On Ukraine Virtue Signalling, And Our Inflation Spike

Inflation at 6.9% is a bad sign of the rising cost of living, and hidden within the headline numbers are some even grislier figures. As CTU economist Craig Renney has pointed out:

Food prices rose nearly 7%, led by fruit and vegetables which rose 17%. Meat rose 7.2%. The price of 91 fuel rose 8.7% even after the effects of the recent cut in duty. The cost of local authority rates increased by 7.5%. These are all unavoidable costs for many New Zealanders and hit those with the lowest incomes hardest.

Fruit and vegetables up by 17%? This strengthens the case for removing GST from those essential, health-promoting food items, but Finance Minister Grant Robertson continues to rule this out. Somehow, other countries manage this feat, and our supermarkets could readily introduce the coding that makes GST exemptions a breeze at checkouts in say, Australia. Go figure. Apparently, our sales tax system was immaculately conceived, and it has to stay that way forever. Whatever.

Just as irrationally, both Christopher Luxon and David Seymour have blamed the inflation numbers on government spending. Given that the government/Reserve Bank stimulus package saved New Zealand from experiencing what was being predicted to be the worst recession since the 1930s, most of us would accept the trade-off, even if some of the stimulus money may still be sloshing around the economy.

Do Luxon and Seynour really think we shouldn’t have spent money during the pandemic on say, wage subsidies, or refused to provide a support package to the tourism industry? No wonder they’re being coy about what they’d have cut: they’re not giving us any specifics. One can agree with Bernard Hickey that the money could have been better spent, but most New Zealanders supported the need for the stimulus package at the time, and they still do.

In reality, Luxon and Seymour are just banging a very old ideological drum about the alleged evils of government. If government spending was the key driver of rising prices then Spain – which as Craig Renney also says, spent 40% less on its Covid stimulus package than we did – would have a lower inflation rate than we do. But it doesn’t: its inflation rate is sitting at 9.8%.

France, which spent more than Spain but less than New Zealand, is experiencing its worst inflation rate since 1997. Sweden tells a similar story: the second lowest Covid spend in the OECD, yet an inflation rate of 6.1%. In sum, and despite what the centre-right are claiming, there doesn’t seem to be much of a genuine connection between the extent of Covid spending supports and the subsequent inflation rate.

There’s nothing unique about New Zealand’s current experience of rising prices. The usual culprits are responsible for the surge in inflation that’s currently hitting rich and poor countries alike, all around the world. Namely… The war in Ukraine has pushed up the price of petrol and of everything transported, and of anything made with wheat. Supply chain blockages are now being increasingly linked to reduced demand from China, and to its recent Covid lockdowns.

Previously… Jigh demand from China had enabled the world in general (and Australasia in particular) to chug on through the Global Financial Crisis without feeling as much pain as they otherwise would have. (Europe’s GFC-related crises were self-inflicted, by their devotion to the same austerity policies that Luxon and Seymour continue to promote.) Unfortunately, China’s recent Covid lockdowns in the likes of Shanghai are creating a fresh round of supply chain blockages, just as they were being cleared from ports elsewhere.

But here’s the concern: if much of our inflation is due to wars and to supply side blockages originating offshore, it is hard to see how the Reserve Bank raising the official cash rate (which affects the demand side of the domestic economy) will do us much good. Sure, this will raise the cost of investing and borrowing - and by making mortgages more costly, this will certainly reduce the amount of disposable income in peoples’ pockets, thereby dampening down demand. But inevitably, this will also hurt the retail sector, and raise the likelihood the slowdown will go off the cliff, into a recession.

In other words, there is something of a disconnect between the main causes of inflation – largely offshore, and likely to recede over the course of the next twelve months – and the remedy, which may only make the patient at home feel even sicker, for longer.

Probably, the RB felt it had to do something. But the outcome could be a stagnating economy, one still cursed with rising prices. Economists call that stagflation.

