The human toll of Russia’s invasion of Ukraine is shocking and incalculable. It’s hard to think of Putin as anything but a monster.
There’s also an economic cost. Putin is destroying Ukraine and as for what he’s doing to Russia, that can only be described as financial suicide. Then there’s the harm he’s inflicting on the rest of the world, including the U.S.
Russia’s invasion — and now the added concern about a broader conflict and even WMDs — throws a massive shadow over the global economy. It’s a watershed event really, with BlackRock CEO Larry Fink writing in his letter to shareholders he believes “the Russian invasion of Ukraine has put an end to… globalization…”
The specific impact of the conflict is actually up for debate — with huge consequences for government officials, investors and the rest of us. The question can be boiled down to this: Is inflation the primary economic concern of the invasion (as war drives up prices of oil, wheat oil and fertilizer)? Or is it a drag on the global economy, (as war slows down business activity)? Or both?
Consider Fed chief Jay Powell. Before the Ukraine crisis, the Fed was fixated on fighting inflation — which had leapt 7.5% in January. As such, there was a consensus expectation the Fed would raise its benchmark rate by a hefty 50 basis points (or half of one percentage point). But once Putin barged into Ukraine, uncertainty gripped the financial markets and the expectation dropped to a quarter point hike, which is exactly what Powell announced on March 16.
Talk about a juggling act! To better understand Powell’s dilemma, let’s first look at how the conflict is pushing up prices and inflation. For starters, Russia’s economy, the 11th largest in the world behind Italy, Canada and South Korea, really isn’t that important globally, except for some key sectors. To wit: check out this chart that shows Russia’s market share of an array of commodities.
Note these numbers are broad brush. Take Russian oil and gas exports. The chart reads 8.4% for oil and 6.2% gas, but that underplays the potential impact here as Russia supplies about a quarter of Europe’s oil and 45% of its natural gas. Beyond that, the price of oil is up sharply this year from $75 to $110, in large part because of fears of constrained Russian supply.
Now let’s look at palladium where Russian exports account for 45% of global supply. Palladium, a highly precious mineral (33% more valuable than gold), is used in catalytic converters to reduce auto emissions (note it is not used in EVs) and other industrial uses. So far this year palladium prices are up 30%.
As for nickel, yes the chart says 5%, but Russia supplies 20% of the world’s purest or class 1 nickel, which is used to make steel and increasingly batteries for electric cars. Supply has been very tight with prices doubling over the past two years — even before the Ukraine invasion. Nickel speculation went so wiggy the London Metals Exchange recently suspended trading. Meanwhile, Elon Musk says Tesla has been looking into manganese-based batteries as an alternative.
Russia is a major wheat producer too and here again prices are up, up and away with futures 47% higher year to date. We should add Ukraine to the mix, as it is also a significant exporter of grain and the world’s number five producer of corn. And did you know, Ukraine and Russia are the number one and two producers of sunflower seeds and sunflower oil with over 50% of the market?
Julia Friedlander, director of the economic statecraft initiative at the Atlantic Council, says the global implications of reduced Russian and Ukrainian grains “could have dramatic ramifications for countries in North Africa and the Middle East, even in parts of Asia. As prices for these commodities rise around the world, that’s going to lead to inflation in less stable markets as well. That is definitely something to watch.”
Russia is also a major global supplier of fertilizer particularly to Brazil, which uses it to produce soybeans, coffee and sugar. The Green Markets Fertilizer Index has doubled over the past year and is now at an all-time high, which will almost certainly result in higher food prices. (See this excellent Wall Street Journal article.)
Now let’s look at how Putin’s invasion is a drag on the global economy as it causes businesses to reduce investment and consumers to curb spending. “We think there’s an enormous threat,” says Dana Peterson, chief economist at The Conference Board. “We downgraded our forecast for the global economy. We originally had 3.9% growth for this year, then lowered it to 3.5% — that’s almost half a percentage point.”
As for the U.S. specifically, consensus is the damage won’t be severe as we have energy aplenty and strong consumer demand. (Capital Economics says oil prices would have to exceed $200 to produce a recession in the U.S.) Still Goldman Sachs recently lowered its 2022 GDP forecast for the U.S. by a tidge from 2% (already on the low side) to 1.75%.
And yes, you can have inflation and slow growth at the same time. In fact Peterson says one can lead to another: “Higher inflation will eat into consumer demand,” she says. “And if you have less demand, that means reduced consumption and that’s going to reduce GDP growth.”
That’s called stagflation, which we endured in the 1970s and which Mohamed El-Erian and former Treasury Secretary Larry Summers think could happen again.
It’s an incredibly fraught and complex environment, and not just for the generals and political leaders. Of course there are some beneficiaries in these dark times. Defense stock ETFs ITA and PPA are up nearly 10% year to date, while the overall market is down some 5%. As so often is the case, when war stocks fare particularly well, millions endure strife, misery and worse.
This article was featured in a Saturday edition of the Morning Brief on March 26, 2022. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe
By Andy Serwer, editor-in-chief of Yahoo Finance. Follow him on Twitter: @serwer
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