A new macroeconomic normal

Two exogenous shocks have disturbed the macroeconomic equilibrium that has existed for several decades. The first in 2020 was the pandemic; the second in 2022 has been Russia's invasion of Ukraine.  Both will alter the global economy in profound ways. 

The pandemic has had both a short and a long run effect. In the short run governments mostly in the developed world sought to less covid's impact with strong economic stimulus. While the intent was to prevent people falling into poverty, a by-product was a fueling of demand as those who continued to be employed found themselves with additional disposable income.  However, the nature of that extra demand shifted from services, which were hard to access due to the pandemic lock-downs, to goods. That led to a spike in prices as demand exceeded supply. The surge in demand also led to supply chain bottlenecks with perversely further restricted supply - containers stacked up on docks meant that the normal functional of logistics operations were disrupted.  

While some thought that the shift from services to goods was temporary there is reason to think that it may be much more long lasting. Even though covid is moving towards endemicity, people's willingness to socialize and make use of services that involve coming into close proximity with potentially infectious others will not recover to pre-pandemic levels for some time if ever. The increases demand for goods may therefore be permanent rather than transitory. 

The second long term change stems from Russia's invasion of Ukraine. Political risk calculations are now front and center of firms economic decision making. Factory locations will be reconsidered and new overseas investments, both for production and markets will no longer be viewed though a purely economic lens. In the short to medium term this will results in reconfiguration of supply chains and lead to additional supply chain bottlenecks. In the longer term access to cheap labor will be constrained and that,  together with  re-shoring of manufacturing, will lead to higher prices.  In particular the reduced flexibility of fewer off-shoring options will shift power away from management and back to labor, which will add to inflationary pressure. 

Finally, while not so much a shock as an increasingly urgent pressure, the need to develop energy independence from autocratic regimes combined with the need to move away from fossil fuels will create a medium term increase in energy prices. Energy costs have almost doubled in Europe and will rise further in coming years. 

Over the last thirty years, most of the developed world has enjoyed a stable and predictable economy. That predictability has almost certainly come to an end.

Sacrifice

It some level, it boils down this. What am I willing to sacrifice in the name or principle and humanity for people I don't know even if "they look like me"? Higher gas prices, while salient and an irritant, is a sacrifice I'm both fortunate enough to be able to afford and willing to make.  But would I be willing to live in a post-nuclear holocaust world? That's much tougher. If continued escalation in Ukraine leads to a nuclear exchange, we might be on course for a strategic strike against the US. 

Cities would be laid waste. People who survived the blast would be dying of radiation sickness. Food would be short and people would starve. There would likely be no electricity and hence for for us no water.  With scarcity might come violence and a breakdown of law and order. My life expectancy might come down from a couple of decades to a couple of years or months depending.  Given that, I'm very reluctant to side with the hawks that escalation is the only way to stop Putin. Ant that's precisely what Putin's counting on. So while I feel terrible for the people of Ukraine, I'm not yet ready to make the kind of sacrifice that would come with a nuclear war. 

A Tipping Point?

Talks to arrange a ceasefire are going nowhere: Russian negotiators have no deal-making authority since to give ground would anger Putin; that would not be good for them.  Whether the war goes on or stops depends entirely on Putin's whim.  He now has no way out. Dividing Ukraine down the middle and leaving him the eastern part of the county is probably not enough from him; he wants it all.  

Given the unexpectedly slow pace of the Russian advance, he is now intense pressure, externally and to some extent internally. As Zanny Minton-Beddoes put it: "Putin cannot win this war and he cannot afford to loose it".  Stress may cloud Putin's judgement, particularly when he lives in an group-think information bubble, so he cannot be depended on to act rationally.   

That leads to a consideration of the possibility of escalation. It now seems well within the realms of possibility that Putin will use chemical or tactical nuclear weapons. Given the West's decision not to respond forcefully when Assad used chemical weapons in Syria, Putin may well be expecting the West to step back again, making him more likely to use them. If it does not, we will be a step or two higher on the escalation ladder. Where that stops without an obvious "off-ramp" for Putin is hard to say and Armageddon is no longer just fantasy.  

