By Graham Vanbergen – The Economic Times: It really would be nice to think that Putin’s attack on Ukraine will be short-lived and everyone goes back to doing what they were just as the world was starting to look up from a global pandemic. But whatever happens, one thing we are assured of – this is now wishful thinking.

Whilst Ukraine sat at 57th in the global league of world economies and Russia still only accounts for 3 per cent of global GDP even with its massive fossil fuel sales – the world order has changed overnight and there is a lot more bad news on the way, not just politically but economically.

First of all, economies are very badly affected by a lack of confidence. Capital flight and moves to safe-haven assets is just one reaction and governments will divert budgets, quite probably from social safety-nets towards military defence spending. There is no escaping the fact that the Russia/Ukraine issue will have serious consequences for the world economy as a whole for years to come.

The reality is that Putin has not just re-kindled the Cold War. The Western-led international order that comprised the USA and its allies are now being challenged by Russia, China, Iran and North Korea. This fracturing of the world order as we knew it will plunge the world deeper into a geopolitical depression of finger-pointing and acts of aggression.  The years ahead now look far riskier now than they did even when Donald Trump kicked off a new and heated economic rivalry between the US and China.

Geopolitically speaking, we know that China will be watching events in Europe very closely as Western values are being heavily tested. And although the tensions are different, it could be said that Taiwan is to China as Ukraine is to Russia. Economically though, the fracturing of globalisation will only speed up and capital will inevitably find a new home. In the West, that will be, for instance, the ratcheting up of new technologies to reduce reliance on fossil fuels. It goes without saying that in this more hostile environment the signs for the world economy look ominous. Inflationary pressures will continue and not be short-lived as many predicted – and there will likely be a period of recession in the near future. The spectre of stagflation now beckons

 

Predictions

Nouriel Roubini, Professor Emeritus of Economics at New York University’s Stern School of Business, is a former senior economist for international affairs in the White House’s Council of Economic Advisers during the Clinton Administration and has worked for the IMF, the US Federal Reserve, and the World Bank.

“In terms of the economy, a global stagflationary recession is now highly likely. Analysts are already asking themselves if the Fed and other major central banks can achieve a soft landing from this crisis and its fallout. Don’t count on it. The war in Ukraine will trigger a massive negative supply shock in a global economy that is still reeling from COVID-19 and a year-long build-up of inflationary pressures. The shock will reduce growth and further increase inflation at a time when inflation expectations are already becoming unanchored.”

The Editorial Board of the Financial Times writes:

“The Ukraine war amounts to a supply shock — reducing the capacity of the global economy to produce goods and services. Such crises hit growth while raising inflation. That is harder for central banks to deal with than a fall in aggregate demand when spending retrenches. Investors have long feared a return to the stagflation of the 1970s; few, however, anticipated that it would come alongside a return to war.”

Jason Furman, is a former chair of President Barack Obama’s Council of Economic Advisers, is Professor of the Practice of Economic Policy at Harvard University’s John F. Kennedy School of Government and Senior Fellow at the Peterson Institute for International Economics.

“The longer-term economic consequences for the rest of the world will be far less severe than they are for Russia, but they will still be a persistent challenge for policymakers. There is a risk, albeit a relatively unlikely one, that higher short-run inflation will become embedded in increasingly unanchored inflation expectations, and thus persist. If that happens, central banks’ already difficult job will become even more complicated.”

 

Consequences

In the immediate term, the consequences of the Ukraine invasion are plain to see. Stock markets are bouncing up and down – its overall trajectory is south. The result of the pandemic has seen global inflation rising, which it will continue to do. Energy prices will continue to rise as will the cost of food. Both can cause domestic problems for governments all around the world. Don’t forget a year of violent protests suddenly emerged in France over rising petrol/diesel prices and the Arab Spring was started originally because of rising food prices. Some of the signs of financial contagion and fear is that the usual safe-haven currencies such as the Swiss franc and USD will strengthen as will the price of gold.

It is inevitable that both recession and inflation, commonly known as ‘stagflation’ will hit Russia very hard. But the same stagflationary effects (on a less severe scale) will also affect the European Union as a whole, as it will the USA. Both are energy-dependent on Russia. The former is a physical requirement, the latter is not in control of global pricing. As jobs get lost and inflation continues its northward trajectory, households will do the inevitable and tighten their belts in expectation of harder times. Interest rates will rise to combat inflation. This will result in banks tightening financial conditions – which will see businesses look at how to save cash and significantly reduce R&D. The effects of stagflation are awful – and dangerous.

In its desperation to wrestle control over its self-induced economic spiral, Russia does have a card up its sleeve – it can reduce the sale of oil and gas merely to cause the price to spike and cause further economic pain to the West, whilst keeping income flowing.

 

1970s oil and energy crisis

The 1970s oil crisis and energy crisis caused global mayhem. That crisis led to stagnant economic growth in many countries as oil and gas prices surged. This is where the word ‘stagflation’ emanated from. And there were winners and losers as always. Fossil fuel producing nations do well, everyone else suffers. Both the 1973 oil crisis and the 1979 energy crisis were the result of some sort of conflict.

In Britain, that crisis caused GDP to decline by nearly 4 per cent for over four years. It led to social unrest, we had the three-day week and a state of emergency enforced by the government. Inflation rocketed off to 20 per cent and the IMF was called upon to help Britain’s finances. In just six years, Britain had four Prime Ministers, a winter of discontent and unemployment reached nearly 12 per cent in the early 1980s.

Whilst I am not predicting a renewed 1970s – what are facing today is potentially worse because geopolitical stability is threatened, not just a period of economic stagflation. But however we look at this, it is a cost we have no option but to absorb – it is the cost of defending Western values – of democracy and freedom. The alternative is a price too high to contemplate. We’ve already had conflicts on a global scale for these same reasons and one only has to look back to the real complications of geopolitical relationships that brought us WW1 and WW2 to see these dynamics playing out.

 

Dangerous moment

Many think that central banks now have the ability to manipulate markets to ensure stability. This was evident with their actions during the very sobering moments of the bank-led financial crisis in 2008/09. However, stagflation offers a very difficult dilemma to central banks – increase interest rates to curb inflation – and the economy gets hurt. It is also not so that central banks will work in unison as they did in the financial crisis because each region will have different stresses (differing values of net imports/exports in differing regions). The other problem for central banks is that in saving the banks that caused the crisis, and household incomes during the pandemic, they in turn have largely run out of the financial clout needed to stave off another global economic event.

In summary, Putin’s aggression has now sparked a new political and economic era – it is a pivotal moment. The geopolitical order is changing and the fight over political ideology is now becoming intense. The cost of the financial crisis was huge, the cost of the pandemic more so – and the axis of China/Russia/Iran and their allies has a renewed confidence. We are entering a global depression – economically and politically – and it may turn very nasty indeed. At the very least – all of this will be painful one way or another.