Economy

Good morning. Ethan here; Rob’s off reeling in a big catch, hopefully.Monday was a brutal day in Ukraine. The latest reports are that Russia is shelling cities as civilians evacuate. The death toll, already grim, is climbing. Western nations are discussing a Russian oil import ban, so stocks fell and oil soared.Today, I look at two economic questions this war has posed. Disagree with me? Agree profusely? Email me: [email protected]. Are oil shocks inflationary?Shock and awe might not describe Russia’s invasion of Ukraine, but it certainly fits the reaction in commodities markets. Wheat prices are at all-time highs. Nickel is spiking. Oil brushed $139 per barrel yesterday, with some talk that it could yet reach $200.High inflation, uncontrolled energy prices, geopolitical turmoil — it’s a wide-open door for 1970s US stagflation comparisons. And former Treasury secretary Larry Summers walked right through it on Friday, telling Bloomberg TV that America faces “real risks of a 1970s-type scenario” stemming from an oil shock and excessive, inflationary stimulus.Federal Reserve chair Jay Powell’s congressional testimony last week was mostly boring. But in it, he too hinted at a stagflationary view of oil shocks. From Howard Schneider of Reuters:Under rough rules of thumb that Powell provided, the jump in oil from around $75 a barrel in late December to around $110 on Thursday, if it lasts, could add nearly 0.9 percentage point to headline inflation and cut nearly half a percentage point from economic growthThe idea is that pricier energy (and, to a lesser extent, other commodities) feeds into other prices and eats away at consumer spending, all while disrupting inflation expectations. Why would expensive energy unanchor expectations when little else has? Partly because everyone buys it, and partly because consumers are highly aware of energy costs. You probably know roughly what a tank of gas costs without checking.Indeed, US inflation expectations have moved uncomfortably high since the invasion:As we’ve heard ad nauseam lately, unmoored expectations risk an inflationary spiral where a cornered Powell has little choice but to choke the economy to sleep. But not everyone is so worried. Among the dissenters is George Goncalves, US macro head at MUFG, who told me it’s a bit overblown:I believe oil-induced inflation, if it persists, will likely be temporarily inflationary, but long-term it usually leads to a growth shock.Short-term inflation expectations are already reacting and it’s possible that consumer survey measures from the NY Fed will react too. However, things like 5y5y inflation measures won’t go unhinged. They did not during the Covid stimulus rounds of trillions of dollars of easing, so this oil move won’t have that big an impact on long-term views.The growth shock Goncalves mentions is probably disinflationary, as Evan Brown and Luke Kawa of UBS argued recently:In our view, an even larger spike in oil and/or natural gas prices would not kick off a sustained inflationary spiral. It is more likely that this would result in lower growth, and in turn lower inflation, before too long. Either spending more on energy would cause consumers to cut back in other areas, or central banks would aggressively tighten policy and crush the expansion — and by extension, inflation.If energy prices get high enough, demand will dry up as more money goes toward buying the same, or a smaller, amount of energy. That leaves less purchasing power for everything else. Or else central banks will get queasy at the short-term price shock. Either way, no spiral.Whether this disinflationary argument is right, the 1970s comparisons are certainly imprecise. At the time, inflation expectations were already elevated — about 4 per cent by one estimate — in the months before the 1973 energy shock. That is much less true now, which could explain the negative correlation between energy prices and core inflation (ie, excluding energy and food) over the past two decades.The tight labour market is where I’m least certain about what an oil shock will do. A crucial component of the 1970s inflationary spiral was labour’s ability to secure wage increases at the tempo of inflation. Post-lockdown market conditions have lent workers newfound bargaining power (though from a low base). There is some similarity here. You might imagine workers, sick of