6 Economic Consequences Of A New Cold War
Opinion: Energy, defense spending will rise; Europe, Russia will slow
by Matthew Lynn
Russia has effectively annexed the Crimea. The United States and the European Union are now planning sanctions, asset freezes and visa bans, as they attempt to punish President Vladimir Putin for expanding his territory. The discussion in the market is of a new Cold War, a long period of heightened tension between East and West.
The assumption is that it would be very bad for economies and markets. In fact, that is not necessarily so. The last Cold War, which ran from 1946 to 1989, coincided with a long period of economic expansion.
Still, a new Cold War would profoundly change the way the global economy works. It would have six likely immediate economic consequences, including a big hit to the European economy, rising defense spending, and more support for embattled emerging markets. The calculations investors make about which countries and sectors to back will change, sometimes dramatically so.
You can argue about whether the Crimea should have been part of Ukraine in the first place, and you can debate whether its people voted freely to re-join Russia, or were bullied by their larger neighbor. But there is little question that the aggressive nature of Vladimir Putin's regime has been exposed. The period of peaceful co-existence between East and West that lasted for two decades from the collapse of the Berlin Wall looks to be coming to an end. Tensions will rise, and the threat of conflict will hang over the global economy.
In fact, that need not necessarily be catastrophic for growth. While hot wars destroy economies, cold ones can help them - or at least, don't destroy them.
Certainly through the 1950s and 1960s, growth was strong and wages grew more rapidly than they have done since the Soviet Union collapsed. The bull market that ran from 1949 to 1955, as the Cold War got underway, was the third longest in U.S. history.
What it will do is change the way the global economy operates. Here are six ways that will start to happen.
1: The European economy gets even worse
Russia is not a huge economic success, relying too heavily on natural resources. But it is still the eighth biggest economy in the world and it is right on Europe's doorstep. EU-Russia trade had grown from $90 billion 10 years ago to $335 billion now. That has helped European companies at a time when their domestic market has been struggling. Exports to Russia account for 0.6% of European gross domestic product. It is not a huge amount, but at the margin it is important. If sanctions are imposed, and trade barriers go up, that is going to suffer - and the European economy will suffer with it. [Related ETFs: VGK, EZU, FEZ, IEV, FXE, EFA, EWG, EWU]
2: Energy prices will rise
Europe is heavily reliant on Russian oil and gas. As much as 40% of Germany's gas comes from that one country, and 50% of Austria's. Sanctions won't mean anything unless they include energy - Russia hardly exports anything else.
Even if there is not an outright ban, the rest of the world is certainly going to start reducing its reliance on Russia. If supply goes down, the price will go up - that is one of the most solid laws of economics. Geopolitical turmoil in the Middle East in the 1970s created the oil shock of that decade. East-West conflict could do the same 40 years later - with the same catastrophic consequences. [Related ETFs: XLE, OIH, XOP, IYE USO, UNG, DBO, OIL]
3: The Russian economy declines
Vladimir Putin has done nothing for the Russian economy, relying instead on natural resources controlled by his cronies to keep the country afloat. Growth was already flagging and was forecast at only 1.5% for this year - not nearly enough for an emerging market.
Sanctions and visa bans are only going to worsen that - how many foreign firms are going to want to invest in Russia in the next few years? Not only is that bad for the global economy in itself - emerging markets such as Russia that are meant to be leading global growth - but it will create yet more turmoil. Poor countries are unstable, and that means more trouble ahead. [Related ETFs: RSX, ERUS, RSXJ, RBL]
4: Defense spending will rise
Since the end of the Cold War, all Western nations have steadily reduced their defense spending. Take the U.K., for example. When the Berlin Wall came down, Britain was spending 4% of GDP on defense. Now it is less than 3%. That may sound a modest shift, but one percentage point of GDP represents a lot of money. If Russian territorial aggression has to be contained, then that is inevitably going to have rise. That will be good for defense industries, and may well have lots of hi-tech spin-off - defense spending helped expand economies during the last Cold War. The trouble is, it comes at a time when deficits are already vast, and governments can't afford to spend more. [Related ETFs: ITA, PPA, XAR]
5: More Quantitative Easing
We have already seen a big drop in global holdings of U.S. Treasuries since the Crimea crisis started - no one knows why, but the speculation is that Russian money has headed somewhere it can't be frozen. In a tense, divided world, money doesn't flow as easily as it does in a peaceful one. But without foreign inflows, governments in nations such as the U.S., the U.K. and now Japan can't finance themselves. The fix? Get the central bank to print money, and buy the bonds instead. It is the only way to stay afloat. [Related ETFs: TLT, UUP, BOND, XLU]
6: Strategic Economies Get Support
In Greece, the far-left Syriza Party is now ahead in the polls, and may win the next election. After the Cold War, strategists stopped worrying about countries like Greece falling to the far left. But now? Russia has always eyed the country as a close ally, mainly for its ports on the Mediterranean. If geopolitical rivalries are back, no one is going to let Greece go bust - it is too important. The same is true of Turkey, which controls access to the Black Sea. And Egypt, with the Suez Canal. Any nation of geostrategic significance will get bailed out, just as they did in the 1960s and 1970s. [Related ETFs: GREK, TUR, EGPT]
Some of those trends will help the global economy, some will hurt it. But those are the six big themes to watch if the Cold War is back - and right now, it looks as if it is.
Courtesy of MarketWatch