Roubini: 6 Financial, Economic Risks of Russia-Ukraine War

Analysis February 25, 2022 at 04:06 PM Share & Print

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In late December, economist Nouriel Roubini warned that 2022 would “be much more difficult than 2021.” He predicted that “the surge of inflation would not be merely temporary” and that “looming geopolitical risks were becoming more acute.”

At the top of this list of risks was Russian President Vladimir Putin’s buildup of troops near the Ukrainian border.

With Russia’s invasion of its neighbor this week, “We now must consider the economic and financial consequences of this historic development,” according to an op-ed posted Friday by Roubini, chief economist at Atlas Capital Team and CEO of Roubini Macro Associates, for Project Syndicate.

Within the context of China, Russia, Iran and North Korea challenging U.S. global dominance, the world has “entered a geopolitical depression that will have massive economic and financial consequences well beyond Ukraine,” he said.

Overall, Roubini — who’s earned the nickname “Dr. Doom” for his often pessimistic predictions — sees a military conflict, or “hot war,” between the major powers as more likely over the next decade. Plus, the escalating cold war between the U.S. and China should make Taiwan more of a “potential flashpoint.”

Here are six risks Roubini sees ahead in light of Russia’s invasion of Ukraine this week:

1. A Stagflationary Recession

It’s possible that the financial markets and political analysts could “underestimate the implications of this geopolitical regime shift,” he pointed out.

On Thursday, the markets initially fell but then rose on the expectation that the war would “slow down the willingness of the U.S. Federal Reserve and other central banks to raise policy rates,” Roubini explained.

“But the Ukraine war is not just another minor, economically and financially inconsequential conflict of the kind seen elsewhere in recent decades,” he added. Before World War I, the economist says, analysts and investors mistakenly thought a major global conflict did not lie ahead.

Today’s crisis “represents a geopolitical quantum leap,” he explained. “Its long-term implications and significance can hardly be overstated.”

Overall, in economic terms, a global stagflationary recession is now “highly likely,” Roubini argues. In fact, analysts are currently concerned that the Fed and other major central banks may not be able to achieve “a soft landing from this crisis and its fallout.”

His own view: “Don’t count on it.”

This is because the Russia-Ukraine war “will trigger a massive negative supply shock” in the context of a global economy already challenged by pandemic-related problems and inflationary pressures.

“The shock will reduce growth and further increase inflation at a time when inflation expectations are already becoming unanchored,” Roubini said.

(Image: Shutterstock)

2. A Bear Market

The economist believes that the short-term impact of the conflict on the financial markets “is already clear.”

Given the “massive risk-off stagflationary shock, global equities will likely move from the current correction range (-10%) into bear market territory (-20% or more),” he explains.

This means government bond yields are poised to drop for a time. They’ll then “rise after inflation becomes unmoored.”

Oil prices will jump higher — to “well above $100 per barrel,” according to Roubini. Plus, many other commodity prices are poised to increase, too, since both Russia and Ukraine “are major exporters of raw materials and food.”

Set to strengthen are “safe haven” currencies like the Swiss franc, as well as gold, he says.

(Image: Adobe Stock)

3. Broadly Negative Global Impact

According to the economist, the painful economic and financial consequences of the war and its resulting stagflationary shock will be “largest in Russia and Ukraine, followed by the European Union, owing to its heavy dependence on Russian gas.”

Still, he argues, “even the U.S. will suffer.”

Rising global oil prices “will strongly affect” U.S. crude oil prices,” Roubini explains. While the U.S. is an energy exporter, the impact across the nation’s economy “will be negative” as households and businesses endure “a massive price shock, leading them to reduce spending.”

As a result, the “otherwise strong U.S. economy will suffer a sharp slowdown, tilting toward a growth recession,” he says. “Tighter financial conditions and the resulting effects on business, consumer, and investor confidence will exacerbate the negative macro consequences of Russia’s invasion, both in the U.S. and globally.”