shelling out for expensive gas, demanding wage increases. I just don’t know if the effect is big enough to spark a wage-price spiral.Powell says he is watching the oil-inflation dynamic “very carefully”. As Covid-specific inflation fades, this could fast become the most important question in markets.How doomed is the dollar?Western sanctions against Russia have made money look political. Is the long-anticipated decline of the US dollar nigh? Jon Sindreu thinks its standing will at least take a body blow. Here’s Sindreu in the Wall Street Journal:Yet the entire artifice of “money” as a universal store of value risks being eroded by the banning of key exports to Russia and boycotts of the kind corporations like Apple and Nike announced . ..Indeed, the case levied against China’s attempts to internationalise the renminbi has been that, unlike the dollar, access to it is always at risk of being revoked by political considerations. It is now apparent that, to a point, this is true of all currencies.The risk to King Dollar’s status is still limited due to most nations’ alignment with the West and Beijing’s capital controls. But financial and economic linkages between China and sanctioned countries will necessarily strengthen if those countries can only accumulate reserves in China and only spend them there. Even nations that aren’t sanctioned may want to diversify their geopolitical risk.His prediction that sanctioned countries will turn to China looks plausible. Right after Mastercard and Visa fled Russia, four Russian banks announced plans over the weekend to forge relationships with UnionPay, China’s biggest card network. But as this argument grows popular, I wonder if it undersells the US advantage.As the international finance economist (and friend of Unhedged) Eswar Prasad wrote in Barron’s on Friday, China’s biggest disadvantage is its lack of independent courts or an autonomous central bank. These, alongside Beijing’s capital controls and the dollar’s usefulness as a funding currency, create a durable advantage for the dollar. For most global investors, the alternatives are worse. Sanctions don’t much change that.I wouldn’t be surprised if, as Sindreu suggests, the dollar’s position is slightly dented as some investors hedge geopolitical risk. Perhaps over time the dollar will suffer death by a thousand cuts. But for now its position remains about as secure as it was a month ago.One good readFor more dollar-themed reading, Adam Tooze in his excellent Chartbook writes that we’re seeing polarities, not blocs, forming in the global economy. More

Punitive sanctions unleashed by the west leave Russia increasingly economically isolated. They may have the unintended consequence of drawing Russia and China closer together. This could be accelerated by the two countries’ efforts to create alternative payment systems. But fears that it will give rise to a powerful new economic bloc look overblown.In theory, Beijing could provide the financial infrastructure needed to help Moscow bypass western sanctions. In practice, it is far from a straightforward process. The credit card payment sector is a case in point.Over the weekend, Visa, Mastercard and American Express became the latest companies to suspend operations in Russia following its invasion of Ukraine. Cards issued by the three companies in Russia will no longer work outside the country. Those issued elsewhere in the world will not be usable in Russia. Russian cardholders can still make domestic purchases, via the country’s homegrown card payment system, Mir. For international transactions, Russian banks say they are looking at issuing cards powered by China’s state-controlled card-payment monopoly UnionPay. But switching over to UnionPay will require the installation of new IT infrastructure and hardware. This will be difficult. More so if US technology companies continue to pull out of the country. UnionPay could become a target of secondary sanctions if it deals with sanctioned Russian companies.Similarly, China’s Cross-Border Interbank Payment System — Cips — has been touted as a way for Russian banks to ameliorate ejection from Swift. But the two serve very different purposes. Swift is primarily a messaging system. It is used by more than 11,000 institutions across 200 countries and allows banks to communicate rapidly, securely and inexpensively. Cips was created