Gleanings & Observations

Note: At this writing negotiations are underway between Ukraine and Russia to find a way to end this war. A flustered Putin has yet to unleash a full-throated attack on Ukraine, which he still might do, unless a face-saving exit can be arranged.

After the shock of his invasion of Ukraine caused a massive share sell-off, a rule established by Nathan Rothschild in the 18th century, who made a fortune buying shares in the panic that followed the Battle of Waterloo, took hold. The great banker advised that “the time to buy is when there is blood in the streets,” which Wall Street wags updated to “the time to buy is when the missiles are flying”. It certainly was. On Friday the S&P 500 closed more than 6 percent above the low it hit the previous day.

The Economic Consequences of Vladimir Putin

Oil prices jumped following Russia’s invasion of Ukraine, but that might well have been an acceleration of an existing trend. Crude oil passed the $100 per barrel mark, perhaps headed to $120, about double one year ago. That means gasoline prices might reach double the $2.50 average of one year ago, with a $7 price no longer beyond the range of possibility. Good news for Putin. Russia produces about 10 million barrels of oil per day, which means that a price jump of $10 per barrel adds $100,000,000 per day to his war chest.

We now rely on Russia for 7 percent of our oil imports, or about 600,000 barrels per day. The Keystone XL pipeline that the President cancelled would have brought 830,000 barrels per day of Canadian crude to the US. Also, Biden has been attempting to reduce domestic oil and gas production. He has fought fracking and offshore and onshore drilling. He has nominated to the Federal Reserve Board of governors Sarah Bloom Raskin, who favours preventing banks from providing credit to oil companies.

That policy should now be up for review. Not that America can ever become “independent” of the global market for oil – prices are set in that market – but it can reduce the impact of that market on our economy. After all, a net exporter of oil does reap some benefit from a rise in oil prices.

Higher gasoline prices raise the cost of transporting goods around the country; they feed through to industries that rely on petroleum as a raw material, industries that manufacture everything from cosmetics to heart valves. They raise the cost of petroleum-based fertilizers and pesticides, and the fuel to drive agricultural equipment. And they cause any incumbent administration political pain.

Fed Readies Interest Rate Rise

Still, this conflict is not likely to have a direct impact on Fed policy. Even before Putin’s invasion of Ukraine, the Bank had planned to tighten monetary policy. Powell has already decided on a quarter-point test of the impact of the end of negative rates. Any economic uncertainty created by Putin’s takeover of Ukraine, and his later toggling between war-war and jaw-jaw, will probably put paid to talk of a one-half point rise to give the Fed time to assess the impact of its move on an economy that is booming and inflating. Real GDP growth in the fourth quarter of last year came in at 7.0 percent, while inflation jumped by 6.3 percent using the Fed’s preferred measure of inflation.

Sanctions Tighten

Led by President Biden, an eventually united NATO imposed ever-more restrictive sanctions on Russia, Putin and his cronies. The belated sanction on Putin personally doesn’t mean much, since his billions are difficult to locate. “I don’t think Putin is really going to lose much sleep on being sanctioned,” Adam M. Smith, a former Treasury official now in private practice told The New York Times.

More significant is the partial removal of Russia from the SWIFT system of international payments. Despite support for Russia from China, and the exemption of energy products from the ban, the sanctions seem to be causing havoc in the Russian economy. The ruble has crashed, Russia’s stock market is closed, there are runs on several banks, and the central bank has more doubled interest rates. Dmitri Peskov, a Kremlin spokesman, announced “The economic reality has, of course, changed.” Indeed.

Unintended Consequences Rattle Putin

Putin did not anticipate either the intensity of the opposition his forces would confront, the economic damage to his economy, or – worse from his point of view – that Biden’s patience with often foot-dragging allies would result in a newly unified NATO and a Germany that has decided to abandon its decades-long neglect of its military forces.

That latter development might well turn out to be of historic importance. Germany has agreed to raise its defense spending above its 2 percent NATO commitment and create a strategic natural gas reserve. Germany’s military, says retired four-star general John Keane, is “non-existent”. “The Bundeswehr, the army I am allowed to lead, is more or less bare. The options we can offer the politicians to support the [NATO] alliance are extremely limited,” says Alfons Mais, the Inspector of the Army and commander of the troops. It will take time, and I never thought I would cheer increases in the potency of the Bundeswehr, but times they are a’changin’.

Biden Prepares His Response To A New Reality

Tomorrow’s s State of the Union (SOU) message provide a clue as to whether Biden is prepared to end his real, inflation-adjusted cuts in military spending. There are two reasons he might not. First, his Left will fight to prevent a diversion of resources from expanding the welfare state to strengthening America’s defenses. Second, even critics must concede that sanctions are a potent weapon, although it is not certain that they are potent enough to change an adversary’s behavior.

U.S. military spending has fallen from 6-7 percent of GDP in Cold War days to about half that. Last year Biden called for a 16 percent increase in funding of non-defense domestic agencies, and a below-inflation 1.6 percent raise for the Pentagon. Lots more butter, lots fewer guns. At a time when Putin is flexing his nuclear muscles and has made clear that the is willing to bear considerable costs to reconstruct the former Soviet Union. Ukraine is not a NATO member, but if Putin succeeds, his next move would be against a NATO member that America is pledged to help defending.

It is traditional for the opposition to select one of its number to respond to the President’s SOU. Republicans have selected Iowa Governor Kim Reynolds as their spokesman. In a new twist, Biden will also hear from his “progressive” wing: representative Rashib Tlaib (Michigan), a member of “the Squad”, will respond on behalf of the Working Families Party, presumably to oppose any shift of green and social spending to the Pentagon.

FDR, Stalin, Nixon, Zhou and Palmerston

This month 77 years ago in Crimea President Franklin Roosevelt and Marshal Joseph Stalin hoisted their glasses at the Yalta conference to toast the everlasting friendship of their nations. Fifty years ago almost to the day – February 21, 1972 – President Richard Nixon and Premier Zhou Enlai hoisted their glasses in China to toast the fact that the great American and Chinese peoples “have always been friendly to each other.”

“We have no eternal allies, and we have no perpetual enemies. Our interests are eternal and perpetual, and those interests it is our duty to follow.” Henry Temple, 3rd Viscount Palmerston, 1 March 1848.