Echoes of Cold War

March 4, 2014

The building crisis in Ukraine has finally put markets on edge, with reports that Russia has massed troops along the border and has taken operational control of the province of Crimea. The Russia-friendly Prime Minister has fled the country, and the jostling between Western and Russian interests has intensified. After reaching new highs last week, U.S. markets have been falling this morning on news of the intensifying conflict.

So, what’s going on? The primary disagreement is on the future of Ukraine. One group, the one that ousted the Prime Minister, wants a Ukraine that increasingly partners with Europe on trade, politics and energy. The “old guard” was a much stauncher ally of Russia, and Russia does not want that partnership to end. After weeks of riots and street protests, the major powers are now getting involved.

What does Ukraine mean to markets? For Russian markets, Ukraine is important. It is one of the largest agricultural regions in the former U.S.S.R., and it has important energy infrastructure. This also makes Ukraine important to Europe. It is less important to the U.S., but from a geopolitical standpoint, the U.S. government would certainly prefer it lean toward Europe.

Will the crisis in Ukraine lead to a recession in the U.S? That is very doubtful. How about Europe? It’s possible, but still doubtful. For this to unfold, it would likely mean that Russia invades, or at minimum cuts off natural gas flows for an extended period. We would probably also need trade to be cut in some way or another, and even that might not do it. Any short, even violent, conflict is probably not enough to derail the global expansion.

Do you remember Cyprus? Yeah, Cyprus; that tiny island near Greece that caused markets stresses about a year ago? Remember how the talking heads on TV told us how a default by a failed Cypriot bank could have brought down a larger, highly-leveraged European bank, and that default would have caused contagion, eventually bringing down other, major European and U.S. banks, leading to another financial melt down? Yep, me too. Remember how that never actually happened? Yep, me too. What about the conflict in Egypt shutting down world oil trade? Me too.

If you watch enough news on Ukraine, you will be presented the disaster scenario where Russia invades, western powers blockade and sanction, more people die, war breaks out and the global economy crashes. While we never want to downplay human suffering at the hands of world leaders, we should also differentiate what it means to us as investors. Similar horror stories existed for Libya, Syria, Egypt, Georgia, Nigeria and others. Maybe it will get far worse this time. History suggests, however, that even if we have a quick sell off, investors and their portfolios will be fine over the longer term.

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