Ukraine: new war, old causes

OK, the raw numbers indicate that meaningful support for Ukraine should include a total European embargo on Russian oil and gas. As the European Union’s foreign policy chief Josep Borell pointed out earlier this week, the EU has sent a billion euros in aid to Ukraine since the invasion began but, Botell added, during the same period the EU has spent 35 billion euros buying Russian oil and gas. The Kremlin is using that hard currency to re-equip its war machine for a fresh offensive in the Donbas region that will kill thousands more Ukrainians, and further devastate the country.

Moreover, there’s this accelerating dismal trend:

The EU buys 2.2 million barrels of oil and 1.2 million barrels of petroleum product from Russia every day (IEA 2022)…..There is also an unseemly and morally appalling scramble by some European and Asian countries to increase their purchases of Russian oil. According to publicly available data….some nations that claim to be fully in support of Ukrainians appear to have significantly increased their purchases of Russian oil since the invasion…

In early April, Charles Michel, the president of the European Council, said that “sooner or later” the EU would have to consider instituting a total ban banning imports of Russian oil, and even gas. German businesses insist that such an embargo would have “catastrophic” consequences for Germany's economy and society.

How catastrophic? Obviously, nothing as bad as what Ukraine is experiencing right now. No doubt though, the economic shock for Germany (and Italy) from a total ban on Russian energy would be very unpleasant by any normal standards:

A forecast released on April 13 by [Germany’s] top economic institutes said a full EU energy embargo would trigger a sharp recession in Germany, sending output down 2.2 per cent next year and wiping out more than 400,000 jobs. “Germany would forfeit €220bn in economic output in 2022 and 2023, equivalent to 6.5 per cent of gross domestic product,” says Stefan Kooths of the Kiel Institute for the World Economy.

Hmm. That’s bad. Yet, arguably not that bad given the circumstances. A recession that wiped out 2.2% of output next year, and 6.5% of GDP spread over 24 months? In recent years, Germany has done far worse to its neighbours. As this column pointed out a fortnight ago… In the wake of the Global Financial Crisis, German banks imposed harsh conditions on Greece that reportedly destroyed circa 30% of that country’s GDP, as punishment for Greece’s allegedly irresponsible borrowing practices.

Irresponsible? Time and again, Germany’s then Chancellor Angela Merkel was warned about her country’s irresponsible (and growing) dependence on Russian energy via the Nord Stream 2 pipeline, but Merkel – under intense pressure from German business interests - ignored the warnings. As much as one has compassion for the German communities and workers who would be affected, Germany is being asked to do no more – and considerably less – than it demanded of others, little more than a decade ago.

Planning the banning

That argument aside, what ingredients might a total EU ban on Russian energy actually need to include, in order to be effective? The embargo package would have to be designed to prevent Russia diverting its oil and gas elsewhere, to buyers in Asia or the Middle East.

Basically, the EU would need to enact a blanket provision that prohibits all Russian oil and oil product imports, and one that would make it illegal to carry such cargo in EU-owned tankers. This system of sanctions would provide the legal basis for breaking the existing contracts along the supply chain, and would severely restrict Russia's ability to finance its military operations in Ukraine.

To spell that out more precisely:

The key point is to avoid a situation in which the EU imposes an embargo on the import of Russian oil, resulting only in more of that oil flowing to Asian markets. Given the large market share of EU-owned tanker fleets, a prohibition on those vessels carrying Russian oil and oil products is essential for sanctions to be meaningful.

Such an embargo would also have to contain exemptions to ensure consistency of supply to Third World countries:

An EU embargo and associated system of sanctions could be combined with a tightly controlled and centralised system of waivers. These waivers would allow limited purchases of Russian oil by designated countries and in specified tankers. The prices charged should be monitored and preferably set below the world price for oil.

