“Economically devastating”. What did Biden have in mind?

Back in January, six months and an eon ago, President Biden laid out a sanctions strategy to bring about “economically devastating” consequences should President Putin attack Ukraine. As a deterrent the policy clearly failed. Nor, so far, have sanctions in any way moderated Putin’s appetite for waging war – indeed they have had the opposite effect.


What Biden failed to spell out was “economically devastating” for whom. Putin is engaged in unsubtle, all-out economic warfare with the West. In the long-term his actions may be self-defeating, his own and Russia’s nemesis; that remains to be seen. But the potential consequences of his winning, the corollary of which is the West losing, with all the encouragement that would give to other pariah states, are unpalatable to say the least. In the near-term, however, the direct and collateral damage, politically and economically, is being wrought everywhere, seemingly more so to others than to Russia itself.

Putin has had a busy week; first, wheat
It is in this light which today’s Ukrainian grain deal should be seen, brokered by Turkey and the UN, to allow Ukrainian exports to resume through the Black Sea. In a shrewd move, Putin’s lifting of the Black Sea blockade to give 20 million tons of grain (mainly wheat) a route to market is politically savvy. He is not doing this because he must; he is doing it because he can. He is exercising geopolitical leverage through his humanitarian largesse (as he will no doubt portray it at home and to the beneficiaries).

To those countries suffering drought and potential famine, particularly in the Horn of Africa and along the North African coastline, but in parts of Asia too, new food supplies from the Kremlin are a lifeline. Those governments are well aware of the potential for civil unrest among their starving populations as the threat to life becomes critical. Remember a food crisis in Tunisia was the original spark which ignited the tinderbox which exploded the 2012 Arab Spring rebellions; more recently, alongside fuel shortages, it has caused the collapse of the Sri Lankan government this month. Eritrea was one of the five countries to vote against the 2nd March UN resolution condemning Russia, while the two Sudans were among 35 (nearly half of whom were African) countries abstaining, and Ethiopia was absent. Egypt voted in favour of the resolution, but Putin has been active already in selling Russian wheat to Cairo in recent weeks. Economically from a Russian perspective, there is also benefit. Although Russian grain exports themselves are not subject to sanctions, the financial sanctions regime has meant that finding shipping and cargo insurance has been very difficult; under this deal, how could Putin still be refused insurance?
Second, gas
Similarly, in Europe, the game of cat-and-mouse continues in the gas markets. Putin has re-opened the Nord Stream 1 pipeline this week after its annual maintenance, albeit at significantly reduced capacity. Many expected him to keep it closed. However, it gives him a ready revenue stream, but on the other hand keeps all his levers available later in the year to exert new pressure having already forced the EU to call for member states to reduce gas consumption by 15% immediately to avoid critical shortages in the winter. In the meantime, Uniper, Germany’s principal utility company buying Russian gas, has been forced to the edge of bankruptcy necessitating a state bail-out by part nationalisation (the government will take a 30% stake), and an immediate liquidity injection of €8bn through new credit facilities which have had to be expanded four-fold.
Third, oil
Finally, to complete Putin’s busy week, his trip to Iran saw the two countries in lockstep backing the Syrian regime, and they agreed in principle the establishment of $40bn of mutual oil contracts, both countries’ oil being in theory subject to international sanctions but Iran with long experience of finding ways to confound them.
Reported inflation up again
To be clear, inflationary conditions were in place before Putin started weaponizing gas last August, let alone his invading Ukraine in February with all its subsequent effects. The pandemic, its dislocation and disruption to the normal supply and demand-side economic trends, the excess money supply created by both extraordinary monetary and fiscal stimulus to prevent economic meltdown in 2020 (in most cases with fiscal help linked directly with accelerating the transition to carbon net zero as the quid pro quo of propping up industries at immediate risk, including autos, airlines, airports, aerospace etc), all of these combined were creating inflationary pressures evident early last year. Putin’s actions since have simply turbocharged the effect, forcing inflation much higher and faster than otherwise might have been the case. But as we pointed out last week, and as Putin himself has implied, even if he does not control global inflation the resulting acceleration in prices worldwide is no accident: it is quite deliberate.

UK inflation (CPI) for June reached 9.4%, up from 9.1% in May. The RPI measure of inflation, used still in the setting of many regulated prices, now stands at 11.8% (with a sense of foreboding season ticket holders on the railways will be awaiting the July RPI figure on which the 2023 rail fares are set, based on RPI+X formula; will the government cap the increase at a lower rate to keep the punters on board, as in 2021?).
But what do householders really think? The Chapwood Index provides the clues
As we know, there is no one fixed definition of inflation. Even under the headline banner of Consumer Price Inflation, however comprehensive the methodology, unsurprisingly there is no agreed commonality between different countries as to what is supposed to be the representative basket of goods and services included against which prices are measured over comparative periods. In the US, the Federal Reserve usually bases its target of 2% inflation on Core Personal Consumer Expenditure which excludes the “volatile nature of food and fuel prices” to smooth the comparisons; it is worth noting that pragmatically and with a firm political shove, in being told by Biden to get a grip on inflation while Core PCE is currently running at a rate that is close to double headline CPI, the US Federal Reserve has had to give way and recognise that food and fuel are highly relevant elements in household budgets. In the UK, we have CPI as the official data, but still recorded is the Retail Price Index, which includes housing costs, whether mortgage interest or rent.

