Economic consequences of the Ukrainian crisis

March 06, 2014

| MoneyRates.com Senior Financial Analyst, CFA

It is difficult to write about the developing situation in the Ukraine while the wheel is still very much in spin, but no event so far this year threatens to have as big an impact on the economy and investments as Vladimir Putin's attempt to exert control over his smaller neighbor.

As things stand now, Putin seems to have backed off incursions into the Ukraine beyond the Crimean region. The latter remains under his effective control, however, and seems headed toward breaking away from the rest of the Ukraine as either a separate, Russian-aligned state or part of Russia itself.

Economic implications

Unless there is some dramatic, peaceful reversal of the situation, here are some possible economic outcomes:

  1. A drag on global growth. The European Union and the U.S. are threatening economic sanctions against Russia, and Russia is threatening economic retaliation. That typically means slower growth all round.
  2. The specter of inflation. Russia already has made a habit of using its gas exports to Europe as economic blackmail. Ramping up that tactic would be inflationary, and oil supplies could also come into play if the conflict escalates.
  3. Other storm clouds. China has long threatened to act on its territorial disputes with Japan and Taiwan. If Russia gains Crimea virtually without bloodshed, what is to discourage China from asserting its claims in a similarly aggressive manner?

The Russian stock market fell sharply in immediate reaction to the crisis. If investors continue to flee, that may be the strongest incentive for Russia to moderate its position.

Impact on stocks, bonds and savings accounts

The U.S. stock market's reaction to all this was wildly negative one day, than bizarrely euphoric the next. The first reaction may have been more on the money.

Unless Putin pulls all the way back from the brink -- that is, not only withdraws Russian troops but also stops supporting separatists in Crimea -- this situation is going to have consequences. Sanctions will be exchanged, and the world will anxiously await the next land grab, whether by Russia or some other nation.

As noted above, the economic consequences are likely to be slower growth and higher inflation. That is a bad recipe for stocks, bonds and savings accounts:

  1. For stocks, slower growth will keep a lid on earnings. Meanwhile, a rise of inflation will hurt stock valuations by pushing up interest rates.
  2. For bonds, rising inflation would mean rising yields. Bond yields only rise one way: by having prices fall.
  3. Savings accounts have not even been able to keep up with a low rate of inflation. The situation in the Ukraine could accelerate inflation, while slower growth would continue to hold bank rates back.

Ever since the financial crisis and the Great Recession, the global economy has been in a fairly fragile state. To twist an old simile, Putin's adventures in the Ukraine may prove to be like letting an angry Russian bear into a china shop.

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