War in Ukraine: The Long-Term Impact

[For some reason, just because I’m German, everyone seems to think that I know the impact of the war in Ukraine on capital markets. I don’t. But I have a hunch. Here we go.]

Bifurcation of Economies

The war will affect the relationship of Western democracies with Russia. But, more importantly, also the relationships of each of their allies with each other. A new, thinly-vailed cold war will emerge. Neither side will want to admit falling back into terminology and long-gone patterns, associated with the old world. Russia will remain isolated from the West, its trade relationships seriously impaired — sanctions will only be lifted in a few corner cases that help marketing and spin of both sides (!). Europe will aim for energy independence from Russia and reduce its commodity imports. Most emerging economies will try to remain neutral, probably so to a comical level, seeking to avoid negative repercussions of any kind to their newly emerging economies and leaders. Some with deep dependencies will take strong-worded sides, but maybe not so strong actions. If Russia strengthens its alignment with China and charms more emerging countries, the world will become even more bifurcated, hurting international trade and global growth.

Return of Regional Networks and Economies

I have heard of institutional investors, family offices, and venture firms about their horror when assets of their (Russian) constituents and limited partners were frozen. You know who you are. The naïve were thinking “Thank god that wasn’t us.” The smart will think about any other regions, countries, economies, industries where assets might be frozen: LatAm? Cannabis? Layer-2 blockchains that stop trading certain tokens, or stop transfers to and from certain countries? .. and also of any other regions where assets might be “unfrozen” and trade resumes: Iran? Venezuela? Cuba? Portfolio rebalancing and “risk diversification” will happen, and at scale.

My auto shops and car part suppliers all were affected — not just because of Covid. The war in Ukraine compounded supply chain issues. Businesses with strong demand and a good product want to seize the opportunity: Diversify supply chains. Heightened interest in transparency of supply chains (who’s behind my supplier?). Simplify supply chains. Localize supply chains. New financial products (“swaps”) to mitigate risks.

Strong US Dollar

People forget that countries are investors, too. And that most long-term investors need reserves. Or collateral. As a single family office, I am having difficulties to find an alternative to the US dollar when it comes to stability and liquidity and variety of investment products.

As an owner of a jewelry business, gold is precious (no pun intended). One of my advisors said that “increased reserve manager interest may help gold resist the potential drag from real rates for longer” — which is a fancy way of saying that gold prices will go slightly up to keep in line with inflation rates (hence the “real” rate), especially when federal policy makers “take away the punch bowl”, as the saying goes.

Bifurcation of Energy Markets

Last year, a staggering amount of investment money has been raised in the name of decarbonization. Spending on oil and natural gas is down about 60% since 2014. In 2016, McKinsey wrote that we will peak oil demand by 2035 (but in more words). That, and policy changes, will be hard to reverse in the short term — good!

Emerging countries will become fig leaf testing ground for new energy innovations, while quietly ramping up fossil fuels and coal to meet a country’s demand for energy security and independence from Russia and its allies, at any cost.

First-world countries will be the (only?) beneficiaries of the best innovations in renewables and “next-generation energy solutions” … and if only to increase first-world dominance and control, under the (valid) guise of gaining independence from Russian oil and gas. You can’t raise a $10Bn Decarbonization Fund from US institutional LPs and old money and think there are no sentiments attached when it comes to where to spend that money (in the US, for the US).

… which also means that the old kings and king makers of oil and coal and gas will suddenly come up with “new innovations” (as opposed to … “old” innovations?!) for fossil fuel startups and companies, also under the (still-valid) guise of energy independence. That will be long-overdue investments and innovations, but they will leave me feel uncomfortable.

Increased Military Investments

Defense spending across European NATO members is set to increase to 2% of GDP. Much of the increase in spending will go toward hardware, with a particular focus on “modern warfare” (unmanned autonomous vehicles and flying machines (fixed/rotor), robot and robotic support. That will require massive innovations and creative sourcing for the supply chains (see above!) and software.

Politicians will feel more comfortable saying “Russia” instead of “Nation States”. Suddenly, dreaded cybersecurity statements that would have previously rocked the boat, are going to be en vogue. The Biden administration sets the tone in no uncertain terms: “Europe: Countering Russian Aggression — Recognizes Russia as an acute threat. Its government is pursuing a political, economic, and military strategy that seeks to fracture NATO.”

Office Of The Under Secretary Of Defense (Comptroller)/Chief Financial Officer, March 2022: UNITED STATES DEPARTMENT OF DEFENSE FISCAL YEAR 2023 BUDGET REQUEST (Overview), Slide 14 -- Europe: Countering Russian Aggression. Recognizes Russia as an acute threat. Its government is pursuing a political, economic, and military strategy that seeks to fracture NATO.
Office Of The Under Secretary Of Defense (Comptroller)/Chief Financial Officer, March 2022: UNITED STATES DEPARTMENT OF DEFENSE FISCAL YEAR 2023 BUDGET REQUEST (Overview), Slide 14

Biden’s budget request is earmarking $11.2Bn for civilian cybersecurity-linked spending, an 11% yoy increase, of which $2.5Bn is to be used for the cybersecurity and infrastructure security agencies (agency? agencies? DHL? hm…). On March 28, 2022, the DoD released the Military Intelligence Program (MIP) top line budget request for fiscal year 2023. The total is $26.6 billion and is aligned to strategic priorities of the Secretary of Defense (The overall requested national defense budget for FY2023 is $813.3Bn. And under the headline “Building Enduring Advantages — Innovation and Modernization”, the document requests “investments across the Department including funding for Responsible Artificial Intelligence, a top priority for AI [..] Establish the Office of the Chief Digital and Artificial Intelligence Officer”)

We’re back to the heydays of Cybersecurity.

Thoughts? Opinions? Comments? Corrections?