These views remain and appear unlikely to change, so the implication is that the war in Ukraine, which has in fact been going on since 2014, is going to be a permanent feature unless there is a radical change of leadership in Moscow. It should be noted, however, that even Putin’s opposition empathizes with at least a version of this view.
Economic heft quantifies the folly
Coming on the heels of the pandemic, and as global supply chains struggled to cope with a re-opening in most countries, the Russia-Ukraine war immediately disrupted supply chains, spiked inflation, and drove many vulnerable countries to the brink of starvation. Many countries that had limited resources to feed, educate and provide health care services for their citizens before COVID-19, are now faced with an increased potential of social unrest due to a combination of poverty, unemployment and inequality.
Russia’s biggest economic lever is its position as a significant producer of oil and gas. But the Kremlin spurned 20 years’ worth of opportunities to diversify its economy; so this strength is now a weakness. The country’s trajectory is to become a bigger version of Iran, structurally cut off from the West, and obliged to operate in the shadow world of sanctions avoidance. However, it has tacit support from Beijing, which sees Russia as a cheap source of raw materials and a useful “spoiler” on Europe’s doorstep—challenging the West and occupying bandwidth in Washington, DC.
The countries that have joined in sanctions against Russia account for 61% of world gross domestic product (GDP) versus 2.6% supportive of Russia or explicitly supporting Moscow.There is a further 9.4% that is described as “West leaning” and around 16.8% that is “Russia leaning”—clearly the largest of these is China, accounting for around 15% of world GDP. But for the Russian economy, the European Union was the single biggest trade partner and its main source of machinery and communications technology. The European Union, the United States, the United Kingdom and Japan together accounted for over 50% of Russia’s exports and 45% of imports before the Russia-Ukraine war.6 Economic logic did not prevail over ideology.
Most Russian manufacturing, processing and refining installations are dependent on replacement parts from Italy, Spain and Germany. The country’s oil and gas production are dependent on the specialist knowhow of Western oil services firms. The Kremlin has gambled that the West would be neither resolute nor united in the face of threats to cut off Russian gas and oil exports. This dependence is a significant weakness, in our opinion.
