The markets, in denial of the nuclear risk

Following Russia’s unprovoked invasion of Ukraine, a nuclear conflict seems more likely now than in decades. Even if the probability of such a catastrophe remains small, that is no reason for asset markets to rule it out entirely.

NEW YORK – It doesn’t appear that the markets are considering all the risks of the Russian invasion of Ukraine in determining prices. The absence of negative responses in the equity, corporate and sovereign debt markets in Europe, Canada, the United States and Japan would hardly make sense even if there were no chance of the situation escalating into outright conflict between NATO and Russia. , but that is not the only real risk, it is also the threat that the conflict turns nuclear.

Outside Ukraine and Russia, the likely short-term economic and financial effects of Vladimir Putin’s war are substantial, but manageable, provided the conflict does not spread. The damage caused by a negative impact on supply would be transmitted mainly through the increase in the prices of basic products, mainly those of oil, gas, wheat, aluminum and strategic raw materials such as palladium and neon gas.

Even in this scenario of restricted conventional conflict, scarcity of fossil fuels, loss of export markets and occasional cyber-attacks will add to the stagflationary impact caused by the jump in commodity prices in Europe. And on a global scale, the product in the medium and long term will suffer from the bifurcation between a commercial and financial system centered on China and Russia, and another with nodes in the United States, Europe and Japan. In addition, risk-averse defensive reallocations of investments and other resources would further depress potential output as governments and corporations seek to increase supply chain resilience.

Global asset markets did not even factor in this less dire scenario when setting their prices. But if the war between Russia and Ukraine were to escalate into a Russia-NATO war, there would be a serious risk of nuclear conflict. One way to ensure that kind of escalation would be for NATO to establish a no-fly zone over Ukraine, as urgently requested by the Ukrainian government.

Although NATO and Western governments have imposed economic and financial sanctions on Russia and provided Ukraine with anti-tank weapons, drones, man-portable surface-to-air missiles and ammunition, such support does not constitute an act of war. Implementing a no-fly zone, however, would involve shooting down Russian targets. If NATO takes that step, it would be inevitable that the war would widen.

Even if this broader conflict were of a conventional kind, the result would be a regional human and economic calamity. The risk of a nuclear confrontation – using both tactical and strategic nuclear weapons – would be greater than at any time since the Cold War. The territories and citizens of all NATO member states would be at existential risk.

So far, NATO has flatly rejected calls for the implementation of a no-fly zone. He also showed restraint in his response to Putin’s nuclear war drums. On February 27, 2022, Putin placed nuclear forces on high alert, in response to Western sanctions and what he called “aggressive statements” by NATO powers. That same day, Belarus abandoned its non-nuclear classification and allowed Russian nuclear weapons on its territory. This escalation occurred on the heels of Russia’s extensive nuclear strategic exercises on February 19 and Putin’s televised speech on February 24, in which he announced the invasion, when he emphasized that Russia is still one of the world’s most powerful nuclear weapons states. powerful.

While those statements are probably bravado, they can’t be dismissed just like that. After all, accidents happen and the risk of a nuclear mishap increases when wielding a nuclear arsenal. On the other hand, although no rational agent would resort to nuclear force in the face of credible mutually assured destruction (MAD), perhaps the reliability of MAD can be questioned. Furthermore, rationality may be in short supply when it is most needed. Some observers questioned whether Putin kept all the powers from him and speculated that his isolation during the pandemic increased his paranoia.

As of January 2020, the Bulletin of Atomic Scientists’ Doomsday Clock stands at 100 seconds past midnight, indicating that the organization believes humanity is closer to a human-caused apocalypse than at any time since Earth. creation of the clock in 1947. This assessment depends mainly on nuclear risks, climate change and disruptive technologies. The clock is set once a year, that happened on January 20. Had they done so on March 1, the clock would undoubtedly have ticked down to midnight and the apocalypse.

The risk of nuclear war seems greater than at any time since the Cuban Missile Crisis in October 1962, or at least since NATO’s Able Archer exercise in 1983, when members of the politburo and the armed forces of the The Soviet Union interpreted the exercise as a front for a genuine initial nuclear attack and preparations for nuclear war. The impact of the Cuban missile crisis on US stock markets was minor: the S&P 500 index fell 7% and recovered almost completely when Soviet leader Nikita Khrushchev relented. The Able Archer incident was not made public until 2015, so the markets cannot be blamed for their lack of response.

Currently, the evidence that the markets have noticed the increased risk of a nuclear conflict is scant. The name of the game is “denial”.

The author

Willem H. Buiter is Associate Professor of International Affairs at Columbia University.

Copyright: Project Syndicate, 2020

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