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Reality Check May 17, 2022

Reality Check #12 — Russia, the West, and the rest: The hard choices the US must make to reinforce its global leadership

By Ferial Saeed

Key points

  • The Biden administration is confronting Russia’s naked aggression against Ukraine without direct military engagement, but a triple threat of inflation, starvation, and a coalition that is not sufficiently global promises trouble ahead for the United States and its position in a global order that is suddenly on an accelerated path to change. 
  • The commodities shock resulting from sanctions and war is amplifying an inflationary storm menacing the global economy, with the specter of mass starvation in the Global South, cost-of-living crises in the Global North, and the spreading risk of instability and illiberalism.
  • Isolating Russia politically requires a truly global coalition of states prepared to sacrifice their interests to cut Russia off and deny it the runway to pursue the war, but three-quarters of the world’s population—including key rising and regional powers—are not willing to do so, undercutting the United States’ immediate interests and global position over the long-term. 
  • Washington needs to make hard choices now to blunt these consequences and deliver the decisive strategic setback to Russian President Vladimir Putin necessary to reinforce US global leadership.  

What’s the issue?

The Biden administration is countering Russia’s naked aggression against Ukraine with an unprecedented strategy: inflict maximum pain without direct military engagement. It is an ambitious effort to deprive Putin of victory, punish Russia with tangible consequences, and avoid stumbling into a third world war. Washington and its Western allies and partners are deploying lethal aid to Ukraine, while seeking to cripple and isolate Russia’s G20 economy and render the country a pariah state, evicted from the post-World War II order. However, this strategy comes with risks, in the form of high inflation, commodities shortages, and a coalition that is not very global. These risks should be addressed now to avert seismic consequences to the United States and its position in the world.

The global economy is gripped by galloping inflation and the biggest disruption to commodities markets since the 1973 oil embargo—but on a far more massive scale. High inflation is the result of the global policy response to, and disruption from, COVID and predates the Russian invasion. However, sanctions on Russia—a commodities superpower—and war in Ukraine—a key commodities exporter—have dealt a second shock, causing scarcity and fanning already red-hot inflationary fires. This is happening even though commodities have for the most part not been sanctioned. Companies involved in financing, buying, transporting, or insuring commodities are “overcomplying”—foregoing permitted transactions—to avoid inadvertently crossing a line given the complexity of the sanctions regime. They are also “self-sanctioning” due to expectations of more sanctions to come, the security risks of operating in a war zone, and strong Western public pressure to sever ties with Russia, among other reasons. War has also disrupted or destroyed supplies of commodities. The consequences are dire. 

Mass starvation stalks the Global South. Russia and Ukraine provide 30 percent of global wheat supplies and large quantities of other foods. Wheat accounts for 20 percent of calories consumed worldwide. Missing supply is the proximate cause of the alarming “meltdown” of the global food system, along with high transport and fertilizer costs. Food prices are skyrocketing. The cost of bread is up 50 percent in Egypt, higher than in the period preceding the Arab Spring. Protests have erupted in Iraq, Albania, Sri Lanka, and Peru. Millions in Africa, facing hunger due to a devastating drought, now face starvation. Developing economies cannot pay for exorbitant food and fuel imports. Some also confront a debt crisis. Do they service their debt or default, like Sri Lanka? The longer the war drags on, the more intractable the damage to the developing world, and the more susceptible it becomes to political instability, not to mention the humanitarian toll.

Cost-of-living crises dog the Global North. Living standards are slipping backwards—by historic proportions in the United Kingdom. Even middle-income households struggle to pay gas and electricity bills, which have doubled in part because of bad policies. State benefits fail to keep pace with inflation. Germany has cushioned the impact on the vulnerable, but soaring costs and shortages are suffocating industry and will seep into consumer prices. Inflation is at a 40-year high in the United States and the highest on record in the eurozone. Advanced economies will cope, but politically, this is a gift to illiberal politicians. French President Emmanuel Macron decisively defeated far-right nationalist Marine Le Pen on April 24, but Le Pen won nearly 42 percent of the vote—the highest percentage ever for the far-right. Her focus on high food and fuel prices appealed to voters anxiously watching their purchasing power drop, underlining the risks to Europe and the United States. 

