World-Watching: The Problem with the Current Russia Sanctions Regime

[from Project Syndicate, by Mohamed A. El-Erian]

There is much debate about the effectiveness of Western sanctions, the Ukraine war’s implications for markets and the global economy, and what the West’s next steps should be. While there are few good options, some are clearly worse than others.

Cambridge — It has been five months since Europe and the United States imposed tough economic and financial sanctions on Russia, a G20 country that was the world’s eleventh-largest economy on the eve of its invasion of Ukraine. While the sanctions have been gradually strengthened in the intervening months, debate rages about their effectiveness, the war’s broader implications for markets and the global economy, and what the West’s next steps should be.

On the first question, although the sanctions have been less effective than Europe and the U.S. had hoped, they also are proving more onerous than the Kremlin claims. Russia’s central bank expects GDP to contract by 8-10% this year, while other forecasters expect a larger fall, together with longer-lasting damage to growth potential. Imports and exports have been severely disrupted, and inflows of foreign investment have essentially stopped. Shortages are multiplying, pushing inflation higher. At this point, the country no longer has a properly functioning foreign-exchange market.

The sanctions would have bitten much harder had the West not opted for a carve-out of Russia’s energy sector, and had many more countries joined the U.S. and Europe in the effort. Because that didn’t happen, Russia has not felt nearly as much pressure as it would have. Moreover, it has been able to continue trading through various side and back doors that will likely become increasingly important as long as the sanctions regime, as currently designed, continues.

Nonetheless, it is only a matter of time before the Russian economy experiences a harder hit. Inventories of imported goods – including many critical technological and industrial inputs – are dwindling fast, and many sectors are becoming less resilient. The cumulative damage to Russia’s economy over time will be significant and long-lasting – a fact that has not yet been fully captured by consensus medium-term forecasts.

The second question concerns global spillovers from the war and the sanctions regime. Most observers agree that Russia’s invasion has increased not just energy insecurity but also food insecurity, highlighting the fallout from the war’s disruption to Ukrainian agricultural exports. But there is still much debate about the West’s use of the economic nuclear sanctions option: the curbs placed on Russia’s central bank and on Russia’s use of the international payments system.

These curbs are far more intrusive than the usual mix of restrictions on sanctioned government and private sector trade and on individuals’ financial dealings. Yet, because they are not subject to any internationally agreed standards, guidelines, or checks and balances, they fall outside the purview of relevant global-governance bodies such as the Bank for International Settlements, the International Monetary Fund, and the World Trade Organization.

In a time of war, such oversight might seem like a nicety. But some worry that the sanctions could significantly reduce the dollar’s role as the world’s reserve currency and the U.S. financial system’s role as the primary global intermediary for other countries’ savings and investments. After all, a growing number of countries undoubtedly now feel more vulnerable to the reach of U.S. sanctions.

But it is impossible to replace something with nothing, which means that no significant loss of dollar or U.S. financial primacy will occur in the immediate future. Rather, the sanctions will lend further momentum to the gradual process of global economic fragmentation, which was also fueled a few years ago by the tariffs imposed by the Trump administration. More countries now have even more of a reason to pursue greater financial resilience and inherently inefficient forms of self-insurance.

That brings us to the third debate. With no end in sight for the war, what should the West do next? Fearing the implications for energy prices and the supply of gas to Europe, many in the West are tempted to call for a moratorium on any new sanctions – or even for additional carve-outs. Others, however, favor additional measures to hold Russia accountable for its indiscriminate attacks on Ukrainian civilians.

In any case, maintaining the current sanctions regime is not problem-free, owing to the twin objectives of pressuring Russia and limiting the economic disruption to Europe. Moreover, as European Commission President Ursula von der Leyen recently said, it feels as if Russia is “blackmailing” Europe by threatening to disrupt gas supplies at any moment. No wonder the Commission is urging member countries to cut consumption by 15%.

