Russia and economic warfare: RIP the free market new world order

It is a quarter of a century since the Berlin Wall came down. The cold war was eventually won by superior western economic power and a new era began once the communist regime collapsed in the Soviet Union and the two halves of Germany were reunited.

For the first time in 25 years, the west is seriously worried about Russia. Ukraine's president, Petro Poroshenko, said at the weekend his country was "close to a point of no return – full-scale war".

Russia faces the threat of tougher economic sanctions from the US and the European Union unless it withdraws its troops from eastern Ukraine.

Economic warfare has the potential to damage Russia just as it did in the 1980s. Indeed, sanctions are hurting the economy, making it more expensive to refinance loans and almost impossible to attract the foreign capital needed to modernise Russia's energy sector. Growth has slowed to a standstill and the country will soon be in what could be a deep and prolonged recession.

If this of concern to Vladimir Putin, he has yet to show it. With the eurozone itself teetering on the brink of a fresh downturn, the Russian leader believes that in a war of sanctions between a west that is barely out of recession and a Russia accustomed to belt-tightening, it will be the west that blinks first. Whether he is right or not, one thing is clear: the era that began with the opening of the iron curtain is over.

Consider what happened when the Soviet Union collapsed. Instead of two great powers, there was now just one: the US. Instead of two competing ideologies, there was just: capitalism. "We know what works", said the then US president, George Bush, "the free market works".

The next decade was the heyday for Bush's vision. Capitalism spread to parts of the world where it had previously been partially or totally off limits: China, India, and Russia. The dollar entrenched its position as the global currency. The Federal Reserve in Washington became the world's central bank.

The completion of the seven-year Uruguay Round of trade talks saw tariffs reduced and markets opened up. A supra-national body, the World Trade Organisation, was set up in Geneva to act as the global trade policeman and to facilitate further liberalisation.

Russia was subjected to shock treatment that saw economy shrink by 40% by the end of the 1990s. Male life expectancy plummeted. Privatisation delivered what had been seen as state-owned assets into the hands of oligarchs who got enormously rich. The poverty rate soared.

In the west, the demise of the Soviet Union was felt in two ways. The obvious impact was that the end of the cold war delivered a hefty peace dividend. It was no longer necessary to spend as much money on defence, and governments were able to recycle part of the budget spent on combatting the perceived threat of the red army on tax cuts or other domestic spending priorities.

The UK today spends 2.3% of national output on defence: at the end of the 1980s it spent 4% of GDP. Over time, though, it also became apparent that the existence of rival ideology had helped to smooth some of the rough edges of capitalism. Once the Soviet Union was no more, capitalism could show itself in its true colours, red in tooth and claw. For a few years, this was not immediately apparent as the flood of cheap goods from the new emerging markets meant low inflation and allowed western central banks to keep interest rates at levels low enough to generate booms in house prices.

But once a model based around cheap credit and excessive borrowing hit the rocks, it also became clear that the new unencumbered variant of capitalism also meant outsourced jobs, falling living standards and welfare cuts. None of this has been popular, which is why so many governments have been kicked out since the financial crisis began.

Politicians have got the message. They have come to the conclusion that in a tougher climate it is really a case of looking after your own interests no matter what the costs for everybody else. So, to take one example, for the unipolar world to work properly the Fed has to take seriously its responsibility as the global central bank. That means taking care that policies such as quantitative easing and the eventual normalisation of US monetary policy is conducted in a way that is sensitive to other countries. Yet Fed policy is being conducted solely with American interests in mind. If quantitative easing leads to a surge of hot money into emerging market economies and the end of QE leads to it surging out again, then that's too bad.

QE has also been used as a way of trying to secure a competitive advantage. Central banks achieve this by electronically printing more money. One of the basic laws of economics is that the price of something goes down if the supply goes up. Increasing the money supply leads to a fall in the value of a currency, making a country's exports cheaper. So, when the Japanese, for example, announced that they were adopting policies designed to drive down the value of the yen, this was the equivalent of announcing that it was slapping a tariff on foreign goods. This is the equivalent of the competitive devaluations seen in the 1930s, only in a more subtle form.

Free trade has also been a casualty. After 12 years of negotiations, the WTO finally thought it had clinched a modest deal in Bali in late 2013. This involved cutting trade red tape, making customs procedures more efficient and rooting out some of the more egregious examples of corruption. It was, in truth, the least the WTO could deliver while retaining its credibility. In late July, the deal was scuppered by India. Unless New Delhi has a change of heart, the Bali deal is dead, leaving the WTO a broken-backed organisation. This is a world in retreat from multilateralism.

Although Putin has no alternative ideology to offer, times have changed. This is now a messier, less clearly defined, multipolar world. It is not just that the pre-eminence of the dollar has been challenged by Russia's announcement that roubles and yuan will be used in the oil deal it has brokered with China. It is not just that we are back to spheres of influence. It is not even that governments have become more interventionist and protectionist. It is that after the convulsions of the past seven years, it is hard to imagine a US president or indeed any western leader saying: "We know what works, the free market works."

So RIP new world order. Born Berlin 1989. Died with Lehman Brothers September 2008. Laid to rest eastern Ukraine August 2014.