Curbing inflation is harder when geopolitical shock stokes the flames. Addressing high transport costs and tight commodity supplies is crucial, especially with respect to energy. Even food production depends heavily on fossil fuels. To dent prices, President Joe Biden is releasing an unprecedented one million barrels of crude oil a day from the US strategic petroleum reserve (SPR). The rationale is to “bridge“to an increase in US oil production, which is hoped for later this year. However, credible assessments, including from the Federal Reserve Bank of Dallas, suggest that US oil production will not increase much until 2023 or later. The Organization of the Petroleum Exporting Countries (OPEC) further warns that the world lacks the capacity to replace a large deficit fast. If the skeptics are correct, markets could be short about three million or more barrels a day as Russian output declines, sanctions intensify, seasonal demand kicks in, China emerges from lockdown, and the EU adopts a phased embargo. Of course, there are also more optimistic perspectives. In a U-turn from March, the International Energy Agency (IEA), now forecasts that reduced demand growth, plus significant additional supply from OPEC and the United States, will ensure that markets weather any storm.

Skyrocketing global inflation, starvation, political strife, and reversals in living standards are a clock ticking down to zero hour.

Regardless of which forecast on crude oil supply is borne out, prices remain a problem. The SPR release is not keeping a lid on them. Even the IEA is alarmed by the surging price of refined oil (diesel, gasoline, jet, and other fuels). Diesel prices are soaring in part because refining capacity has shrunk and Russia is a major diesel exporter (like China), so markets are anticipating further supply disruption. This is driving prices higher across-the-board. Diesel is the “workhorse” of the global economy, moving people and goods where they need to go, and its costs are reflected in virtually all goods and services. Russian oil can be replaced, just not fast enough to avert price-and-supply earthquakes that will shake the world. Similarly, the amount of liquified natural gas (LNG) the United States is selling to Europe is a drop in the bucket. To reduce purchases from Russia this year, Europe will fight Asia for some supply and contract with Qatar and Algeria. Again, Russian supply can be replaced over time, but the need for energy is immediate, as are the consequences of shortages.

Russia is also a major exporter of industrial minerals and metals, such as the steel, copper, and aluminum Europe needs to build wind, solar, and LNG terminals to transition from Russian energy. Prices are spiking. The cost of palladium—used in everything from catalytic converters that curb emissions in cars, to mobile phones, to dental fillings—is soaring. Rising commodities costs increase the prices of everything they touch. Canned food is more expensive because the price of metal is up. Costs will ripple through manufacturing, housing, and service industries, and land squarely on households.

On the political front, the challenges are daunting: most of the world—including every rising and regional power outside the Western coalition—refuses to isolate Russia. Even some loyal members of the coalition are not “all in.” Japan’s support for sanctions and isolating Russia is unprecedented, and an overwhelming majority of Japanese polled are willing to bear the costs so far. Nevertheless, Tokyo refuses to abandon an LNG project in Sakhalin because it is essential to Japan’s energy security. Although the United States, Europe, Japan, South Korea, Australia, New Zealand, Taiwan, and Singapore—representing over half the global economy—seek to isolate Russia, the rest say “not so fast.” These countries include China, India, Brazil, South Africa, Israel, Saudi Arabia, and the United Arab Emirates (UAE)—easily accounting for three-fourths of the world’s population and 60 percent of the global economy by 2030, per the Organization for Economic Co-operation and Development. These countries refuse to bear the costs or sacrifice their national interests to punish Russia. They reject Russian aggression without rejecting Russia itself. They want access to resources and believe relations with Moscow confer strategic benefits. Above all, they refuse to become proxies in a Western ideological confrontation between democracy and autocracy. These countries have aspirations for regional, and some for global, dominance and believe a political settlement better serves their national interests.