Under the current sanctions regime, the West risks falling between two horses. While easing sanctions could help alleviate concerns about Europe’s economic outlook, this option is a non-starter, given the atrocities that Russian forces are committing in Ukraine. But if the West is serious about pressuring Russia through truly crippling economic and financial sanctions, it needs to bite the bullet and eliminate the carve-outs for energy.

Doing so would undoubtedly have a severe short-term economic impact on European economies and the rest of the world, amplifying the “little fires everywhere” syndrome that I warned about in May. It is therefore critical that governments use their available fiscal space to provide targeted support to vulnerable segments of the population, as well as to fragile countries; and multilateral agencies must support developing countries through aid and a more operational debt relief framework. If done properly, this option would yield better outcomes in the medium and long term than the current strategy.

Muddling through risks bringing about the worst of all possible worlds. It is insufficient to dissuade Russia from continuing its illegal war; it is fueling deeper fragmentation of the international monetary system; and it is not even protecting Europe from a winter gas disruption.

Mohamed A. El-Erian, President of Queens’ College at the University of Cambridge, is a professor at the Wharton School of the University of Pennsylvania and the author of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse (Random House, 2016).

WANG Huiyao: To Save Global Trade, Start Small

[from the Center for China and Globalization]

by WANG Huiyao (王辉耀), Founder of the Center for China and Globalization

The global economy is being rocked by war, sanctions and spiraling commodity prices—not to mention the ongoing strain of the pandemic, geopolitical tensions and climate change. These compounding risks present a serious challenge to the system of open trade that the World Trade Organization was designed to uphold. But it also offers a chance for the beleaguered organization, which is holding its first ministerial conference since 2017, to prove its continuing relevance.

The WTO has traditionally focused on combating protectionism—measures designed to insulate producers from international competition. Now, though, the biggest threats to free trade come from policies meant to safeguard national security and protect citizens from risks, such as those related to health, the environment or digital spaces.

Former WTO Director-General Pascal Lamy has called this growing use of export controls, cybersecurity laws, investment blacklists, reshoring incentives and the like “precautionism.” It’s been on the rise since the start of the pandemic, when many countries moved to restrict exports of medical supplies and other essentials. COVID-19 has also raised concerns about the vulnerability of supply chains, particularly those dependent on geopolitical rivals.

The world’s two biggest trading nations, the United States and China, have both engaged in precautionism. The U.S. is actively pursuing a policy of “friend-shoring”—shifting trade flows from potentially hostile countries to friendlier ones. China’s “dual circulation” strategy aims in part to reduce dependence on foreign imports, especially technology, while its government has long imposed limits on data flows in and out of the country.

With Russia’s invasion of Ukraine, the momentum toward friend-shoring has grown. Meanwhile, food shortages and surging prices have triggered another round of precautionary measures: Since the war began, 63 countries have imposed a more than 100 export restrictions on fertilizer and foodstuffs.

While the impulse driving such policies is understandable, the trend could cause great harm if allowed to run unchecked. It will increase inflation and depress global growth, especially if it involves costly redeployment of supply chains away from efficient producers such as China. A recent WTO study estimated that decoupling the global economy into “Western” and “Eastern” blocs would wipe out nearly 5% in output, the equivalent of $4 trillion.

As a recent study by the International Monetary Fund points out, the way to make global value chains more resilient is to diversify, not dismantle them. Turning away from open trade will only make states more vulnerable to economic shocks such as war, disease or crop failures.

The WTO is an obvious vehicle to rally collective action on these issues. However, like other global institutions, it has been weakened by years of deadlock. At this week’s meeting, countries should start to build positive momentum with some small but symbolically significant breakthroughs to show the WTO can still mobilize joint action.

Given current threats to food security, at the very least members should agree not to restrict exports of foodstuffs purchased for the World Food Programme. A step further would be a joint statement calling on members to keep trade in food and agricultural products open and avoid imposing unjustified export restrictions. There should also be closer coordination to smooth supply chains and clogged logistics channels.

