How Ukraine Could Affect European Debt Crisis

There has been much written and discussed about the current situation in Ukraine and how the ensuing sanctions could affect the Russian, Ukrainian, and European economies.  A European study was leaked to the press recently that showed almost 1% of GDP could be shaved from Germany if Europe restricts Russian gas imports and levies level three sanctions, which could also include restrictions on other sectors.

Yes, sanctions will hurt all involved; however, the real issue is how this geopolitical conflict and tension, due to events in Ukraine, could impact Europe’s exit from the 2008 debt crisis.  Europe is far from being out of the woods on this issue.

The reality is that countries like Greece are still hurting badly from the crisis and the ensuing austerity imposed by the Troika, or the ECB, IMF, and EU.  Although Greece recently tapped the bond market for the first time in several years, the underlying fundamentals of the economy are still quite fragile.

The southern, peripheral economies of the European Monetary Union are very afraid of the economic consequences of sanctions on Russia and vice versa.  Level three sanctions which boycott large sectors of the Russian economy will bring only more pain to these financially insolvent nations.  The economic damage could negate any positive benefits that have been created by the ECB getting involved in the bond market and purchasing sovereign debt, or printing money.

At any rate, a deeper conflict in Eastern Europe would almost ensure the ECB will ramp up another round of QE; they have already been making noises that this intervention is being considered.  This action would dig Europe’s financial hole even deeper.  At some point, as in the U.S., all of this money has to be taken out of the economy.

At its core, the crisis in Ukraine has highlighted an even greater truth in geopolitical strategy.  Machiavelli famously said, “It’s better to be feared than loved.”  The conflict has reiterated the historical truth that economic weakness leads to military weakness.

Due to the high cost of the European welfare state, Europe has neglected its regional security for too long.  It has become dependent on the United States for its protection and now America is economically weak as well.  The Kremlin is sitting on over half a trillion dollars in foreign currency reserves and has almost no debt.  Yes, sanctions will have an effect on their economy and standard of living, but they have several years to reorganize their customer base and turn to the East to sell gas.  Europe and America no longer have a safety net.  History repeats itself and now the fruits of the West’s financial mismanagement have come full circle.

It remains to be seen whether Europe can even come to an agreement on sanctions if Putin decides to destabilize the May 25th elections in Ukraine.  If they cannot stand up to the face of Russian aggression, Europe is finished as a political force.  This could further weaken the region’s economy as confidence in the Euro will be undermined as well.  Confidence in NATO will also be damaged.

The decades of Western fiscal neglect and living beyond its means has led to the current security problem for Europe.  Now the piper has to be paid; the bill is due.  The West must deal with its fiscal insolvency once and for all and live through the pain that will definitely ensue.  There will be further economic suffering, due to the crisis in Ukraine, for all involved.

The alternative to dealing with the problem is to see Europe, NATO, and the West in general fall into further decline that may be irreversible.  Russian president Putin is famous for playing the long game.  He sees the weakness emanating from Europe and the United States as well.  Perhaps he will just bide his time and wait for the self-imposed economic crisis in the West to deepen and he will have further attempts at a bite at the apple.

L. Todd Wood is a former emerging market bond trader.  His thriller novel, Currency, deals with overwhelming sovereign debt.