With the fluid situation in Ukraine dominating the geopolitical narrative -- and rightly so -- many global investors are wondering what it means for their portfolios. Here are some key takeaways:
On a standalone basis, Ukraine is not systemically important. With a relatively small GDP (around $175 billion), its external economic links are limited, as is its role in global supply and demand chains. Indeed, other than gas pipelines form Russia to Europe, there isn't much that Ukraine buys, hosts, or sells -- whether physical products, services, or financial instruments -- that cannot be easily absorbed by the international economic and monetary systems. Moreover, its currency has little global reach; and the country's bond issuance is relatively small, with holdings unlikely to create real or technical financial market shocks beyond segments of the emerging world.
Yet Ukraine is in the midst of an unpredictable tug of war between East and West. This, of course, is the key issue; it is what makes Ukraine more systemic; and it is why investors are correct in seeking information about the situation there and how it may evolve. If the current course of action is maintained, the escalating geopolitical tensions among major world powers would end up by spilling over to financial markets. This is already occurring to some extent, illustrated most vividly by the sharp decline this morning in Russian equities and some generalized flight to quality in global markets.
No side, whether internal or external, is strong enough to impose its will at this stage. Absent overwhelming outside military intervention (whose outcomes would be far from certain, and its chaos would be considerable and inevitable), it is hard to argue that any single side is in a position to prevail decisively in the next few weeks. Russia does not have sufficient influence with enough of Ukraine to pull the whole country back into its orbit; and it cannot do so by force. For their part, the European Union and the United States do not have the means to decisively pull all of Ukraine the other way. And the reality of these external anchors means that a partly fragmented Ukrainian society is unlikely to resolve the tensions internally any time soon.
In favorable circumstances, calmer heads would prevail and iterate to a negotiated compromise. Given the cul de sac that all parties find themselves in, and if the issue were just Ukraine, both Russia and the West would quickly conclude that it is in their individual and collective interests to de-escalate the situation and reach a compromise. A negotiated resolution would be the base case. As such, they would also be able to establish some guardrails for opposing political forces within Ukraine. But there is much more at stake here.
Ukraine is but the latest illustration of a deeper geopolitical rift that has played out elsewhere, including in Syria. This inevitably complicates national strategies, while rendering multilateral cooperation much more difficult. It also makes it hard for all parties involved to resist the narrower agendas of domestic constituents -- all of which give rise to talk of sanctions, boycotts, and G-8 malfunctions.
Even under a set of most optimistic (and still-realistic) assumptions, the tensions over Ukraine will not be resolved in one or two rounds. If the immediate tensions subsides -- a big if -- we should still expect difficult Ukrainian issues to resurface over and over again in the next few months. As well as what we all observe publicly, competing external back channels could well fuel divisions within a Ukrainian society that, as yet, is neither able to return to its past nor able to forge a decisive new course.
In sum, global investors are right to be asking lots of questions about Ukraine. Importantly, the vast majority needs to do so in a broad context and, thus, immediately confront the most basic -- and, yes, most contentious -- question of all: Is Ukraine simply the latest example of a more disturbing general phenomenon of less effective global political coordination, and the tensions that inherently come with that?
I worry that the answer to this question is yes. If you agree with me, then overall geopolitical risk may not, as yet, be adequately reflected in some risk markets.
Mohamed A. El-Erian is the outgoing CEO and co-CIO of PIMCO.