by China’s central bank to promote the global use of the renminbi. It is mainly used for settling payments in the Chinese currency. More than 80 per cent of its transactions rely on Swift for information flow.Cips is also a smaller network compared to Swift. It counted 1,159 participants as of February 2021. Russia’s own version of Swift, System for Transfer of Financial Messages, is even smaller, with just 400 users from countries such as Cuba and Belarus.China may offer a way for Russia to keep its coffers filled. But it will be in renminbi. Long term that does not look like a viable alternative as long as the greenback maintains its omnipotence in global trade. More

The rise in oil and gas prices triggered by the Ukraine conflict and western moves to punish Moscow has raised the threat of the worst stagflationary shock to hit energy importing economies since the 1970s. Crude prices surged after Antony Blinken, US secretary of state, said at the weekend that Washington was in “very active discussions” with European allies over a ban on Russian oil. On Monday, US politicians were discussing bipartisan legislation while European officials were devising plans to reduce reliance on Russian fossil fuels.Even without a ban on exports from Russia, the second-biggest crude producer, many experts doubted whether the global economy, and Europe’s in particular, was robust enough to escape a new oil crisis and recession. “The post-Covid recovery will surely be significantly delayed with a clear risk that we could be heading into a period of stagflation — if not even a recession with inflation,” said Erik Nielsen, economic adviser to UniCredit.The talk of stagflation — the combination of sluggish growth twinned with high inflation — raises memories of the two 1970s oil shocks, when prices surged after Arab states imposed an oil embargo in 1973 on countries that had supported Israel in the Yom Kippur war and in 1979 after the Iranian revolution. The problem for western governments has been that the rise in energy prices is indirectly helping Moscow withstand the tough sanctions they have imposed in response to the Ukraine invasion. “High oil prices lower the anticipated costs or punishments for bad behaviour [by Russia] and provide partial insurance against risky behaviour,” said Cullen Hendrix, senior fellow at the Peterson Institute of International Economics. But talk of an embargo on Russian exports sent the price of oil and gas shooting even higher. Oil prices jumped 20 per cent in morning trading on Monday to exceed $139 a barrel and European wholesale gas prices hit €335 a megawatt hour, up from a price a year ago of about €16. Sustained increases at that level would sharply raise inflation and squeeze consumer incomes. EU countries import 40 per cent of their gas from Russia, while Moscow has also consistently supplied over 10 per cent of the world’s crude oil. Some economists said prolonged high energy costs for consuming companies and households were likely to tip European economies into recession.Rupert Harrison, portfolio manager at BlackRock and former economic adviser to UK chancellor George Osborne, said “massive” energy subsidies would be needed because “a serious attempt to rapidly limit Russian energy imports risks causing a European recession”.The 1970s oil shocks caused rampant inflation and recession across most advanced economies, primarily because higher oil prices redistribute global income from energy consumers to producers. For this reason, economists expect Europe, Japan and emerging economy oil consumers to be the hardest hit again, while the US could increase domestic oil production. American energy consumers, however, would be hit just as hard if not harder than those in Europe because fixed levels of taxation are a smaller factor in US petrol prices. Some African oil producers are already expecting to be beneficiaries of the Ukraine crisis. The African Energy Chamber predicted an “influx in investment” this year. Far from all economists, however, are forecasting a recession in Europe even though stagflationary forces have hit new highs. The underlying recovery dynamics of European economies are still strong despite the price rises. Germany posted strong retail sales and factory orders for January, highlighting how any Ukraine-related weakness will be initially offset by robust consumer demand.

