Cutting Russia out of the global economy means higher prices, a slower recovery, and a whole new global power structure: ‘We don’t really have a playbook for how this might work’

Cutting Russia out of the global economy means higher prices, a slower recovery, and a whole new global power structure: 'We don't really have a playbook for how this might work'
  • The Russian people are feeling the brunt of sanctions, but the pain is spilling into other nations.
  • Oil bans have driven prices higher worldwide, and fears of food shortages abound.

An economic cold war has emerged.

It’s bringing higher inflation and a slowdown in recovery from pandemic setbacks. It could also usher in a new global power structure.

Russia has now been the world’s most-sanctioned country by one measure for about a month. President Vladimir Putin’s invasion of Ukraine prompted the US, UK, and European Union to retaliate with an unprecedented wave of economic punishments.

There’s no clear end in sight for the crippling sanctions imposed, and the impact has already left the country’s economy reeling. The ruble has lost a third of its value against the dollar. JPMorgan data shows the worst recession in the country since its 1998 financial crisis.

Yet prolonged sanctions are also likely to spill into other countries in two major ways: higher prices and slower pandemic recoveries worldwide.

The world might be past the worst of the Omicron wave, but Russia’s invasion and the global financial retaliation are putting a new — and possibly more powerful — drag on its rebound.

“The bottom line is that so long as war smolders in eastern Europe it will cloud the economic picture for the entire globe,” Dana Peterson, chief economist at The Conference Board, said in a Barron’s column published Thursday.

Moving away from Russian oil will be a major challenge, especially in Europe

The crux of the new economic risk starts with common goods like oil and wheat. These key Russian and Ukrainian commodities, along with others like nickel and natural gas, have seen their prices surge through 2022 as the conflict has raised fears of supply strains.

Gas prices soared into the spring as countries moved away from Russian crude oil. Europe was already struggling through an energy crunch that started in the fall of 2021, and the continent now faces the biggest hit from pricier gas.

“Given Europe’s dependence on Russian energy, and its closer linkages to Russian industry, the drag on its growth is much greater than elsewhere,” JPMorgan economists led by Bruce Kasman said in a note. The EU imported about 40% of its natural gas from Russia in 2021, according to the International Energy Agency, and replacing that would be a huge challenge.

A major world breadbasket is now on fire

Food prices are also poised to climb. Ukraine and Russia together account for a quarter of the world’s wheat exports, according to the Observatory of Economic Complexity, and the invasion has lifted prices 38% in the last month alone. That’s set to weigh on common foodstuffs like bread, cereal, and pasta.

Rising fertilizer costs raise a longer-term food risk. Russia is a major exporter of all sorts of crop fertilizers, and the souring of trade relationships could cripple future crops.

In advanced economies, the disruption to food and fertilizer supply is likely to keep inflation higher for longer. The toll in poorer countries, though, is far more dire. Some economies can’t afford to bear the brunt of higher food prices, leaving residents trapped in an impossible situation. If backstops aren’t put in place soon, the supply issues could spark civil unrest and casualties in areas far from the invasion’s front lines.

“Vulnerable populations are most likely to become refugees and will find it hardest to bear the rising costs of food and fuel,” McKinsey economists said in a March report. “Securing the continual supply of food to the countries most exposed to exports from these regions is becoming a major near-term issue.”

The advanced economies can reshuffle their trade relationships and import necessary goods from elsewhere. But that will take time, and until then, Americans are likely to shoulder the costs of even pricier gas and groceries.

Central banks’ task to fight inflation without hurting economic recoveries just got trickier

Central banks were already aiming to cool inflation before war broke out by raising interest rates. Timing that transition is now an even more difficult task. Moving too fast could discourage spending and kick off recessions, but acting too slowly could allow inflation to worsen.

In the US, the Federal Reserve began raising interest rates this month, and while the central bank is widely expected to continue rate hikes at each of its six remaining meetings this year, the exact scope and timing of the Fed’s monetary tightening remain up in the air.

Now that the conflict has exacerbated inflation, central banks could feel the pressure for more aggressive interest-rate increases. The conflicting forces could result in “subpar growth,” JPMorgan’s economists said. Only by cooling the economy to a less-than-ideal level, they argue, can the Fed and its peers get their hands around inflation.

The West has never tried to cut off an economy as big as Russia’s

Severing the Russian economy — the 11th-largest in the world — from the financial system could shake up the global economic order.

There’s simply no precedent for the economic dislocation Russia is experiencing, Brian Coulton, chief economist at Fitch Ratings, told Insider. Similarly severe sanctions have been levied on smaller economies like North Korea and Cuba, but never against such a global superpower. That leaves economists without much foresight as to how the sanctions will play out in the coming years.

We don’t really have a playbook for how this might work, trying to disconnect an economy of this scale,” Coulton said, adding that the immediate effects will arise in the global energy supply.

The Russia-Ukraine war “may fundamentally alter” the status quo in global trade, economists at the International Monetary Fund said in a recent report. Supply chains, payment networks, and central-bank reserves could all be disrupted as new global alliances and rivalries form.

So far, that’s starting to look like a new delineation between the East and the West. The US, UK, and EU might have removed Russia as a trade partner, but other countries like India and China will likely step in and fill that void, Tania Babina, a business professor at the Columbia Business School, told Insider.

That could spark a “bipolarization” in the global economy and cut away at decades of globalization, she added. “Where the West is going to come in and cut off supplying stuff to Russia, you’re going to have all these non-Western countries and nondemocratic countries set up increased trade and new trade opportunities.”

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