Hello, and welcome to our latest video MacroMemo. There’s quite a bit to cover this week.

We won’t be speaking to a wide range of subjects, though. It will be very much focused on the Russia-Ukraine conflict, and so its military development, the sanctions that have arisen, some of the risks in terms of where this might go from here. And then a little bit closer to home—market implications, the economic implications, and some long-term thoughts as well about how this conflict may well have multiyear repercussions.

But first, a very quick handful of words on a few other matters, just to set them aside. And so the first would be on the COVID-19 front. Broadly speaking, the numbers are still mostly improving, and certainly much improved relative to a few months ago. I can say the new BA.2 sub-variant, while seemingly more contagious than Omicron, is not obviously triggering major new waves at this juncture. And so that is very much a positive.

On the real-time or on the economic data front, more broadly, I can say the real-time data does suggest we’re continuing to see some happy rebound after a bit of a low in the December and January months. And with specific regard to Canada, I can say anti-government protests are largely over. It seems to us the economic damage was fairly small, if not zero. And more broadly, a lack of action in Canada’s currency and sovereign bond market suggests the country hasn’t suffered any lasting international reputational damage.

On to Russia-Ukraine. And so let’s begin with the military development side of the equation, and with, of course, the caveat that this is all changing very quickly indeed, and so this could well prove stale quite quickly. The conflict has been brewing, I suppose, for years. Of course, Russia invaded Ukraine in 2014, but it then took several significant steps forward over the past week or so. And so the first was Russia’s official recognition of two breakaway regions in Eastern Ukraine. The next was the announcement that Russian troops would be formally installed in those breakaway regions. And in fact, at that point, you could say, really not that much had truly changed as there was Russian support for those regions, and they were effectively recognizing them even beforehand.

But then things did begin to change. And so, Russia clarified and indicated it intended to claim the entirety of the two Eastern provinces in Ukraine, as opposed to just the rebel-held areas, and so that suggested some bloodshed would result versus Ukrainian troops. Then Russia invaded, not just that part of the country, but indeed from every direction, nearly from the north, east, and south, and seemingly with an intent to capture a pretty large fraction of Ukraine. And so the war scaled up quite quickly.

Russia has made significant advances. It should be acknowledged, Ukraine has put up a fierce resistance, and perhaps those advances have not come quite as quickly as Russia had anticipated. But in the end, it does still seem more likely than not that Russia manages to capture the major cities of Ukraine. Holding them may prove somewhat more challenging, given a highly armed Ukrainian population, a highly motivated Ukrainian population. And so perhaps the best conclusion this non-military strategist can reach is that a clean, clear resolution doesn’t seem likely anytime soon. We’ve seen the West and NATO not actively support in the sense of entering the conflict, but support in the form of providing weapons to Ukraine, and maybe of greater relevance, providing economic sanctions against Russia. And so we’ve seen sanctions applied against Russian elites, against Russian banks, against the Russian Central Bank, against the provision of technological goods to Russia. And Russia actually has then imposed some capital controls of its own which limit the ability for foreigners to pull their money out, but again, further separates Russia from the rest of the world. In terms of where this could go from here, well, anyone’s guess is probably not a bad statement, but escalation is an obvious trend. And so, Russia attacked with greater vigour than anticipated. The West has now applied sanctions, perhaps with greater vigour than Putin had anticipated. And so, the military conflict could easily intensify from here. In fact, that’s a pretty good guess, as it stands right now.

Russia, maybe in a worst-case scenario, has aspirations of recreating something approaching the Soviet Union or historical Russia, and so you could envision perhaps other countries being in the crosshairs as well. It seems unlikely that Russia has the capacity to pull all that off, but Putin has been underestimated so far; certainly, his aspirations have been.

From an economic standpoint, maybe the central risk is that Russia could withhold certain of its commodity exports, and in particular, Russia exports a lot of oil and gas and wheat and other key commodities. And that would be highly problematic for the global economy. You’d see massive inflation and massively higher energy costs, in particular.

Maybe one other risk worth mentioning is that of financial contagion, which is just the extent to which Russian banks suffer, the extent to which Russian government debt is thought at risk of defaulting now. In fact, it’s trading at about 30% of its normal value. There could well be contagion into banks elsewhere in the world, though I would say it’s far from sure that there will be major problems from that. And the banks exposed are mostly European banks.

From a financial market perspective, I can say certainly markets weaker, for the most part. Russian equities are down in the realm of 40%; Russian currency is down around 50% compared to October levels; and commodity prices, of course, much, much higher; risk aversion in general dominating, so risk assets like equities and credit, some weaker than they had been before.

In all of that, as much as there is great uncertainty and certainly the risk of missteps, we do tend to see opportunity. And so, we note that stock markets are down, in part for Russian-related reasons in part over the last several months. And so stock markets are cheaper than they were.

We’re also aware, having conducted fairly extensive studies, that geopolitical events usually see markets bottom fairly quickly, in fact, surprisingly quickly relative to the beginning of these events. We often see them rebounding fairly quickly within a matter of weeks to months as well. And so all else equal, we are inclined to take a little bit more investment risk as opposed to a little bit less, despite the obvious challenges and tragedies surrounding this Russian-Ukrainian conflict.

Let’s move now to the economic implication side, so this is closer to home for an economist like me. And I can say, clearly, the Ukrainian economic damage is enormous. We’re seeing physical infrastructure destroyed, you’re seeing electricity outages, and it’s hard to fathom very much economic activity being generated at all. You have Ukrainian men broadly conscripted into fighting. You have many other people fleeing. And so the Ukrainian economy is, of course, devastated. And even when this war eventually ends, there will be a lot of rebuilding that’s necessary. And so the biggest and most horrific economic damage is to Ukraine.