Oil ministers from Opec countries meet officials from western oil majors in Vienna in October 1973 © George T Piercy/AP

Even if some countries could face quarters of contraction, many economists still think that higher energy prices will lower growth but not push the eurozone into a prolonged recession this year, especially if Monday’s prices moderate a little.Reducing its growth forecast by 1 percentage point, Neil Shearing, chief economist of Capital Economics, said: “We don’t expect the [European] post-pandemic recovery to be derailed.” But the research group cautioned that if a complete ban on Russian energy was introduced, the eurozone economy would not be able to avoid a recession.In its downside scenario, Oxford Economics reckons that output in the eurozone will be 3.2 per cent lower than in a “no war” scenario by next year, but even with this hit, it still forecasts growth in eurozone gross domestic product of 2.2 per cent in 2022 and 0.9 per cent in 2023. The greater optimism is based on factors that limit the potential for damage and restrain stagflationary forces. First, the reliance on oil is much weaker now than in previous supply-side crises. The world is now able to produce more than twice as many goods and services for every barrel of oil as it could in 1973. Progress in advanced economies has been even stronger. In a study of oil intensity of economies, Christof Rühl, senior research scholar at the Center on Global Energy Policy at Columbia University, New York, said wars, revolutions, booms and busts have all failed to break a steady decline in the amount of oil needed to produce economic output. “Oil has become a lot less important and humanity has become more efficient in making use of it,” he said. Alongside the reduction in energy intensity, after adjusting for inflation, oil prices are still lower than the peak of the late 1970s.Second, economists expect governments, supported by central banks, to offset the higher price of energy resulting from sanctions with a further batch of extraordinary fiscal support. Producing new global economic forecasts, Jagjit Chadha, director of the UK’s National Institute of Economic and Social Research, predicted that higher energy prices would reduce the level of global GDP by only 1 per cent by the end of 2023, but with significantly larger effects in Europe. Even then, he did not predict a recession. “We expect higher public spending to support a massive inflow of asylum seekers from Ukraine and to bolster military spending, which will limit adverse effects on European GDP,” Chadha said. More

The newly added sanctions target 20 Russians including deputy chiefs of staff for President Vladamir Putin’s administration, deputy chairmen of the state parliament, the head of the Chechen Republic and executives of companies with close ties to the government such as Volga Group, Transneft and Wagner.It also includes 12 Belarusian government officials and business people, as well as 12 organisations in Russia and Belarus. Payment and capital transactions with those on the list must require government permits from now on, the ministry said in a statement.Japan is also banning exports of Russia-bound oil refinery equipment and Belarus-bound general-purpose items that could be used by its military, the ministry said.It will ban exports to the Belarusian defense ministry, armed forces and police organisations, and a Minsk-based company JSC Integral. More

Ratings firms are facing the twin pressures of Western sanctions that ban transactions with targeted Russian firms and a new law passed in Russia last week that threatens jail terms of up to 15 years for spreading what the Russian government describes as “fake” information. The law makes it illegal to report any event that could discredit the Russian military.Fitch and Moody’s (NYSE:MCO), which also suspended its commercial operations in Russia at the weekend, downgraded Russia’s sovereign rating by a record-equalling six notches earlier this month, warning the West’s sanctions had raised the risk of a default.Both firms, along with the other main rating agency, S&P Global (NYSE:SPGI), have also withdrawn or suspended ratings on a number of the most heavily-sanctioned Russian and Belarussian banks, including VTB, Promsvyazbank (PSB) and Sovcombank. “Fitch Group has decided to suspend its commercial operations in Russia with immediate effect,” Fitch said in a statement, saying that involved credit ratings and some other services it provides.It added it would comply with “all applicable sanctions”, support its Russia-based staff and “continue to provide the market with its independent analytical views through ratings coverage undertaken outside of Russia.”Russia’s financial markets have been in a turmoil due to the sanctions imposed over its invasion of Ukraine, the biggest attack on a European state since World War Two.The conflict, which Russia calls a “special operation”, has triggered a blizzard of drastic rating moves and dire warnings from top investment banks about the impact on Russia’s economy. S&P has downgraded its Russia rating by an unprecedented 9 notches since Moscow launched its assault. The firm did not reply to emailed questions or reply to calls on whether it would also suspend its commercial operations in Russia. More

