In 1914, Europe found itself embroiled in what was to be a quick war, over by Christmas. In February 2022, many expected Russia’s invasion of Ukraine to be over within a month. There are echoes between the two situations, explains Harold James, professor of history at Princeton University. “And we now know that this war will not be over by Christmas either,” he adds.
For most Europeans, the fallout is not directly military but economic, and both sides weaponize finance against each other. The West has imposed economic sanctions on Russia, which, in turn, is cutting off gas supplies to Europe. Inflation and a looming energy crisis are the new realities of life.
At an extensive discussion chaired by Xavier Vives from IESE, organized for the European Finance Association (EFA) on the Barcelona campus in late August, James was joined by Nicholas Veron (from Bruegel and the Peterson Institute for International Economics ), Lucrezia Reichlin (London Business School) and Elena Carletti (Bocconi University) to dissect the situation from various historical and economic perspectives – taking into account the financial effects so far, the possible evolution of the situation and the difficult reconciliation of energy security and climate objectives.
First results of the financial sanctions
Veron pointed out that the Russian Central Bank’s reserve freeze marks the first time since the construction of the financial system that a central member of the Bank for International Settlements (BIS) has been subject to sanctions by the BIS itself. What is also striking is the remarkable coordination between countries in adopting these sanctions – not only the United States and the European Union, but also countries like Switzerland, Monaco and San Marino. “It’s remarkable and tells us something about what’s possible,” says Veron. Fellow panelists James and Reichlin also noted the unanimity of the Western response in support of Ukraine, though they pointed to potential fragmentation and disagreement going forward.
The results of these financial measures – freezing of reserves and decoupling of Russia from the SWIFT payment system – are still difficult to assess with certainty. Veron argues that they could actually stabilize the system by presenting a united front to an invasion that was a violation of global norms. “Even China obeyed,” he said. “It sends a strong message.”
And yet, on another level, these measures have been destabilizing: politicizing supposedly neutral issues, such as banking relationships, and exposing that neutrality to be a lie. “It’s not just Russia’s point of view,” Veron said. “Many agree.” (See, for example, “Collateral Damage of War: The End of SWIFT as We Know It.”)
How does the crisis find the EU?
Lucrezia Reichlin considers that the position of the European Union in the face of this crisis is weak. The crux of the matter is energy and geopolitics, and she finds Europe ill-prepared as an importer of energy and as a conscientious fighter against the climate crisis. For example, as Bocconi’s Elena Carletti points out, banks may need to refinance coal as an alternative to Russian gas before renewables can truly take over as secure sources for Europe’s needs. And Green Deal commitments mean that EU members are not supposed to fund such dirty forms of fuel.
“The war will have both short-term and long-term economic consequences,” Reichlin said. Although at present there is much concern about the depth and duration of a recession, the long-term consequences are ultimately more important, as energy and climate policies are essential to the long-term functioning of the world. EU.
“During decades of low energy prices, Europe has forgotten the importance of energy. Europe’s ability to manage energy security and not renegotiate the commitment to the Green Deal will be very important in understanding where we are going.
For Reichlin, this presents the EU with “the sobering realization that a common energy policy is an indispensable complement to the common green agenda”. And that requires staying savvy in terms of global geopolitics, including maintaining good relations with China, a key supplier in the renewable energy supply chain.
Banks weather the storm
Carletti’s remarks focus on the role of European banks in the current conflict. Contrary to Reichlin’s pessimistic outlook on EU preparedness, Carletti points out that his banks, at least, entered the current crisis with higher scores in terms of capital and liquidity compared to the global financial crisis of 2008.
Nevertheless, there are challenges. Inflation could force banks to take on even higher operating costs, especially if they implement much-needed investments in digital and IT now. These areas are becoming increasingly important given the increased risks of cyberattacks as a result of the Russian war.
And while Carletti accepts that exceptional global cooperation resulted in the imposition of sanctions against Russia, operationally, she says, it has not resulted in identical sanctions across the board. The same language has not been used by different countries to describe what the sanctions should accomplish, which has led to variations in interpretation. “Before, the banks were very used to dealing with sanctions coming from the United States” Now the waters have become muddy. Will we see banks being fined in the future for failing to meet the complexities of a Canadian or Japanese sanction?
Second-quarter banking results were broadly, and perhaps surprisingly, positive, but Carletti points out that there is still great uncertainty: how much caution will be needed going forward? Only time and the geopolitical situation will tell.
Who will blink first?
Global cooperation in these early days of crisis response is mentioned and welcomed by all participants. But not everyone believes it will last.
James in particular feels that the conflict has become a waiting game, with each side trying to hold out until the other implodes. For the West, the risk comes from inflation and energy shortages, which, if prolonged, can erode government support and ultimately cause a disintegration of the united front against Putin. Still, it’s unclear whether Putin can wait long enough. Economic sanctions, military setbacks, the brain drain in Russia, and general desperation over the long-term prospects for young Russians could initially contribute to regime change.
Underlying all the current worries was the nagging reality of a scorching European summer that is the backdrop for the cold winter to come. With the climate crisis looming, unity, creativity and focus are needed on a large scale.