Sanctions, trade wars worsen US inflation

By: Dan_Steinbock

The Fed’s aggressive and belated rate hikes will escalate economic challenges in the US and elsewhere, thanks to ill-advised sanctions and trade wars.

Recently, the Federal Reserve lifted its benchmark interest rate by half a percentage point, to a range of 0.75%-1%, following a smaller rise in March. It was the Fed’s biggest increase in 22 years.

Last fall, Jerome Powell, the Fed chairman, still characterized rising prices as "transitionary" which would not leave “a permanent mark in the form of higher inflation.”

So, when inflation began to climb rapidly after mid-year 2021, the Fed ignored it until it soared.             

40-year-high inflation driven by commodities and trade wars        

In March, US inflation rate accelerated to 8.5 percent; the highest since December 1981. In part, it was fueled by energy and food prices; in part, by the consumer price index (CPI), which shot to 6.5 percent, the most in four decades.

Typically, the rapidly-increasing energy and food prices are being attributed to the Ukrainian crisis. Effectively, they should be associated with economic sanctions that have turned a regional conflict with a limited, short-term trajectory into a global crisis with a broad, protracted horizon. That's the net effect of the hybrid proxy war in Ukraine.

Excluding volatile energy and food categories, the soaring inflation has been associated with pandemic-induced global supply disruptions and the recent COVID-19 outbreaks in China. Reportedly, new cases peaked in China in late April and are now coming down.

But disruptions in global supply chains may penalize global economic prospects as long as the failed efforts to contain the virus in the West continue to give rise to new waves of variants.

Energy and food shocks, prelude to more global pain               

Commodity prices peaked in early March, remain close to the peak level and have soared 39 percent since the beginning of the year. Food prices climbed to an all-time high in March, up nearly 20 percent year-on-year, and remain high in what UN Secretary-General Antonio Guterres has called the “hurricane of hunger and a meltdown of the global food system”, while crude oil price reached a high of $125 in early March, increasing 43 percent since January.

In Europe, the most exposed region to Russian energy, natural gas price quintupled to a high of 230 euros and has dropped to 104 euros, as concerns over Russian supplies have dissipated somewhat, but only temporarily.

Russia is the world's 11th largest, $1.8 trillion economy. It is the world's largest gas exporter and the second-largest crude oil exporter after Saudi Arabia. Goldman Sachs has warned that the global economy “could soon be faced with one of the largest energy supply shocks ever”.

A benign scenario in the Ukrainian crisis was possible, but it would have required rapid, proactive diplomacy. Unfortunately, that has not been the priority of the proxy war. As US defense secretary Austin acknowledged in late April: “We want to see Russia weakened.” It was a stunning admission.

Misguided trade wars derail global prospects, again                

Currently, the Biden administration is reviewing US tariffs imposed on Chinese products ahead of their expiration in July. Meanwhile, some policymakers are calling for reductions in order to provide relief to consumers struggling with rising prices. These calls are fueled by the fear of a potential Republican landslide win in the midterm elections.

The misguided trade wars against China and other large trading economies have caused irreparable harm by undermining global recovery since 2017. Currently, average tariffs on Chinese imports are levied at about 19.3 percent covering over two-thirds of all goods the US buys from China.

Yet, the US trade deficit has not shrunk, as the Trump and Biden administration expected. In March, it widened sharply to a record high of $110 billion, due to a broad-based rise in prices, especially as energy imports increased by 10.3% to a new record high of $352 billion.

The lessons are unambiguous. Unilateral tariffs can resolve neither multilateral challenges nor distortions in US domestic economy. In effect, recent research suggests that a trade liberalization policy equivalent to a 2-percentage-point reduction in tariffs could reduce U.S. inflation by 1.3 percentage points from the current rate.

Yet, the Biden administration’s priorities have been geopolitical rather than economic. That’s precisely why it has continued the Trump White House’s tariff hikes since January 2021.

Ironically, hoping to kill two birds with one stone, the Biden administration now blames “Trump’s tariffs” for the record high inflation. In a disingenuous face-saving measure, it hopes to reframe its economic failures to derail Republican advances in the impending mid-term elections.

Protracted policy mistakes, medium-term damage

“Has US inflation peaked?” the New York Times asked already 3 weeks ago. “Has US inflation finally started to slow?” seconded the Financial Times more recently. Recent headlines reflect optimistic but premature hopes that inflation peaked in March.

Yet, the Ukraine crisis is far from over, thanks to Biden's proxy war. Moreover, the bottlenecks in the global supply chains are yet to be cleared and could again clog supplies when new variant waves re-emerge.

These pressures are likely to weigh on commodity prices longer, particularly if the Biden administration opts for new, ill-advised trade wars and continued misguided sanctions. Meanwhile, the Fed’s aggressive and belated rate hikes are escalating economic challenges in the US and elsewhere. And these could worsen in July, when the Fed plans to start quantitative tightening by culling assets from its $9 trillion balance sheet.

Dr. Dan Steinbock is the founder of Difference Group and has served at the India, China and America Institute (US), Shanghai Institute for International Studies (China) and the EU Center (Singapore). For more, see http://www.differencegroup.net/  

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