International Business Cycles and Economics Contagion: Russo - Ukrainian War Scenario
Executive Summary
It has become clear the global economy is going to enter recession, with both the American yield curve and the Eurodollars futures curves inverting, it is only a matter of time. This comes as the world economy is starting to truly recover from the coronavirus pandemic and supply constraints are ushered in by the Russian Federations invasion of Ukraine. The Russian economy is one of the largest commodity exporters in the world, and their ostracization from the world economy will have horrifying effects on agricultural, energy, and mineral markets worldwide. This has the potentially of causing a global depression, and will make it extremely hard for a new global expansion in the subsequent business cycle.
Introduction
The introduction of the coronavirus pandemic triggered one of the swiftest economic deteriorations in human history. It was the worst economic crash since the Great Depression. Unprecedented monetary and fiscal stimulus from central banks and governments around the world paved the way for the fastest economic recovery on record. This worked, until now. Two widely used recession indicators are flashing alarm bells. The first is the inversion of the yield curve on American treasury bonds, specifically the two year and the ten years. This has resulted in a situation where individual investors are compensated more for purchasing shorter term debt instruments than longer term ones. Which makes no economic sense, hence telling us something in the wider American financial system is broken. The second indicator is the inversion of the Eurodollars futures curve. The US dollar, as the cornerstone of all international trade, investment, and other forms of commerce, is an integral part of the workings of the global economy. Its dominance as the world reserve currency has generated a considerable sum of dollars outside the United States, outside the control of the Federal Reserve. The yield curve for these dollars has also inverted, signifying that something is wrong with the global economy.
This was all before the Russian invasion of Ukraine. Economically, the response to this event has been a substantial supply shock. This shock has taken one of the largest commodity suppliers off the market and the result will be catastrophic. The impact of this event can be measured by its effect on global agriculture, energy, and raw materials.
Overview
Russia is now the most sanctioned country in the world.[1] The Americans have completely shut the Russians out of the international financial system, and confiscated roughly half of Russia’s currency reserves.[2] Perhaps private American corporations have taken the most damning action, most of whom have ceased operation within Russia due to their actions in Ukraine. The European Unions was expected to only place limited sanctions on Russia due to overreliance on Russia energy. However, in some ways they have placed more sanctions than the United States.[3] The effect of the Russian invasion of Ukraine will be three-fold; there will be famine, an energy crisis, and a decline in the feasibility of the environmental portion of ESG. This will exacerbate any recession the global economy in the next coming years.
Famine
Russia and Ukraine combined represent the single largest chuck of global grains output.[4] Nearly all of this will be unavailable for global consumption. Ukrainian farmers are all fighting a war, so this year’s planting season is going to be skipped.[5] So nothing short of an immediate end to the current conflict will allow Ukrainian grains to be available for global markets by this fall. In Russia, international companies are refusing to take the country’s agricultural goods abroad. Notably, cargo ship insurers are refusing to ensure any ship going to a Russian port.[6] Nearly all of this product is sold to African and Middle Eastern countries, but sizeable amounts also go to South Asia. The Middle East is at significant risk, and the current situation is reminiscent of the causes of the Arab Spring.
Fertilizer shortages will be the other punch to global food insecurity. “Russia is the world’s largest exporter of fertilizers, accounting for 23% of ammonia exports, 14% of urea exports, 10% of processed phosphate exports, and 21% of potash exports.”[7] For example, the same source states 85% of Brazil’s fertilizer comes from Russian fertilizer exports, which is now offline for the same reason agricultural products are. This will lead to global food insecurity contagion, as countries one by one fall to famine.
Energy
Energy prices are high at the moment due to the increased geopolitical risks, American sanctions, and the Russians leveraging their energy against the Europeans.[8] The United States and Canada are sanctioning Russian oil, but the real pain will be felt after the European Union sanctions Russian energy. The reason they haven’t done so already; they simply can’t. The lights across Germany would go out. Russia is at a conundrum at the moment, because they have to sell their energy to the Europeans for the near future. Because insurance companies are not ensuring anything coming from Russian ports, no oil cargo ship is coming to pick up Russian energy. The risks are far to high, especially since most of the oil would be forced to go through the black sea, next to an active warzone. The result is Russia needing to send its Ural energy towards Europe via pipelines. China cannot consume this energy even if it wanted to, because the infrastructure isn’t capable of sending the oil there way.[9]
If the Europeans are able to diversify their energy consumption by the fall, then a sizable portion of Russia’s leverage would disappear. If the Europeans refuse to import oil and natural gas, then the pipelines will get backed up.[10] Once they get backed up, the oil rigs must be turned off. The results would be Russian energy production being shut off for years. A substantial portion of Russian energy production is made possible because of technology from western corporations. If they do not come back soon the global economy will have less energy available for consumption, leading to an even more pronounced and longer energy shortage.
Environmental collapse
Crude petroleum is the world’s number one traded product, making up approximately 6% of international trade.[11] The United States, Saudi Arabia, and Russia collectively produce 43% of global oil production.[12] Since energy production is very centralized, it requires complex supply chains to sustain the global economy. Currently, there is no real substitution for fossil fuels in the modern economy. Even with a worldwide green energy revolution, it would not get rid of the demand for petroleum products. Everything from the computer I’m writing on to cosmetics to the food we eat; there are petroleum products used in the inputs at some point of production. This doesn’t mean the world won’t try to turn away from fossil fuels.