Sanctions “inevitably will hurt not only Russia but also the U.S, the West, and emerging markets,” the economist adds.

There’s also the chance that Russia responds to new sanctions by, for instance, drastically cutting oil production to push up oil prices globally, according to Roubini.

(Image: Adobe Stock)

4. Exacerbated Stagflation or Recession

“A deep stagflationary shock is also a nightmare scenario for central banks, which will be damned if they react, and damned if they don’t,” he argues. For the sake of growth, central bankers are keen to delay interest-rate hikes or at least slow them down.

“But in today’s environment — where inflation is rising and central banks are already behind the curve — slower policy tightening could accelerate the de-anchoring of inflation expectations, further exacerbating stagflation,” Roubini explains.

At the same time, if they move to raise rates in a more hawkish way, “the looming recession will become more severe,” he says.

Fighting inflation entails higher interest rates, which raises the price of money and dampens the economy overall. “We have seen this movie twice before, with the oil-price shocks of 1973 and 1979,” Roubini states. “Today’s re-run will be almost as ugly.”

In this context, central bankers are likely “to fudge it, as they did in the 1970s,” he says. When the due eventually opt “for a slower pace of monetary tightening … this will de-anchor further inflation expectations.”

For its part, the U.S. probably will move to draw down its Strategic Petroleum Reserves and nudge Saudi Arabia to employ spare capacity. “But these measures will have only a limited effect, because widespread fears of further price spikes will result in global hoarding of energy supplies,” the economist insists.

At the same time, he believes that without a new nuclear deal with Iran, that country will move ahead with its nuclear program, resulting in higher tensions with Israel and a possible strike against Iran’s facilities.

“That would deliver a double-whammy negative supply shock to the global economy,” Roubini explains. “The upshot is that various geopolitical constraints will severely limit the West’s ability to counter the stagflationary shock inflicted by the war in Ukraine.”

(Image: Shutterstock)

5. A Fiscal Policy Fiasco

The West can’t count on fiscal policy “to counter the growth-dampening effects of the Ukraine shock,” he insists.

Many countries are now running low on “fiscal ammunition” due to their responses to the COVID-19 pandemic; governments have built up large deficits, and servicing this debt is set to become more costly as rates rise.

Keep in mind, Roubini says, “a fiscal stimulus is the wrong policy response to a stagflationary supply shock.” While it can reduce the impact of the shock, it also adds to inflationary pressure.

Furthermore, using both fiscal and monetary policy against the shock means “the stagflationary consequences will become even more severe, owing to the heightened effect on inflation expectations.”

Roubini points out that stimulus policies rolled out after the 2008 global financial crisis did not lead to inflation, since the source of that shock was on the demand side — meaning it was driven “by a credit crunch at a time when inflation was low and below target.”

Today’s situation, of course, is completely different, he explains: “We are facing a negative supply shock in a world where inflation is already rising and well above target.”

(Image: Shutterstock)

6. Pain Beyond Oil

While it’s tempting to believe that the Russia-Ukraine war is poised to produce just “a minor and temporary economic and financial impact,” he says, it’s dangerous to think this way.

True, Russia accounts for less than 5% of the global economy — and Ukraine much less, he says. “But the Arab states that imposed an oil embargo in 1973, and revolutionary Iran in 1979, represented an even smaller share of global GDP than Russia does today,” and the global economy faced serious and painful challenges at these times.

“The global impact of Putin’s war will be channeled through oil and natural gas, but it will not stop there,” Roubini explains.

He predicts “knock-on effects” that will “strike a massive blow to global confidence” in the midst of “the fragile recovery from the pandemic … already entering a period of deeper uncertainty and rising inflationary pressures.”

In other words, the economist believes the consequences of the Ukraine crisis — and the “broader geopolitical depression” it signals — “will be anything but transitory.”

(Image: Shutterstock)

(Cover photo: Bloomberg)