Again, this money would have to be ring-fenced. Any payments to Russia under the waiver scheme would have to be diverted away from the Kremlin’s military machine, and into escrow accounts to pay for only humanitarian needs within Russia.

In addition, all payments for Russian oil under the waiver programme would go into supervised escrow accounts. The funds in these accounts should be available to Russia only once there is a ceasefire and, even in that case, should be used to buy food and medicine only – no weapons or industrial components that can be used to make weapons or military equipment of any kind.

Is any of this very likely? Probably not. Yet something very much like it will be necessary if the outside world is going to be much more than an ineffectual onlooker to the carnage occurring within Ukraine – carnage that is being financed by the EU’s priority on keeping its homes warm and cosy, and its wheels of commerce turning.

Footnote One: The fighting in Ukraine has recently changed shape. After street fighting exposed the lumbering weaknesses of the Russian military machine, Russia has moved the bulk of its forces to the east. In the Donbass region, the war is being fought on Russia’s preferred terms, on relatively open ground. Big set piece artillery barrages and tanks are operating under air cover to soften up the entrenched Ukrainian troops for the waves of infantry to follow.

If this new offensive proceeds to plan… After decimating the Ukraine military in the Donbass, Russia could then return to conquer Kyev and the rest of the country at a later date, and suffer fewer casualties in the process.

If that plan is to be thwarted, the West will need to supply more effective weapons –Vlodomyr Zelensky has been asking in vain for fighter planes – and an escalation of the economic embargoes currently in place. This morning, US President Joe Biden announced a further $800 million military aid package, plus another $500 million to sustain the Kyev government’s basic functions.

The U.S. [military] support — including heavy artillery, howitzers, drones and ammunition — aims to help Ukraine fend off Mr. Putin’s offensive in the east, where Russian forces made minor gains across a 300-mile front, according to military analysts.

Footnote Two: Not for the first time in its history, Russia has been justifying an imperial war of expansion as being an exercise in self-defence. The US diplomat George Kennan was the key figure who shaped America’s Cold War policies to deter and contain the Soviet Union. However:

As far back as 1997, Kennan wrote in his diary, “I have been rendered most unhappy by the admission of Poland, the Czech Republic and Hungary to membership in NATO.” How was such a development “to be reconciled with the assurances to the Russians that they need not worry, that the extension of NATO’s borders to the east has no military implications?”

Kennan saw nothing in the rapid and reckless expansion of NATO “other than a new Cold War, probably ending in a hot one, and the end of the effort to achieve a workable democracy in Russia.”

Not that Kennan believed that isolated concessions made to placate Russia’s insecurity would be advisable, or likely to be reciprocated:

[Kennan] also believed firmly that if the West failed to respond with counterforce, resolve, and a unanimous voice to Russia’s deeply ingrained expansionist tendencies, Moscow would surely attempt to challenge Western encroachment on territory it saw as falling within its rightful sphere of influence.

Its rightful sphere of influence…. Yep, that is how imperial powers eternally insecure about the security of the borders, do tend to think. The trouble for Russia is that Moscow’s post WW2 empire in eastern Europe was full of independent people who would not submit to Moscow’s domination forever, and nor would they perpetually subordinate their own aspirations to what Moscow saw as its own self-interest. Hungary in 1956, Czechoslovakia in 1968, and now Ukraine have been only a few of the outcomes:

At the heart of Putin’s view of world affairs is what Kennan called “Russia’s traditional and instinctive sense of insecurity… They have always feared foreign penetration, feared direct contact between the Western world and their own, feared what would happen if Russians learned the truth about the world within. And they learned to seek security only in the patient but deadly struggle for… destruction of rival power, never in compacts or compromises with it.”

Even paranoids though, can have genuine enemies. Arguably, NATO ( and the Kyev government) could have done a lot more to reassure Russia. Yet given the fiercely nativistic claims by Putin (both here, and here) that Ukraine as a country with its own culture and language has no valid right to exist, probably that would not have been enough.

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