The crisis in Ukraine has told us eight things about world markets and what is likely to drive them in coming months and years.
First and foremost, in recent months world share prices have been driven higher by the global liquidity created by the US quantitate easing and European Central Bank’s actions, so are now priced at levels that assume nothing is going to go wrong. That means they are vulnerable to sudden adverse events like the Ukraine crisis.
Second, the fact that Wall Street recovered some of its early losses and US Treasury yields fell shows just how resilient the American market has become to shocks outside its own economy.
Indeed as soon as there is a non-US global shock money comes running home to Uncle Sam, which is exactly what happened last night, sending US Treasury yields lower.
In former times a rise in oil prices would have created US jitters but America is on the way to self-sufficiency in oil. And Ukraine is a major wheat producer so the increase in the price of wheat also helps the US (as it does Australia).
Third, in this crisis gold is a major ‘safe haven’ beneficiary. That has not been the case in recent troubles. It feels good because it makes the Ukraine crisis appear “normal”.
Fourth, Australia will not see a rush of safe haven money but we also benefit from higher oil/gas and wheat prices. And so to the extent that a global crisis lifts the prices of commodities (and not all do) we benefit.
Fifth, and most importantly, we saw just how difficult it has become for countries, like Russia, to mount military actions.
Russia is now woven into the global economy in ways that simply did not exist a decade ago. And so we have seen the Russian currency and stock market plummet and it has been forced to lift interest rates. Russian banks have loaned heavily into the Ukraine so will need to be rescued if Ukraine collapses.
Given the crucial role the Crimea has to Russian defence, President Putin was never going to stand for an anti-Russian government being in control of the Crimean region. But in former times Russia would have moved into the rest of Ukraine. Russian generals, knowing they have the firepower to take Ukraine, will want to move on. But the economic consequences are holding President Putin back. Who will come out on top – the Russian military or the Russian banker? Maybe it’s my background, but my money is on the economy.
And just as there is a huge economic cost to Russia if it widens the conflict so it will not be easy for the US to repeat what happened in Iraq and Afghanistan.
Sixth, the simple fact is that the European community, Ukraine and Russia are interdependent. That’s why European markets were hit so hard. Russia provides a quarter of Europe’s gas energy and most of that gas passes through Ukraine on its way to Europe. Russia is very dependent on that revenue. Vladimir Putin, a ranking officer in the KGB at the time of the collapse of the Soviet Union, would be aware how profoundly weakened the USSR was by the steep drop in revenues when the price of oil dramatically dropped in 1985/6.
Seven, if it were to continue the Ukraine crisis would spread much more widely. A prolonged rush of money back to the US would trigger problems in many emerging countries and could cause a domino effect. That’s exactly what markets fear should the US taper gather momentum.
And finally there are other festering situations that may erupt in coming months/years – for example the fall in the Chinese currency will make it much harder to fund Chinese developments, which will affect demand for commodities; the Euro/European bank crisis still has a long way to run and the US taper’s effect on emerging countries is still untested.
For what it’s worth I think markets will force Russia to confine its military operations to Crimea and we will look back in the current crisis as a market correction that taught us a lot about the state of the world in 2014.