The Economist: War and sanctions have caused commodity chaos

Global commodity crises tend to cause severe economic damage and political upheaval. The oil shocks of the 1970s left Western economies with runaway inflation and deep recessions. Oil revenues also helped prop up the Soviet Union and fueled the export of Saudi extremism. The skyrocketing of grain prices in 2010 and 2011 was the trigger for the street protests that led to the Arab Spring and the toppling of dictators.

Today, Russia’s invasion of Ukraine is triggering the biggest commodity shock since 1973 and one of the worst wheat supply disruptions since the first world war. Although commodity exchanges are already in chaos, ordinary people are yet to feel the full effects of rising gasoline prices, empty stomachs and political instability. But make no mistake, those things will come, and in dramatic ways if sanctions on Russia are tightened further and if Vladimir Putin retaliates. Western governments must respond to the commodity threat with as much determination as to Putin’s aggression.

The turmoil unfolding in the energy, metals and food markets is broad and wild. Headline commodity price indices are now 26% higher than they were in early 2022. The cost of a barrel of Brent crude oil has oscillated wildly around levels that indicate the biggest supply shock since the military Saddam Hussein crossed from Iraq to Kuwait in 1990.

Gas prices in Europe have nearly tripled amid panic that eastern gas pipelines will burst or run out of supply. The price of nickel, which is used in all electric cars, among other things, has skyrocketed so much that trading in London has ground to a halt and Chinese speculators are suffering multimillion-dollar losses. These are the consequences of Putin’s decision to drive his tank through Europe’s breadbasket and the subsequent isolation of Russia, one of the world’s largest exporters of raw materials.

Western sanctions on Russian banks have made lenders, insurers and shipping companies wary of making deals to carry Russian cargo, leaving growing piles of unsold industrial metals and an armada of ships full of unwanted Ural crude. The stigma and danger have caused others to stay away. Shell has abandoned the purchase of Russian crude after a backlash. The Black Sea is a no-go zone for commercial shipping because some ships have been hit by missiles and Russia threatens Ukrainian ports. Not many seeds will be planted in Ukraine’s blood-soaked fields this spring.

This could get worse. On March 8, in the latest move to increase pressure on Putin, the United States announced that it would ban purchases of Russian oil. The United States is a small consumer of Russian crude, but if the European Union were to join the embargo, about two-thirds of the 7-8 million barrels per day of Russian crude and refined product exports would be affected, equivalent to around 5% of world supply.

A full global embargo, imposed by the United States, could raise the price of oil to $200 a barrel. If Russia were to retaliate by limiting gas flows, Europe would be reeling: last year, the EU depended on Russia for 40% of its consumption. Meanwhile, bitter experience teaches that countries often respond to food shortages by banning exports, leading to a collapse of world trade.

The effects of this commodity calamity could be brutal. If you look closely at the economy, the world consumes much less energy per unit of GDP than it did in the 1970s. Yet global inflation, already running at 7%, may rise another two or three percentage points, to a level last seen over an extended period in the early 1990s, when Putin was doing business with the mafia in St. Petersburg and globalization had yet to flourish. Growth may slow as business confidence weakens and interest rates rise.

On the political front, Western leaders will have to contend with angry voters, especially in the US midterm elections in November. Remember the yellow vest protesters in France in 2018, furious about the cost of gasoline. In poorer countries, where food and fuel account for a larger share of people’s spending, the backlash could be even more violent: food price hikes in 2007-08 sparked riots in 48 countries, and there are already signs of panic and unrest today.

Such a panorama of suffering and instability is worrying in itself. But it also threatens to undermine the credibility of the Western response to Russia’s decision to start what may become the biggest war in Europe since 1945. The greater the global pain, Putin believes, the harder it will be for the West to sustain the penalties: all you have to do is wait.

That is one more reason for Western governments to counteract the ill effects of the commodity crisis. The priority is to boost supply. US allies in OPEC, including Saudi Arabia, have refused to pump more oil, but more adept US diplomacy could pay off.

Rich countries could speed up the release of the 1.5 billion barrels of oil they have in reserve. Having disparaged America’s shale fractioners, the Biden administration needs to goad them into drilling more. The EU must promote or prolong the use of nuclear, renewable and coal-fired generation in order to stock up on gas for the winter. You should also prepare for the worst case scenario: gas rationing. Rich country governments may have to protect the poor at home with financial aid. Stimulus could mean higher interest rates or taxes, but that’s a risk worth taking to protect the world against an aggressor.

digging deep

Whatever the deprivations of rich countries, the poorest have worse problems. Therefore, the West must strengthen the global financial safety net. Some food and oil importers may face a contraction in the balance of payments and falling currencies. Even in Europe, some countries, such as the Baltic states, are vulnerable to gas outages. The Federal Reserve and the IMF should facilitate the access of friendly but fragile countries to loans in hard currency. And Europe should go ahead with the idea of ​​issuing joint debt to help spread the costs of the crisis.

A world facing a physical scarcity of raw materials pulled from the ground seems like a throwback to an earlier time. However, that is exactly the situation that lies ahead. After decades of drift, the West has shown resolve and cohesion in confronting Putin’s aggression. Now he must match that by showing leadership in the midst of the economic storm.