The buildout of renewable energy will require extensive use of commodities, such as copper, aluminum, cobalt, and lithium. Due to governments and corporations implementing Environmental, Social, and Governance (ESG) standards, the demand for these and other commodities will explode. Causing their prices to increase dramatically. According to the International Energy Agency, “a doubling of lithium or nickel prices would induce a 6% increase in battery costs. If both lithium and nickel prices were to double at the same time, this would offset all the anticipated unit cost reductions associated with a doubling of battery production capacity.”[13] This general logic can be used for all commodities, and the influx of demand will cause the energy transition to be hard and expensive. In order for any greening of the global economy to happen, Russian commodities must be accessible to global markets. Without Russian minerals, supply will restrict right as the demand for these new technologies are just starting to measurably increase in a meaningful way.
Policy Recommendations
There are several policies options for the United States to limit the effect of the economic contagion the Russian – Ukraine war imposes on the international business cycle. The following two policy options vary in both political feasibility and ease of implementation. There are also various geopolitical implications we must be aware about.
The first policy option is the removal of all Russian sanctions, the immediate buildup of American and NATO forces in Poland and the Baltic States, and the entrance of Finland and Sweden into the NATO alliance. Russian commodities form an integral part of the global economy and sanctions, both current and planned, will force the international business cycle’s recession to be more pronounced. In order to prevent both global economic depression and future environmental catastrophe, Russian sanctions should be removed. In order to prevent a military contagion, the United States and NATO should forward position troops as far east within NATO as possible. This will prevent Russia from further expanding past Ukraine. For the same reason, Sweden and more importantly Finland should be admitted into the NATO alliance. The political feasibility and ease of implementation of this policy is largely unknown. Current it is almost unimaginable, but this generally due to the fact that most of the economic pain from Russian sanctions are not being felt yet. In the summer and fall, the world will have a clearer understanding of the famine and energy crisis to come, and the will to remove sanctions will grow.
The second policy option involves continuing the current sanctions regime of the west. In doing so, the western democratic alliance will show the world that internationalism and the neoliberal world order are not dead. The international business cycles recessionary phase is going to be bad, and will be made much worse by the commodity contagions caused by Russian sanctions. If America chooses to do this, they will need to find a way to supply their European allies with energy. The easiest way to do this will be to convince African oil suppliers to redirect petroleum north towards Europe instead of China. The Europeans have colonial connections with all of Africa, but they will still need to pay more than the Chinese. This policy will be easy to implement, and the political will is there; however, we should recognize the global economic effects of this policy. There will be less energy going to East Asia as African suppliers redirect energy towards Europe. North Africa and the Middle East will experience famine and the green technological revolution will take a hit.
[1] "Bloomberg - Are You A Robot?". 2022. Bloomberg.Com. https://www.bloomberg.com/news/articles/2022-03-07/russia-surges-past-iran-to-become-world-s-most-sanctioned-nation.
[2] Karatnycky, Adrian. 2022. "Opinion | Use Seized Russian Assets To Defend Ukraine". WSJ. https://www.wsj.com/articles/seized-russian-assets-defend-ukraine-moscow-sanctions-currency-war-crimes-economy-11649612933.
[3] "EU Restrictive Measures Against Russia Over Ukraine (Since 2014)". 2022. Consilium.Europa.Eu. https://www.consilium.europa.eu/en/policies/sanctions/restrictive-measures-against-russia-over-ukraine/.
[4] "Ukraine Invasion Threatens Global Wheat Supply". 2022. Nytimes.Com. https://www.nytimes.com/2022/02/24/business/ukraine-russia-wheat-prices.html.
[5] "Global Food Price Fears As Ukraine Farmers Forced To Reduce Crop Planting". 2022. The Guardian. https://www.theguardian.com/environment/2022/apr/02/global-food-price-fears-as-ukraine-farmers-forced-to-reduce-crop-planting#:~:text=While%20most%20of%20Ukraine's%20wheat,spring%2C%20over%20the%20coming%20weeks.
[6] 2022. Thenewsglory.Com. https://thenewsglory.com/russia-faced-difficulties-in-delivering-grain-to-egypt/.
[7] "War In Ukraine And Its Effect On Fertilizer Exports To Brazil And The U.S. • Farmdoc Daily". 2022. Farmdoc Daily. https://farmdocdaily.illinois.edu/2022/03/war-in-ukraine-and-its-effect-on-fertilizer-exports-to-brazil-and-the-us.html#:~:text=Russia%20is%20the%20world's%20largest,data%20from%20The%20Fertilizer%20Institute.
[8] "What Is Behind The Rise In Oil Prices?". 2022. Caixabank Research. https://www.caixabankresearch.com/en/economics-markets/commodities/what-behind-rise-oil-prices.
[9] "Commentary: China's Not Going To Save Russia's Energy Exports Anytime Soon". 2022. Fortune. https://fortune.com/2022/04/06/china-buys-russia-energy-exports-oil-gas-coal-ukraine-sanctions-thane-gustafson/.
[10] "The Future Turns Dark For Russia’s Oil Industry". 2022. Nytimes.Com. https://www.nytimes.com/2022/03/08/business/russian-oil-industry.html.
[11] "Crude Petroleum (HS: 2709) Product Trade, Exporters And Importers | OEC". 2022. OEC - The Observatory Of Economic Complexity. https://oec.world/en/profile/hs92/crude-petroleum.
[12] "What Percentage Of The Global Economy Is The Oil And Gas Drilling Sector?". 2022. Investopedia. https://www.investopedia.com/ask/answers/030915/what-percentage-global-economy-comprised-oil-gas-drilling-sector.asp.
[13] "Executive Summary – The Role Of Critical Minerals In Clean Energy Transitions – Analysis - IEA". 2022. IEA. https://www.iea.org/reports/the-role-of-critical-minerals-in-clean-energy-transitions/executive-summary.