TOKYO (Reuters) – Japan recorded its largest current account deficit since the start of 2014 in January as a jump in oil import costs offset gains in investment incomes, with continuing uncertainty due to the Ukraine crisis and COVID-19 pandemic.The current account data highlighted the dependence of Japan’s resource-deficient economy on imports of commodities and raw materials, which caused trade deficit to widen amid slowing demand from its largest trading partner China.Japan, the world’s No. 3 economy, posted a current account deficit of 1.1887 trillion yen ($10.31 billion) in January, the data showed, versus economists’ median estimate of a 880 billion yen deficit in a Reuters poll.It was the second straight month of deficit after slowing demand from China before the Lunar New Year holidays put a drag on Japan’s recovery from COVID-19-induced doldrums. It also marked the second largest deficit under comparable data going back to 1985.Surging fuel costs drove up the value of imports by 39.9% in January from a year earlier, outpacing a 15.2% rise in exports.A weak yen also inflated the cost of imports, helping to lead to a trade deficit. While the weak currency helped increase yen-denominated profits from overseas, the boost to export volumes was not as great as previously due to an ongoing shift of exporters’ production abroad, analysts say.Underscoring changes in Japan’s economic structure, a steady rise in returns from Japanese direct and portfolio investment overseas helped offset the trade deficit, bringing Japan’s primary income surplus to 1.289 trillion yen in January.Adding to the decline in Japan’s purchasing power, the data also showed sharp declines in foreign tourist arrivals, reducing the travel account to a surplus of just 12.3 billion yen. The services deficit came to 737.9 billion yen, the data showed.($1 = 115.3300 yen) More

Global stocks dipped on Monday as U.S. officials discussed an oil cutoff, and gas prices hit a national average above $4, up more than 10 percent in a week.WASHINGTON — President Biden came under pressure on Monday to ban Russian oil imports into the United States, forcing the administration to consider action that could further punish President Vladimir V. Putin of Russia but exacerbate high gas prices that are hurting consumers at home.On Monday, a bipartisan group of American lawmakers agreed to move ahead with legislation that would ban Russian energy imports in the United States and suspend normal trade relations with Russia and Belarus. Some European countries, which are highly dependent on Russian energy, have expressed a willingness to reduce their reliance on those imports.Jen Psaki, the White House press secretary, said that “no decision has been made at this point by the president about a ban on importing oil from Russia,” adding that discussions were “ongoing internally” and with European allies.“I would note what the president is most focused on is ensuring we are continuing to take steps to deliver punishing economic consequences while taking all actions necessary to limit the impact of prices at the gas pump,” she said.Global stocks slid on Monday amid worries of an oil ban and escalating Russian attacks on Ukraine. It was Wall Street’s worst day in more than a year.The S&P 500 fell 3 percent, its sharpest daily decline since October 2020. The Nasdaq composite dropped 3.6 percent and is now 20 percent off its November record, entering territory known on Wall Street as a bear market, denoting a serious downturn.The Biden administration, along with its global allies, has already imposed sweeping financial, trade and technology sanctions on Russia, but Western countries have deliberately carved out its energy sector, with top U.S. officials saying it would be unwise to disrupt global supplies given how heavily Europe relies on Russian oil and gas. Some officials also view the move as potentially enriching Mr. Putin by driving up gas prices. The average price in the United States reached a national average of $4.07 per gallon on Monday, up more than 10 percent from a week ago.At his State of the Union speech last week, Mr. Biden talked about the economy’s strength but noted that high gas prices, along with rapid inflation, are hurting consumers. Those dynamics pose a political problem for the president, whose approval rating has suffered amid voter concerns about his handling of the economy.Mr. Biden spoke with the leaders of Britain, France and Germany by video on Monday, and the four “affirmed their determination to continue raising the costs on Russia for its unprovoked and unjustified invasion of Ukraine,” according to a White House statement.But that cross-border cooperation could stop with oil. Chancellor Olaf Scholz of Germany said his country could not simply turn off the spigot.