By Michael Every of Rabobank
The fog of war is now descending on Ukraine. Things are now likely to move *very* fast, but at time of writing: the leaders of the two breakaway Russian republics had sent official requests to Moscow for military aid against “Ukrainian aggression”; the city of Kiev had declared a state of emergency; the country was again experiencing major cyberattacks; the Russian military had closed all civilian Ukrainian airspace along the country’s eastern border --until 18 May-- warning it “may experience a high incidence of aircraft collision with missiles”; European airlines are being told Ukraine as a whole is now a “do not fly”; airports in Kharkiv, Dnipro, and Zaporizhzhya have had their runways blocked with tractors to prevent Russian paratroopers landing there easily; and President Zelenskiy gave a speech that had the feel of being one for the history books. Allow me to quote some of it below from live simultaneous translation on Twitter:
"Today I initiated a phone conversation with the president of the Russian Federation. The result was silence. Although it's the Donbas where there should be silence…We are divided by a shared border of more than 2,000km. Almost 200,000 of your troops and thousands of military vehicles are standing alongside it. Your leadership has ordered them to move forward, onto another country's territory. This step could be the start of a big war on the European continent. The whole world is talking about what could happen any day now… Any provocation. Any flare-up – one that could burn everything."
"They're telling you that this flame will liberate the people of Ukraine, but the Ukrainian people are free. They remember their past and are building their future… Ukraine on your TV news and the real Ukraine are two totally different countries. Ours is real. They told you I'm ordering an attack on Donbas, to open fire and bomb indiscriminately… to shoot at whom? to bomb whom?"
"I'm speaking Russian, but nobody in Russia understand what these places, streets, and events are. This is our land and our history. What are you fighting for? And with whom? Lots of you have relatives in Ukraine, you studied in Ukrainian universities, you have Ukrainian friends. You know our character, our principles, what matters to us. Listen to yourselves, to the voice of reason.”
“The people of Ukraine want peace. The government of Ukraine wants peace. It's doing everything it can. We're not alone. That's true, lots of countries support Ukraine. Because this isn't about peace at any price. It's about peace, principles, justice, international law, the right to determine your own future. This is about society's right to be safe and people's rights to live without threats. This is all important for us and for the world. I know for sure that this is important for you too.”
“We know for sure that we don't need war – neither cold, nor hot, nor hybrid. But if troops attack us and someone tries to take away our country, our freedom, our lives, the lives of our children, then we will defend ourselves. We will defend ourselves. When you attack, you will see our faces, not our backs. War is a great misfortune and it comes at a great price. People lose their money, reputation, freedom, living standards, and most importantly – they lose their loved ones and themselves. Nothing's ever enough in a war, but there's more than enough pain, dirt, and death. Tens of thousands of deaths.”
“They're telling you that Ukraine could be a threat for Russia. That never happened in the past, it's not, and won't in the future. You demand security guarantees from NATO. We demand guarantees of our security. The security of Ukraine. From you, Russia, and the other guarantors of the Budapest memorandum. We aren't in any defensive alliances. Ukraine's security is tied to our neighbours' security. Today we need to talk about the security of the whole of Europe. But our main goal is peace in Ukraine and the security of our citizens, Ukrainians. We will tell everyone, including you, in different formats, in any venue."
"War will take guarantees away from everyone. Nobody will have security guarantees anymore. Who will suffer most of all? People. Who doesn't want that to happen more than anyone? People. Who can stop that? People. These people are among you. I'm sure. Activists, journalists, musicians, actors, athletes, scientists, doctors, bloggers, stand-up comedians, TikTokers, and many others. Ordinary people, simple people, men, women, the old, the young, fathers, and most of all - mothers. Just like the people in Ukraine. Just like the government in Ukraine. However they try to convince you otherwise.”
“I know that Russian TV won't show my speech. But citizens of Russia need to see it. They need to see the truth. The truth is you need to stop before it's too late. And if the leadership of Russia doesn't want, for the sake of peace, to sit at the table with us, maybe it'll sit at the table with you. Do the Russians want war? I'd love to answer that question. But the answer only depends on you – citizens of Russia."
