The Fog of War in Ukraine Darkens the Global Economic Outlook
Russia’s brutal invasion of Ukraine intensifies the product shortage and price rise issues we have come to associate with Covid-19.
The good news — if anything about the conflict can be characterized as good — is that these issues may ease sooner than is generally expected. The not-so-good news is that the war in Europe could trigger the recession that many observers — including myself — have predicted owing to the accumulation of inventory in manufacturing.
Moderating forces will prevail
Shortages of consumer goods and price hikes were on an upward track before the Russian offensive. The scarcities were caused by a significant increase in demand driven by government efforts to support their struggling economies with huge injections of cash. Pandemic-related business closures and worker shortages added fuel to the fire, and stoked inflationary pressures.
The conflict in Ukraine has accelerated these trends in dramatic fashion. There was consternation in the US when the average price of regular gasoline surpassed $4 per gallon and kept on climbing.
While price rises like this are alarming, both shortages and prices are likely to moderate relatively soon for various reasons.
First, we can expect a significant decline in the demand for products. During the height of the pandemic, especially during 2021, consumers spent lavishly on goods because access to many services, such as eating out in restaurants, was restricted. The table is now turning as the pandemic wanes, which means that much of this spending will shift to the service sector.
Second, the likelihood that governments will use more stimulus payments to prop up their economies any time soon is very low. In addition, central banks are starting to realize that inflation is not transitory and are about to raise interest rates and take other anti-inflationary measures that will slow down their economies.
Another demand dampener is the impact of high prices on consumer buying behavior. In a high-price environment, consumers tend to be judicious about what they buy and when. Americans become more thoughtful about filling their gas tanks when the price of a gallon of fuel breaks the $4 threshold.
Other drivers of shortages and price hikes that appear to be moderating include the cost of freight transportation. At the time of writing, the World Container Index from research firm Drewry was in decline. The queues of container ships anchored outside the ports of Long Beach and Los Angeles are dwindling, and this should reinforce the easing of product shortages as well as the downward trend in transportation prices. After a period of further price increases due to the rising cost of oil, I expect transportation costs to trend downwards in the next few weeks.
The negative side of the ledger
While less expensive, more available goods are welcome, these gains could be wiped out by an economic downturn — an outcome that became a distinct possibility after Russia invaded Ukraine. The war could well turn out to be the trigger that ignites a recessionary “bullwhip” effect and throws the world’s economies into decline.
As I explain in my recent LinkedIn Influencer post It’s Time to Confront the Prospect of a Global Recession, recession-building economic and social forces have been gathering steam over the last two years. During this time markets were plagued by product and labor scarcities. Also, central banks made it plain that they will ratchet up interest to contain rising inflation. The bite of the bullwhip effect — where over-ordering is amplified along the supply chain — is another force that threatens to tip economies into a downturn.
But the invasion of Ukraine could preempt these triggers, as the fallout ripples through global supply chains. For instance, as a new Cold War descends and Russia becomes an international pariah, supplies of key materials from that country are almost certain to be compromised. An example is palladium used in the manufacture of auto catalysts; it is estimated that Russia accounts for 40% of the global production of the metal. Other destabilizing forces emanating from the conflict include geopolitical realignments, and shifts in the supply of oil as Western countries attempt to curtail imports of Russian oil that help to finance the country’s military aggression.
The new normal is a long way off
The war in Ukraine makes it even more important that companies start to prepare for recession. There are many measures they can put in place, such as conserving cash, reducing inventory levels, and prioritizing customers.
Perhaps the experience of navigating a pandemic might help companies to weather the coming economic storm. Certainly, there will be no letup in the level of unpredictability. War and its unintended consequences are inherently unpredictable.