“Europe has deliberately exempted energy supplies from Russia from sanctions,” he said in a statement on Monday. “At the moment, Europe’s supply of energy for heat generation, mobility, power supply and industry cannot be secured in any other way.”Biden administration officials say the immediate discussions over Russian energy are focused on banning domestic oil imports rather than carrying out wider sanctions that would cut off purchases by other countries. That could lessen the economic shock to oil markets given the United States does not import much Russian crude.Last fall, it imported about 700,000 barrels per day from Russia, less than 10 percent of its total oil imports, U.S. officials said. By contrast, Europe imported 4.5 million barrels per day from Russia, about one-third of its total imports. The United States can easily find a way to make up for any loss of Russian oil, while Europe would have a harder time doing so, analysts said.But any disruption in the flow of oil could further rattle global markets, including oil prices, which have surged because of the uncertainty over Mr. Putin’s invasion of Ukraine. Brent crude, the global benchmark, ended Monday up about 4.3 percent to $123.21 a barrel, but earlier it had climbed as high as $139 a barrel. The price of oil has soared about 26 percent over the past week as the conflict has intensified.In a sign of how concerned the administration is about the uncertainties around global energy flow, American officials have been discussing the possibility of increasing supply or distribution with their counterparts in oil-producing nations, including Saudi Arabia and Venezuela, which is a partner of Russia and has been subject to broad U.S. sanctions for years.On Feb. 15, more than one week before Mr. Putin’s invasion of Ukraine, Mr. Biden said in a speech that a conflict involving Russia could affect American consumers. “I will not pretend this will be painless,” he said. “There could be impact on our energy prices, so we are taking active steps to alleviate the pressure on our own energy markets and offset rising prices.”It is unclear how much pain an import ban would actually inflict on Russia. Moscow could try to make up for import bans by arranging to sell more oil to other customers, including China.China is Russia’s most powerful strategic partner, and it has supported Moscow’s grievances against the United States and NATO during the war in Ukraine. On Monday, the Chinese foreign minister, Wang Yi, said at a news conference in Beijing that “no matter how perilous the international landscape, we will maintain our strategic focus and promote the development of a comprehensive China-Russia partnership in the new era.”Customers like China would have leverage to bargain down the purchase price, so Russia might still face a shortfall in revenue.Russia-Ukraine War: Key Things to KnowCard 1 of 4A humanitarian crisis. More

(Reuters) -General Motors Co and South Korea’s POSCO (NYSE:PKX) Chemical will build a $400 million facility to produce battery materials in Canada as the carmaker ramps up plans to produce mainly electric vehicles (EVs) in the future, the companies said on Monday.The plant will produce cathode active material (CAM) for vehicle batteries in Becancour, Quebec. Cathodes are the most complex and costly chemical component of an electric vehicle battery. The cathode “represents about 40% of the cost of every EV battery cell,” said Scott Bell, GM Canada’s President and Managing Director, in a news conference. “We plan to have capacity by 2025 to build a million EVs in North America.” The plant’s construction will begin immediately and the goal is to have it running by 2025. Once completed, it will create an estimated 200 jobs, according to a statement. GM aims to produce light vehicles that run exclusively on electricity by 2035.The CAM produced at the plant will be used to make GM’s Ultium batteries that will power the company’s EVs, such as the Chevrolet Silverado EV, GMC HUMMER EV and Cadillac LYRIQ. GM’s Ingersoll, Ontario, factory will launch EV production later this year, Bell said. Both Canada’s federal government and Quebec’s provincial government are working with GM and POSCO Chemical, the companies said, though details were not released.Rich in key materials for EV battery production – including lithium, graphite, cobalt and nickel – Canada has been wooing battery makers to safeguard the future of its car manufacturing industry as the world seeks to cut emissions.It is the second CAM plant announcement for Becancour in less than a week. On Friday, BASF SE (OTC:BASFY) said it was planning one there, too. Canada’s Industry Minister Francois-Philippe Champagne said that Becancour will become a hub for the country’s EV battery “ecosystem”. More “good news” is on the way, Champagne said, adding that there were “very live discussions” under way about building a battery factory in Canada.”Starting from this announcement, we will be integrated in the global supply chain for cars in North America,” Champagne said. More