I hope the hair on the back of you necks is standing up, as Zelenskiy had been a consistent voice trying to downplay the risks of Russian invasion. Meanwhile, Russian state TV are showing a map of Ukraine that only names a small central region of the country as “Ukraine”, with the rest of its territory titled “Gifts from the (Russian) czars; gifts from Lenin; gift from Stalin; gift from Khruschev.” The messaging is clear. And, no, the Russian people who see that will not also get to hear Zelenskiy’s call for them to rise up in protest – but it will be taken as a further attack by a paranoid Moscow after what happened in both Belarus and Kazakhstan.
In short, just as we flagged a month ago, it appears we are headed for a serious war in Ukraine starting as soon as today. Given the failure of Russia to achieve any of its political goals vis-à-vis Ukraine, except a lack of NATO membership that was already unlikely to ever change, this only raises the strategic imperative to use more military force. Indeed, if war starts then we won’t have seen a Russian operation on such a scale since the Second Chechen War of 1999-2000. Here are some images of that to sober you.
We have already shown what this is likely to mean for markets: further downside for equities; and for bond yields - and another huge problem central banks don’t understand and cannot control; huge increases in key commodity prices; higher inflation (only NOW about Ukraine!); lower economic growth; and in FX, a stronger US dollar and JPY, a far weaker ruble, and while CNY will remain pegged to the US for now, one wonders how other EM FX will fare as prices soar. But this is just the start.
Will we see more biting sanctions as a result of these actions? The ones we have already seen were either deliberately designed to scare, not hurt, or were drawn up by people who don’t understand Russia at all. If we stick with milquetoast measures, Russia is unshaken; if we impose harsh sanctions, markets are shaken. Which is it to be? Consider this current Russian military move has been slow and deliberate. That means it has planned out all possible Western responses and likely costs. Are they factoring in that the West won’t sanction them, or that they can thrive even if they do?
If Europe’s borders are now to be redrawn by force, so will geopolitics be. Poland and Lithuania now back Ukraine for EU membership. Of course, the West of the EU will reject that for many reasons – but intra-EU tensions may rise at this lack of solidarity at a time of crisis. Finland’s PM has just flagged it may join NATO. Again, this leaves Russia in a far worse national security position – unless it can achieve a major victory in Ukraine that won’t come via posturing or a de minimis attack. China’s looming strategic decision is also clear, as noted yesterday. Despite censoring all of Putin’s attacks on Lenin’s errors this week (which are taboo: Mao broke from the USSR after Khrushchev broke from Stalin over Marxist ideology, and Vietnam censored the news too), Beijing is so far blaming this all on the US for supporting Ukraine, which has parallels that should be clear.
If Europe’s borders are now to be redrawn by force, so will geoeconomics be. Aside from sanctions, long just-in-time global supply chains tried to shrug off the US-China trade war; then Covid; now they have to deal with war. How long until governments enforce supply-chain ‘resilience’ on firms that opt to do the complete opposite of taking out economic insurance and so leave the entire national economy more vulnerable while they make higher profits? e.g., on-shoring or shortening supply chains; having multiple import and export markets; and/or limiting dealing with states/entities that are well known ‘risk points’. In peacetime, the answer might be “they won’t, because markets”; in wartime, is that still true? We shall see, but the historical track record is pretty clear - national security wins by knock-out. And what of governments that have actively supported such non-resilient business strategies “because mercantilism”? How long until allies lean on them “because national security”? Think of what just happened to Nord Stream 2, and what we argued about Germany’s existential choices in ‘“Ich Bin Ein Berliner”(?)’.
Expect a risk-off day in markets. Expect major volatility. Expect the fog of war: known and unknown unknowns, fake news, false flags, and even censorship can all be expected; sadly, so can “pain, dirt, and death”. And don’t expect this to be resolved by the end of the day, or the end of the week, or the end of the month.