But to what extent do the official inflation data reflect one’s personal household inflation rate? Every household is different and it is almost guaranteed that 100% of households’ expenditure varies to at least some degree from the official list.

In the US, there is an unofficial annual inflation survey, the Chapwood Index. As the blurb on its website boasts, “The Chapwood Index reflects the true cost-of-living increase in America. Updated and released twice a year, it reports the unadjusted actual cost and price fluctuation of the top 500 items on which Americans spend their after-tax dollars in the 50 largest cities in the nation”. It has its detractors, seen by many economists as unscientific and inappropriate because of its lack of controls compared with the formal government figures.

Back in the pre-Covid days when headline inflation was reported often below the central banks’ 2% target rate, there was always the sneaking feeling that one’s own household inflation rate was outstripping what the government was telling us we were experiencing. In 2019 in the US, for example, Core PCE was averaging 1.7%; the Chapwood Index based on a simple arithmetic average recorded 9.6%, ranging from 5.5% in Mesa (Arizona) to 12.6% seen in Los Angeles and San Jose, both in California. The latest Chapwood data has just been released for 1H 2022: on the same basis, it weighs in at 15.4%, with the highest rate seen in Chicago at 18.8% (just pipping Fresno at 18.7), and the lowest being Minneapolis with 11.3%.

The criticisms of Chapwood’s crudeness are entirely fair, but they substantially miss the point. The point is not whether the data is accurate or not, it is that perception is as good as reality in the minds of the average voter. And if Mainstreet USA somehow has the impression that the wool is being pulled over its eyes, that reality (Chapwood) and officialdom (government inflation data) are a chasm apart, there tends to be a reaction. As real earnings fall, and more than a decade of central bank policy with its asset price inflation has exacerbated the economic gap further separating the “haves” and the ”have nots” leaving the latter even further behind, the effect is political polarisation. It leads to “populism”, both to the left and right, often turning long-established political habits and constituencies on their heads. That in turn creates instability, or at least throws up the increasing likelihood of surprising political outcomes.
The perception gap has real consequences
In the US, it gave rise to Trumpism on the right; now, on the far left, it gives political oxygen to the likes of Alexandria Ocasio-Cortez and others trying to unseat Joe Biden as their party leader ahead of the next presidential election. In France, the recent parliamentary elections saw a marked split to the more political extremes and away from the centre. Allied to climate change politics, the left-wing Greens are now strongly influential in coalition governments in Germany and Scotland. Similar polarising patterns can be seen in countries such as Spain, Poland and Hungary.
Italy in a mess. Again.
But perhaps nowhere in the West is it more immediately a major problem than in Italy where political crisis reigns again. Mario Draghi’s coalition government is rapidly disintegrating, pulled apart by the opposing forces of Five Star on the left and Forza in the centre-right and The League to the right of that finding their only common ground is to vent their combined fury on a technocrat, appointed prime minister failing to deal with the cost-of-living crisis and Italy being the most vulnerable after Germany to Putin squeezing gas supplies to the EU. It is a well-established truism of Italian politics that there is almost never a workable or sustainable Plan B, having executed Plan A by throwing out the incumbent government. The level of anxiety is palpable, as seen through bond yields: while Germany’s 10 Year government bond trades on a yield today of 1.17%, Italy’s is 3.45%, almost identical to that of Greece at 3.5%, hardly flattering given Greece’s history of being on the brink of going bust.
Italy is just another headache for the ECB…..
This week, the European Central Bank (ECB) increased eurozone interest rates, not by the quarter percentage point predicted by Christine Lagarde last month, but by a half point to bring the ECB’s deposit rate to zero, the first time since June 2014 that the rate has not been negative in nominal terms. Another half-point increase is on the cards in September. Also introduced following the ECB’s panic meeting three weeks ago, is the new “anti-fragmentation” programme (officially now called “Transmission Protection Instruments”), allowing full quantitative tightening for the economically stronger eurozone member states, while continuing with bond purchasing from the weaker ones, including Italy and Greece, despite raising their interest rates.

However bizarre and contradictory from a monetary standpoint, and to the extent that it explodes the entire notion and principle of “monetary union”, there’s nothing so inventive as the ECB to cobble together strange strategies to keep what is a political construct more-or-less together. But if Putin gets his way, that inventiveness is likely to be tested to the limit, if not quite to destruction, over the next nine months should he decide to make the EU shiver and shut.
….as German business confidence also takes a dive
The harbingers are not good. Today’s German Composite Purchasing Managers’ Index (PMI) fell from 51.3 in June to 48 in July. PMIs are not hard, recorded data—they are a snapshot of business leaders’ confidence of the future as measured through the responses to set questionnaires; as such the results are ephemeral but they do give a sense of a shop-floor outlook rather than what has already happened in fact; when the index is above 50, the implication is of sufficient confidence to see a growing economy; when below 50, it shows declining confidence and implying the risk of falling GDP and recession.

We might just have had a record-breaking heatwave, but at the risk of sounding like Eeyore, it’s going to be a long old winter.

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