After the trade wars and pandemic depression, the West’s aggressive sanctions and US rate hikes will derail economic prospects around the world. The devastation has only just begun.
BEFORE the Ukraine crisis, the Biden administration promised targeted sanctions that would hurt Russia. However, the wider Russian economy, its people and the global economy would not be harmed. Yet, that is precisely what happened.
Ukraine is the way. The maximum sanctions were designed to fail the Russian economy (see my article “The Avoidable Ukraine Crisis, The Inevitable Global Blow”, TMT, March 14, 2022). American allies will take a heavy blow in Europe, but Asia will not be immune.
The global economy will bear the collateral damage. Developing economies will suffer the most. The recent shocks are a prelude to the global tsunamis to come.
Energy and food shocks
Commodities hit a high of 4,160 in early March and are up 42% year-to-date. Food prices hit a record high, almost 21% above their level a year ago. The United Nations had warned of a collapse of the global food system. At the same time, energy prices have soared on world markets.
Crude oil hit a high of $125 in early March and has risen to $114 a barrel, nearly 50% year-to-date. In Europe, the region most exposed to Russian energy, natural gas quintupled to peak at more than 250 dollars and oscillate around 108 dollars (99 euros). But these data are based on the assumption that energy security will improve, another naïve assumption (Figure 1).
FIGURE 1 COMMODITY SHOCKS, OIL AND NATURAL GAS COMMODITY OIL NATURAL GAS (EU)
Sources: Commodities: The Commodities Index; food prices: oil: crude oil; natural gas, March 25, 2022
Russia is the world’s 11th largest economy with $1.8 trillion. Given its key role in global energy supply, Goldman Sachs warned that the global economy “could soon face one of the greatest energy supply shocks of all time”.
If things don’t improve anytime soon, the global economy could be heading for a severe scenario, reminiscent of the OPEC (Organization of the Petroleum Exporting Countries) oil embargo. In the still possible worst-case scenarios, crude prices could climb as high as $200; a third more than in the summer of 2008.
United States: Slowing growth, stagflation, rising rates
In 2021, U.S. real GDP (gross domestic product) grew 5.5%, the fastest rate since 1984, as the economy continued to recover from the adverse effects of the pandemic. Wages rose at the fastest rate in decades, but prices rose even more, so the net effect was negative.
In 2021, most of the GDP expansion comes from increased inventory investment and spending on services. Over the past two years, the pandemic has reduced the potential for economic output. In the current year, GDP growth will slow as the level of fiscal support is lower and the economy is closer to peak employment.
Worse still, inflation turned out to be more rigid than expected as the Federal Reserve started cutting rates late in March 2020, ignoring early warnings from the World Health Organization. The second mistake occurred after mid-2021, when the Fed left ultra-low rates intact despite rising inflation. By last December, runaway inflation had climbed to 7%, the fastest since 1982. Now America faced low interest rates and high inflation: self-induced stagflation (Figure 2).
FIGURE 2 TWO POLICY MISTAKES: SOARING INFLATION LATE FED RESPONSE
Source: Bureau of Labor Statistics; Federal Reserve; Difference Group, March 25, 2022
In addition to rate hikes, the Fed will also begin to reduce its balance sheet, perhaps already in May, and these reductions could happen twice as fast as last time.
The painful consequences were predicted by Thomas Koenig, a former Fed Committee member, years ago. But they were ignored.
China: Hedging vs energy, food risks
At the start of the year, the Chinese economy, despite the threat from Omicron overseas, was still fueled by strong trade and investment data and further opening of capital markets. Foreign holdings of government bonds hit record highs, helping the yuan appreciate. Export-led industrial expansion and retail sales rebounded.
On the supply side, fiscal spending and government infrastructure investment have helped improve investment in fixed assets. As policies have been refined in the housing markets, the aim has been to facilitate the completion of pre-sold homes and support new purchases.
Despite strong vigilance, Covid-19 infections, due to fallout from Hong Kong, have led to the confinement of major cities, including Shanghai and Shenzhen in Guangdong province where factories account for nearly a quarter of exports.
Nevertheless, the government work report indicates strong support for the economy and fiscal spending. The central bank will further ease monetary policy. Premier Li Keqiang announced the new growth target for the year “of about 5.5%”.
China is promoting priority policy support to bolster the economy in the face of global headwinds. Some key investment areas will now focus on food and energy security.
Last year, more than half of China’s energy imports (nearly $425 billion) consisted of crude oil. Since energy imports are diversified, losses could be partially offset by cheaper imports from Russia, China’s second-largest oil supplier. Recently, Beijing and Moscow also signed a new 30-year $112 billion natural gas contract. Saudi Arabia, China’s biggest oil source, is considering accepting payment for some oil purchases in Chinese currency.
As the yuan has strengthened from around 7.18 in June 2020 to 6.37 per US dollar, this will allow China to secure imports of other raw materials at lower cost.
US Interest Payments: A Time Bomb
After trade wars, the pandemic depression, aggressive sanctions and rate hikes, the Biden administration has dramatically ramped up debt to pay for its multi-trillion dollar infrastructure initiative while spending ever more on trade wars. after September 11.
Markets are increasingly worried about a recession in the United States as soaring commodity prices, cuts in fiscal spending and rising interest charges threaten economic expansion.
As of December 2020, the White House has declared that aggressive indebtedness is tolerable as the burden of its service has diminished. But the advice was naive (see my “Contradictions of the ‘Biden Doctrine'”, TMT, October 25, 2021).
Here’s why: Net interest payments are becoming the fastest growing item in the US federal budget. It is an economic time bomb.
Within a decade, interest charges are expected to exceed 12% of the entire federal budget, while nearly tripling to $910 billion (Figure 3a). By 2050, the total sum of net interest expense is expected to exceed $60 trillion, as interest payments will account for nearly half of all federal revenue (Figure 3b).
FIGURE 3 INCREASE IN INTEREST COSTS
a. Net interest expense will rise sharply… Net interest as % of GDP, 2020-30 b… and absorb an increasing share of revenue Net interest as % of federal revenue, 1970-2050 Source: Congressional Budget Office ; Office of Management and Budget; Difference Group
Sanctions aggravate global risks
In the West, Russian economic sanctions are presented as a solution to the Ukrainian crisis with minimal damage to the global economy.
In reality, they will become globalized and thus greatly aggravate the negative impact of a regional war, which itself was avoidable, unjustified and preventable.
These negative spillovers are likely to undermine the near-term global outlook while contributing to unsustainable global risks over time.
Dr. Dan Steinbock is an internationally recognized strategist in the multipolar world and the founder of Difference Group. He has worked at the Indian, Chinese and American Institute (USA), the Shanghai Institutes of International Studies (China) and the EU Center (Singapore). Learn more at https://www.differencegroup.net/
This article is an updated and abridged version of a commentary posted by China-US Focus on March 22, 2022.
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