The potential parallels between current events in the Ukraine and those that led up to the outbreak of the First World War 100 years ago are so superficially obvious that they may seem too trite to mention. The two cases are clearly far from similar. Nonetheless the recent crop of new historical analyses of how the world stumbled into war in 1914, when coupled with the latest events in Kiev and the Crimea, do prompt some thoughts about the way that modern financial markets assess risks and react to potentially low probability, high impact events.
The first is simply that while global crises often have obvious trigger points, their causes are rarely as simple or as uni-faceted as contemporaries choose to think, either at the time or in hindsight. In The Sleep Walkers, his critically applauded book about the origins of the First World War published last year, Christopher Clark, a distinguished Cambridge University professor, makes the point that the Treaty of Versailles, which at French insistence placed all the “blame” for the start of the war on the Kaiser and the German state, helped to colour perceptions of how the war came to take place for at least a generation.
In reality, as Prof Clark shows, any textured account of how a single dramatic event, the assassination of Franz Ferdinand by a Serbian student revolutionary, was somehow allowed to morph into a four-year war that claimed millions of lives right across Europe has to take a more subtle, less judgmental approach. He goes to draw what I thought was an interesting parallel with the Eurozone banking and debt crisis of 2011-12. That crisis, he writes, was in truth “a present-day event of baffling complexity”, just as the lead up to the First World War had been.
“The leading actors in the Eurozone crisis, like those of 1914”, he goes on, “were aware that there was a possible outcome that would be generally catastrophic (the failure of the euro). All the key protagonists hoped that it would not happen, but in addition to this shared interest they also had special – and conflicting – interests of their own. Given the inter-relationships across the system, the consequences of any one action depended on the responsive actions of others, which were hard to calculate in advance, because of the opacity of decision-making processes”.
In the case of the euro two years ago, political leaders in Europe were saved at the last minute from the outcome that many of them feared by the decisive intervention of a relatively recently appointed (and usefully unelected) newcomer, Mario Draghi, the head of the European Central Bank. The protagonists of 1914, in contrast, had no such helping hand. They were, in Prof Clark’s vivid phrase, “sleepwalkers, watchful but unseeing, haunted by dreams, yet blind to the reality of the horror that they were about to bring into the world”.
Whether or not you agree that the failure of the euro would have been a catastrophe, let alone that the consequences can be sensibly compared to the horrors of the Great War, the point of the analogy is that it is not difficult to imagine how, despite the best intentions of those involved, the outcome of the crisis could well have been different, given how many principals were involved, and the multiple conflicting interests that needed to be accommodated before a solution could be reached. (As it is, as one policymaker recently put it, Europe seems to have found a way to “manage the euro crisis, but not to resolve it”).
Will Russia’s intervention in the Crimea turn out to have large and serious consequences as well? It is clearly impossible to know for sure at this stage. True to form, the financial markets sniffed the initial danger of military escalation after last weekend’s events, but recovered as diplomatic initiatives appeared to be leading towards a more peaceful solution. While gold edged up a little, bond yields and other safe havens barely moved. It was almost back to business as normal within a couple of days.
But then historical experience again reminds us that financial markets are rarely as sensitive as they are cracked up to be at anticipating future events, particularly geopolitical risks. Another fascinating book about 1914, Richard Roberts’ Saving The City, tells the largely forgotten story of how the London financial markets seized up completely within a matter of days in July 1914, prompting a rescue by the Government and Bank of England that was every bit as dramatic and wide-ranging as the 2008 experience.
The truth is that the outbreak of war in 1914 took the City and the global financial system almost completely by surprise. On 23 July, nearly a full month after the assassination of Franz Ferdinand, Lord Rothschild, the senior partner of the London branch, was telling his partners across Europe: “There is a general idea that the various matters in dispute will be arranged without an appeal to arms”. The war, said the head of Barings, “came like a lot from the blue and nobody was prepared”, reflecting the near universal complacency of bankers and brokers about the imminent disaster.
By the end of that same week in which Lord Rothschild made his comment, war had broken out and the financial markets in London, then the centre of the global financial system, had gone into meltdown. The price of Consols tumbled, gold soared, 22 members of the Stock Exchange failed in two days, banks shut their doors for five days, the stock exchange closed (not to reopen for six months) and the entire credit system effectively imploded, prompting a dramatic governmental rescue.
Even if the Ukraine crisis can be calmed with a bailout, and some form of negotiated settlement, given the financial fragilities that are evident in many parts of the world, you certainly do not need to posit anything as extreme as war to worry about investor complacency today. A rolling series of political/economic crises, in Egypt, Cyprus, Syria, Turkey and now Ukraine, has been lapping at the eastern edge of the European Union over the last 12 months, while Europe faces its own economic problems without clear and decisive leadership. A historical perspective might suggest politely that in their all-consuming obsession with central bank liquidity and monetary stimulus, financial markets may once again be underestimating and underpricing a deeper systemic risk.
Jonathan Davis 