Sanctions

(c) Economist 2022

The sanctions regime deployed by the West and others to persuade Russia to halt its invasion of Ukraine is by all accounts the most draconian and consequential ever imposed on a large industrial economy. Nevertheless, there are two reasons to think they will not halt the Russian invasion nor prevent Putin from deposing Ukraine's legitimate government.

The first is and overarching reason is timing. Sanctions, even those just implemented, despite already having profound effects on the Russian economy, are widely thought to require weeks or months to achieve their desired effect. But Ukraine likely has only days not weeks in which it can hold out. 

The second is the mechanism. Sanctions are meant to be persuasive at several levels; on Putin himself, on his oligarchs and on the Russian people as a whole.  They will not deter Putin personally since for him this is no longer about his personal wealth but about power, control, his standing as a world leader, and his grandiose ambitions to reconstruct the old USSR.  If he wins he stays in power and will have access to all the money he wants. For Putin, alternatives to a win are two; he backs down, but remains in office (in the totalitarian state he has built he will never loose another election) although his standing on the world stage will be reduced to pariah. But if he refuses to back down, the end results is the same. So there is no upside for him to back down now. 

Sanctions on the oligarchs will only cause Putin to change course if the oligarchs collectively believe he can be deposed; while Putin remains in power, they are beholden to him for their wealth, at least that not yet frozen by the West, but more importantly for their future earnings. They have no real power themselves unless they can either persuade the Russian parliament to act to curb Putin's power or persuade the Russian military to mount a coup.  Both the military and members of the Duma must in turn weigh the chances of success; should legislative measures to rein Putin or a coup fail, all those involved, directly or indirectly, will likely face long prison or death sentences. Weighing such odds depends on an assessment of outcome probabilities. That in turn depends on a critical mass willing to support such a course of action. Developing that critical mass takes many quiet conversations and time. 

The last mechanism by which sanctions act is through their effect on the Russian people. The there are only two ways in which ordinary Russians get any say. The first is through the ballot box. But not only is an election too far distant to matter, even were an election to be held tomorrow, because Putin controls the press, the media and hence the narrative, he would likely win even without rigging the election. Oddly, sanctions work to Putin's advantage. As the Iran's Ayatollahs have done since sanctions were imposed on their country, Putin will telling the Russian people that their suffering is due to evil regimes in the West who are trying to destroy Mother Russia. 

Where does this leave Ukraine? If sanctions are the only tool the West is prepared to use against Putin, Ukraine will fall; it may take weeks rather than the days Putin had hoped, but in the medium term the end is the same.  A Putin-friendly puppet regime will be installed, freedom of speech will be harshly curbed using the same tactics as Putin is now using in Russia, and Ukrainians will be subjugated into the new Russian empire.  They may fight an insurgency but displacing another pro-Russian leader from their country will be far more difficult than the ousting of Viktor Yanukovych. Putin may even reinstall Yanukovych, someone who was not only loyal to Putin when he was president before, but like so many of those Putin has promoted and richly rewarded, he will owe his position entirely to Putin's largess. Putin was upset by Yanukovych's ouster in 2014 and will make sure not to let that happen again.  

If sanctions are an ineffective tool, what then? If only military action is sufficient to stop Putin's current, not to mention future land-grabs, does the West have the stomach for what could easily escalate into a nuclear holocaust?  That, sadly, is a question we will be facing in the weeks ahead.

Confiscating personal assets

Several countries including the US and the UK announced yesterday that they are moving to confiscate the personal assets of a number of wealthy Russian oligarchs. While the logic is clear and the cause is just, it raises a troubling question about property rights and the rule of law.  

It may set an uncomfortable precedent that property rights are only inviolate when its suits a particular government in whose country those assets reside. It signals that if politically expedient, foreigners' rights may be abrogated. 

There has always been political risk in investing abroad, but it was general accepted that in Western democracies that were upholders of the international rules based order, property rights would be upheld.  But by abandoning this principle, it will be harder for those countries to protest when their citizens' assets are confiscated in other countries; what a "just cause" is that makes such seizures legitimate depends to some degree on ones point of view. 

This increase the uncertainty for companies and individuals investing abroad and that may have negative implications for the global economy.  Of course one might argue that it has always been so; Israel has been stealing land from the Palestinians with impunity for years (although that's the only example that immediately comes to mind).