Russia, though, suffers quite extreme economic damage of its own. Those sanctions do bite in a significant way. And so it seems very likely to me that the Russian economy will not just be in recession, but pretty deep recession across the span of 2022.

And as much as there’s a lot of uncertainty as to the military outlook in all of this, I can say there’s also uncertainty on the economic side, but for different reasons, in the sense that it seems unlikely that sanctions on Russia will be lifted anytime soon. The war could end tomorrow and, likely, Russian sanctions would persist for quite some time. And so that’s where the damage comes to the Russian economy.

But the big question is, what happens to the rest of the world or the global economy? And as much as there are many, many relevant channels here, I think the most relevant is via commodities, and so commodity prices and the availability of commodities; most importantly, energy and food. And so there is a fair amount of damage that comes from that.

And optimistically, you could say that, with commodity prices where they are now, which is elevated, that perhaps global growth loses about a quarter of a percentage point in 2022. The eurozone might lose half a percentage point; it’s of course, much more exposed to Russia.

However, if you want to envision worst-case scenarios and the supply of energy being cut off to Europe and things like that, which is far from certain, you could be talking about, in a worst-case scenario, as much as a percentage point chopped off global growth; as much as 2 percentage points, perhaps, chopped off European growth. And that then starts to question whether Europe could even grow in 2022. So there are fairly high stakes here.

We’re taking a middle view right now, which is to say, we’re looking for about three-quarters of a percentage point chopped off European growth, taking it from about 3.7 to 3% growth. We’re thinking something in the realm of a quarter percentage point off for the U.S. and Canada, still north of 3% growth. Canada affected less because it makes oil, it makes wheat, it actually is hurt less than a lot of other countries. But the situation clear is obviously quite fluid, so I wouldn’t want to pretend I’m putting too much precision. These numbers are written in pencil, not pen.

I will say as well, the recession risk obviously higher than it was by virtue of lower growth and higher uncertainty. And so, some models were saying a 10%-or-lower recession risk for the U.S. for 2022. I would have to say it feels to me like it’s more like a 25%-type number these days.

I can say from an inflation perspective, we should expect inflation to peak at a higher level. And so, previously, we thought U.S. CPI would peak around 7.5%; that’s about where it is right now. We think maybe 8.5% peak instead makes more sense.

And it does raise some extra questions as to whether inflation can come down quite as tidily over the second half of the year. This has to be described as, at least in part now, a negative supply shock as the availability of some commodities goes away. And those can take longer to resolve; those can be a bit more pernicious. And so, we still think inflation comes down, but maybe we’re not quite as certain in that conviction as we were as of a few months ago.

Lastly, let me turn to some long-term thoughts. And so there are quite possibly rather significant long-term repercussions from all of this. And so the first would be, the Cold War appears to be very much back. You could argue there was already a cool war, perhaps, between the West and China, so perhaps it’s not brand new, but nevertheless, a cold war is back.

And from an economic lens, I can say, really what that means is you get cliques of countries forming, international institutions weaken, and all of that is to the detriment of global trade and global growth. So you just lose a little bit from the global economy over time.

I can say that Russia and China seem more likely to be linked up. China has been less critical of Russia than many other countries. There has been a trend toward those two countries coming together as both receive criticism from the West. China’s in a position to consume more Russian energy. China’s in a position perhaps to furnish more loans at a time that the West is not able to or not willing to provide those loans. So, a closer connection there. It feels a little bit like the 1950s and ’60s on that front.

China perhaps more tempted to take Taiwan than in the past. That’s been a long-standing aspiration. Of course, there would be huge consequences if that happened, to the extent that sanctions on China would do a lot of economic damage to the world. And Taiwan produces many of the world’s most sophisticated computer chips and electronics, so that would be a much more problematic scenario than Russia-Ukraine, if it arose. I will say though, at least one betting market is arguing the risk is still no more than about 10% for 2022. But it is a higher risk, I think, than it would otherwise have been.

On the flip side though, NATO has strengthened. NATO was questioning its relevance not that long ago, and so NATO no longer doing that. Other countries interested, perhaps, in joining NATO; NATO countries increasing their military spending. Germany set to nearly double its military spending after having a moribund military for a very long period of time. And fiscal deficits will be a little bit bigger as a result of that as well.

I think the risk of nuclear proliferation is higher. Belarus is now talking about acquiring nuclear weapons; it’s a Russian ally. Other countries obviously noting Ukraine was not able to prevent attack; it doesn’t have nuclear weapons. Russia able to do just about what it likes; it does have nuclear weapons. And so, unfortunately, this could be a period of greater nuclear proliferation.

And then I’ll finish just with a quick thought on energy trends. And so the most obvious comment is, this is a scramble for Europe. It is heavily reliant on Russia for natural gas and oil. For the moment, it’s getting that, but it’s not certain it will receive its normal allotment going forward. In fact, we think it’s likely that some fraction of Russian energy exports will fall toward Europe and toward the West; not completely, but some fraction. And so that is a challenge for Europe.

In the short run, you can argue all of this is actually anti-green. So Europe will revive coal plants, will perhaps, in the German case, revive nuclear plants, which some think are clean, some aren’t; that its own debate. So in the short run, not good for green energy. The U.S. less focused on its own green initiatives, as Biden seeks to pursue lower energy costs and gas costs in the U.S.

But in the long run, we can say that’s conceivably better for green energy in the sense that Europe is now very much focused on energy independence via green energies. And so, Germany committing to achieving that by 2035 instead of 2040. And similarly, I can say that this period of high energy prices classically generates more innovation in the green space, more green technology in general, and so perhaps better for green over the long run. I’ll stop there. Lots and lots to think about. Clearly, a pretty key issue and pretty key theme for the foreseeable future. Thanks very much for sticking with me, and I wish you well with your investing.