India is a case in point. For over two decades, Washington has groomed New Delhi to be a democratic counterweight to an authoritarian China. Yet, as Western democracies face their most existential crisis since World War II, India seeks to maintain relations with Russia and even contemplates rupee-ruble trade. Doubling down on this position, the Indian government recently asked state firms to consider buying stakes in Russian energy assets vacated by Western firms. New Delhi is unlikely to budge. It sees itself as an independent power on par with Washington. Notably, India is not responding to US offers to replace Russia as a supplier of arms and energy. In so doing, New Delhi is also creating Russian dependence and Indian leverage over Moscow. That is valuable, particularly because of the array of commodities Russia offers.

African states also have complex interests at stake. Russian influence around the continent has grown dramatically, and the Soviet Union’s support for ending colonialism and apartheid in South Africa has not been forgotten. In the Middle East, Saudi Arabia and the UAE are leveraging the energy crisis to force accommodation of their interests, spurning US entreaties to break with OPEC and ease supply. They are defiant in other ways: Riyadh is considering Beijing’s request to pay for oil in renminbi; the UAE hosted the Syrian president for talks; and Israel is undermining sanctions and considers Russia a key to its security, though the relationship is under strain over recent, indefensible Russian claims regarding the Holocaust and Naziism. Moscow also has a large profile in Latin America, and a rising Brazil sees the relationship as a low-cost way to manage the United States. These worrisome shifts in multiple regional orders are inimical to US interests.

Why does it matter?

Isolating Russia is a long game, but its consequences are urgent and have collided with a global economy still emerging from a pandemic shock. The war was Putin’s choice, and Russian brutality shocks the conscience. Nonetheless, it is discouraging that Washington took on such a monumental effort to inflict pain on Russia (and, indirectly, others) without being prepared for the obvious consequences: the unfolding global hunger crisis, the political impact of high inflation, and the threat to energy security arising from overcompliance with sanctions, refining capacity constraints, and policy choices to disfavor investment in fossil fuels. These problems require serious choices to create solutions. Slogans that shift blame to “Putin’s price hike” and corporate greed may work in the Washington echo chamber, but as populations across the globe suffer real-world consequences, domestic unrest will follow. Time is not on Washington’s side.

Skyrocketing global inflation, starvation, political strife, and reversals in living standards are a clock ticking down to zero hour. The early days of the US response were breathtaking, with an impressive array of sanctions reinforced by private actors fleeing Russia. Without a broad coalition to cut Russia off, however, Moscow retains the runway to pursue the war, and the consequences of war and sanctions will weaken the current coalition. To see how vulnerable Europe is, consider how Le Pen’s message on inflation resonated with French voters. Pressures will build for a political settlement. Likewise, if the coalition does not become truly global, Russia will be hobbled but can survive outside the post-World War II security order—presenting harrowing new risks. Can the nuclear nonproliferation regime survive without the cooperation of a nuclear superpower? Furthermore, while Washington judges that Moscow is not likely to use nuclear weapons against Ukraine, Russian nuclear doctrine has evolved to embrace the use of nuclear weapons to counter an existential conventional threat to the homeland. Could that doctrine become the basis for an alternate nuclear order led by Russia?     

Washington should address these economic and political challenges and recalibrate both tactics and goals to safeguard the United States’ position as the leader of first resort in an international order suddenly on an accelerated path to change.

What is the solution?

To deliver a decisive strategic setback to Putin, Washington needs a broad coalition to ameliorate the economic damage from war and sanctions, as well as a strategy for a political endgame to resolve the conflict. Following are a few recommendations:

1. Adopt a durable energy policy. Replacing supplies of Russian crude and refined oil while keeping markets stable requires hard decisions and preparation for shortages and price hikes. Europe is developing plans to ration gas. The Biden administration should promote the IEA’s ten-point plan for voluntary rationing. Equally important is to lay out how it will recalibrate its climate goals and policies to balance the urgent need for more fossil fuels while rebalancing toward environmentally sustainable energy sources.

