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A Growling Bear is Bad for Everyone

I was convinced last week that the stock markets, as well as the inflation markets, were underestimating the importance of the Ukrainian conflict. I thought that I had a little more time to write about that before the crisis came to a head, which turned out not to be true. However, it seems that markets are still underestimating the importance of the Ukrainian conflict.

About the best possible outcome at this point is that Putin stops with an annexation of the Russian equivalent of the Sudetenland, with the episode merely pointing out (again) the impotence of Western leaders to respond to Russian aggression but not actually damaging much besides our pride. Even in that case, to me this signals a dangerous new evolution in the development of Russia’s relationship with the West. But the worse cases are far worse.

The angry fist-shaking of the old democracies is moderately amusing; less amusing are the stupid threats being made about economic sanctions. Let us stop for a minute and review what the West imports from Russia.

According to this article from Miyanville (from early 2013), Russia is the world’s largest producer of chromium (30% of the world market), nickel (19%), and palladium (43%), and is the second-largest producer of aluminum (10%), platinum (12%), and zirconium (19%). It has the largest supply of natural gas (although we are gaining rapidly), the second largest supply of coal, and the 8th-largest endowment of crude oil. The Ukraine itself is the third largest exporter of corn and the sixth-largest exporter of wheat. Meanwhile, the top 10 exports to Russia include engines, aircraft, vehicles, meat, electronic equipment, plastics, live animals, and pharmaceuticals.

So, we are fundamentally exporting “nice to haves” while importing “must haves.” Who needs trade more?

Let me make a further, suggestive observation. I maintain that the tremendous, positive trade-off of growth and inflation (high growth, low inflation) that the U.S. has experienced since the 1990s is at least partly a story of globalization following the end of the Cold War. Over the last couple of years, I have grown fond of showing the graph of apparel prices, which shows a steady rise until the early 1990s, a decline until 2012 or so, and then what appears to be a resumption of the rise. The story with apparel is very clear – as we moved from primarily domestically-sourced apparel to almost completely overseas-sourced apparel, high-cost production was replaced by low-cost production, which dampened the price increases for American consumers. It is a very clear illustration of the “globalization dividend.”

Of course, mainstream economic theory holds that the inflation/growth tradeoff suddenly became attractive for the U.S. in 1991 or so because inflation expectations abruptly became “anchored.” Why look for a good reason, when you can simply add a dummy variable to an econometric model??

But suppose that I am right, and the fall of the Soviet Union in 1991 played a role in the terrific growth/inflation tradeoff we have experienced since then. Incidentally, here are some data:

  • Cold War (1963, immediately following the Cuban missile crisis, until the fall of the USSR): U.S. annual growth averaged 3.4% (not compounded); inflation averaged 5.4%. The DJIA rose at a compounded nominal rate of 5.6%.
  • Post-Cold-War (1991-2013, including three recessions): U.S. annual average growth 2.6%; annual average inflation 2.4%. The DJIA rose at a compounded nominal rate of 7.5%.

This is not to say that globalization is about to end, or go into reverse, necessarily. It is to illustrate why we really ought to be very concerned if it appears that the Bear appears to be back in expansion mode – whether it is something we can prevent or not. And it is also to illustrate why putting a firm end to that expansion mode, rather than sacrificing global trade and cheap energy to a resurrection of the Cold War, is probably worth considering.

I still don’t think that equity investors understand the significance of what is going on in the Ukraine.

  1. eric
    March 3, 2014 at 2:47 pm

    I completely agree with your market analysis of this. But I’m confused about what you mean in your second to last sentence. Last time I checked Russia still had the second largest nuclear arsenal in the world, and an Army that’s perfectly capable of marching back to Berlin if it wants to. what kind of firm stop are you proposing?

    What I want to know is why our state department is continually so clueless. who are these people? Who thought it was a good idea to instigate Ukrainians to sweep in a pro-west government. Did they really think that Russia was going to sit on its hands while the ENTIRETY of their black sea fleet, and their only warm water port, fell to NATO control? And what about the fact that all that natural gas you mention above flows to western Europe _through_ pipelines in the Ukraine. In what possible world were the Russians going to let this happen? Taking and controlling the Crimea was one of the great geopolitical accomplishments of the Czarist era.

    • March 3, 2014 at 3:33 pm

      They certainly have a nuclear capability, but their Army is certainly no longer capable of marching to Berlin. Mostly they have second and third generation heavy artillery, and no air power to speak of. They would be slightly more difficult to beat than the Iraqi army, but not much more so.

      It is definitely more difficult to push the Russians OUT than it would have been to keep them out in the first place. But somewhere along the line the State Department and the Administration that put them into place thought that telling them “we really should be able to reach agreement on this” was going to stop a geopolitically-aggressive adversary. It never has, and never will. When the Ukrainian government went pro-west, our first step should not have been to offer bond guarantees but to offer troops. As soon as they said “yes,” the Russians would have been stalemated…unless they wanted to take on a country capable of projecting power in a way that they haven’t been able to do in thirty years.

  1. March 4, 2014 at 8:35 am

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