Three Ways the War in Ukraine Could Crash the Financial System

A siege of kyiv. The deployment of chemical weapons. Maybe even a tactical nuclear strike or a full-scale assault on one of the country’s nuclear power plants.

There are still many ways the war in Ukraine could get much worse than it already is. They are all pretty terrifying. And yet, there is also another threat, one that hasn’t even begun to be added into the potential calculus: a financial crash.

In truth, the markets have never experienced stress at these levels, or such violent price movements, without cracks starting to appear somewhere. The eurozone could soon begin to fragment, with the oligarch-dependent Cypriot economy in deep trouble, and potentially Malta as well.

Energy-intensive manufacturers may soon shut down as their costs become unsustainable; and we could soon be back in a full-scale sovereign debt crisis, with developing economies having to choose between buying oil and wheat and paying off their creditors.

One point is certain. We have only seen the beginning of the financial turmoil. It’s going to get a lot rockier over the next few months.

Three weeks after Russian soldiers began entering Ukraine, it is already clear that the invasion is becoming the biggest shock to the global economy since the Yom Kippur War in the early 1970s and the quadrupling energy prices that followed.

The Great Inflation, Dot Bubble, Financial Crash and Covid-19 already look like minor escapes by comparison.

One of the world’s major economies, and one of the biggest exporters of energy, food and raw materials, is being ruthlessly pulled out of the global economy, driving up prices and causing shortages of all types of basic products.

We will find out over the next few weeks how long the war will last. At present, it appears that the Russian advance has stalled and its army is about to be bogged down in a long and brutal war of attrition.

If so, Russia is unlikely to be re-admitted to the club of civilized nations anytime soon. The rest of the global economy will simply have to figure out how to function without access to Russian energy, grain and raw materials, just as Russia will have to figure out how to survive without Western capital, technology and expertise.

And yet, it is useless to pretend that it will not fracture the world economy. Where are the stress points? Here are three to watch closely.

First, the euro zone. All attention has been focused on how Germany is going to wean itself off Russian gas. But there are smaller economies that depend entirely on Russian money.

If anyone thinks London was a laundromat for oligarchs’ money, they haven’t paid attention to Cyprus. It is the offshore banking center of Moscow and St. Petersburg.

There has been over €100 billion in Russian investment in the island – with a population of just 1.2 million – in 2020 alone. Cyrus is also by far the biggest investor in Russia , because the money is recycled through its financial system in the country of origin (it “invests” almost 20 times more money in Russia than in Germany, according to data from the central bank of Moscow).


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Don F. Davis