The administration contends that US industry is sitting on unused drilling permits and that nothing holds back fossil fuel development. Permits are not the issue. A tight labor market, rising raw materials prices, and supply chain snarls are. Without experienced labor and necessary materials, industry cannot increase production. These factors also double drilling costs. Oil prices are high, but so are operating expenses. Public companies are accountable to shareholders who saw oil drop from $100 to $30 a barrel between 2014 and 2016 and demand capital discipline. Lack of policy and regulatory predictability increases the risk of making costly investments in new exploration and extraction. President Biden canceled the $9 billion Keystone XL pipeline his first day in office. He also signed an executive order proposing “ending international financing of carbon-intensive fossil fuel-based energy.” Private actors, such as index funds and other institutional shareholders, amplify the administration’s support for environmental, social, and governance concerns, constraining access to financing. Index funds have used their scale and market power to pressure financial intermediaries to eschew traditional energy investments, creating a void of financing for necessary investments in capacity. Only recently have these entities begun to re-think that policy. In a related matter, immigration is the solution for labor shortages.

2. Provide food aid and debt relief for the Global South. The heads of the World Bank, the International Monetary Fund, the World Food Program, and the World Trade Organization are calling for urgent action to provide emergency food supplies and unhindered trade, among other measures. Treasury Secretary Yellen’s meeting with counterparts is a step in that direction. Nonetheless, to demonstrate responsible use of sanctions, Washington should convene a donor’s conference resulting in significant new aid announcements and report on its disbursement of the $11 billion committed to food security in March. The G20 could agree to prohibit biofuels, whose feedstock could be consumed as food for the next year. Fuel prices impact food production, but gas tanks cannot take precedence over hungry people. About 40 percent of the US corn crop and a third of US soybeans are used to meet US renewable fuel standards requirements. The G20 should also drop requirements to ship food aid in national-flagged vessels. Washington should also coordinate with China. This would be a reassuring sign that the world’s two largest economies are capable of cooperating on a global solution to a global crisis, something they failed to do during the pandemic.

3. Support vulnerable households in the Global North. Inflation hits lower-income households hardest because a larger share of their income goes to food and fuel. Western central banks are increasing interest rates to cool inflation, but this step will most likely be only somewhat effective: rate hikes cannot deflate price increases caused by supply shocks. If rates are raised too high or too fast, households already paying more for food, gas, and rent will become severely stressed, and economies could dip into recession. Governments need to be ready with means-tested financial support.  

4. Cut transportation costs. Washington’s initiative to move to 24/7 operations at the Ports of Los Angeles and Long Beach, California, which together handle 40 percent of US container traffic, is not working because warehousing, trucking, and retailers do not operate on the same basis. If the bottlenecks are fixed, it will take a bite out of inflation: out of 351 container ports worldwide, the World Bank ranked Los Angeles 328 and Long Beach 333 in efficiency. At the same time, with post-pandemic demand for goods outstripping demand for services, traffic at the ports, which used to go through seasonal peaks and valleys, now operates at peak every day. A new data-sharing initiative is unlikely to provide relief unless corporations comply and share data. With the labor market tight, the answer is automation—which is resisted by unions. Their contract expires June 30; a compromise on automation is necessary but unlikely. Barring port expansion, automation is key to improving efficiency and the future of transportation.

5. Create consequences for the fence-sitters. The perception that close US partners can openly defy Washington needs to be disproved. Doing so requires depriving these partners of something that matters to them as a consequence of their continued ties with Russia, which give Putin runway to pursue the war and concentrates the pain on those countries cutting ties with Russia.

6. Re-engage for a political settlement. In a war of such catastrophic consequences for the entire world, a formal diplomatic process is essential. Washington should draft a proposal for multilateral talks that would create the prospect of an off-ramp, without setting terms that either side might prematurely reject. Putting the shell of a process together would obviate concerns over undercutting the impact of sanctions and military aid too quickly. The longer the war drags on, the harder it will be for either side to relent.

None of these measures will be easy, some will be unpopular politically, but inaction would be devasting for global security and prosperity, as well as for humanity.  

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Image: US President Joe Biden listens to Indian Prime Minister Narendra Modi during the Quad summit at the White House on September 24, 2021. Photo by Evelyn Hockstein/Reuters.