Another low-hanging fruit is finally securing a  waiver covering intellectual property rights for COVID-19-related products. This proposal has languished for over 18 months but has now been redrafted to address concerns from the U.S. and European Union. Signing it would go some way to expanding global access to vaccines, which are still sorely needed in many parts of the world.

Beyond this week, the WTO secretariat and members need to develop a work program to reform the organization. This should include developing a framework to ensure that if states do take precautionary measures, they do so in a transparent, rules-based manner that does not slide into more harmful forms of protectionism.

Reviving the WTO’s defunct dispute settlement mechanism is a clear priority. Twenty-five members have agreed to an interim arrangement that would function in a similar way. More members should join this agreement, ideally including the U.S., and start negotiating the full restoration of a binding mechanism. They should also set clear criteria for carveouts for legitimate precautionary measures related to national security, healthcare and environmental issues.

No one should expect big breakthroughs in Geneva. But practical agreements on immediate priorities such food security and vaccines would at least help to reassert the WTO’s relevance and show that the world’s trading partners are not simply going to give up on multilateralism. At this dangerous moment, even small victories are welcome.

Essay 80: Short-Term Energy Outlook

U.S. Energy Information Administration
November 13, 2019 Release


Global liquid fuels
  • Brent crude oil spot prices averaged $60 per barrel (b) in October, down $3/b from September and down $21/b from October 2018. EIA forecasts Brent spot prices will average $60/b in 2020, down from a 2019 average of $64/b. EIA forecasts that West Texas Intermediate (WTI) prices will average $5.50/b less than Brent prices in 2020. EIA expects crude oil prices will be lower on average in 2020 than in 2019 because of forecast rising global oil inventories, particularly in the first half of next year.
  • Based on preliminary data and model estimates, EIA estimates that the United States exported 140,000 b/d more total crude oil and petroleum products in September than it imported; total exports exceeded imports by 550,000 b/d in October. If confirmed in survey-collected monthly data, it would be the first time the United States exported more petroleum than it imported since EIA records began in 1949. EIA expects total crude oil and petroleum net exports to average 750,000 b/d in 2020 compared with average net imports of 520,000 b/d in 2019.
  • Distillate fuel inventories (a category that includes home heating oil) in the U.S. East Coast—Petroleum Administration for Defense District (PADD 1)—totaled 36.6 million barrels at the end of October, which was 30% lower than the five-year (2014–18) average for the end of October. The declining inventories largely reflect low U.S. refinery runs during October and low distillate fuel imports to the East Coast. EIA does not forecast regional distillate prices, but low inventories could put upward pressure on East Coast distillate fuel prices, including home heating oil, in the coming weeks.
  • U.S. regular gasoline retail prices averaged $2.63 per gallon (gal) in October, up 3 cents/gal from September and 11 cents/gal higher than forecast in last month’s STEO. Average U.S. regular gasoline retail prices were higher than expected, in large part, because of ongoing issues from refinery outages in California. EIA forecasts that regular gasoline prices on the West Coast (PADD 5), a region that includes California, will fall as the issues begin to resolve. EIA expects that prices in the region will average $3.44/gal in November and $3.12/gal in December. For the U.S. national average, EIA expects regular gasoline retail prices to average $2.65/gal in November and fall to $2.50/gal in December. EIA forecasts that the annual average price in 2020 will be $2.62/gal.
  • Despite low distillate fuel inventories, EIA expects that average household expenditures for home heating oil will decrease this winter. This forecast largely reflects warmer temperatures than last winter for the entire October–March period, and retail heating oil prices are expected to be unchanged compared with last winter. For households that heat with propane, EIA forecasts that expenditures will fall by 15% from last winter because of milder temperatures and lower propane prices.
Natural gas
  • Natural gas storage injections in the United States outpaced the previous five-year (2014–18) average during the 2019 injection season as a result of rising natural gas production. At the beginning of April, when the injection season started, working inventories were 28% lower than the five-year average for the same period. By October 31, U.S. total working gas inventories reached 3,762 billion cubic feet (Bcf), which was 1% higher than the five-year average and 16% higher than a year ago.
  • EIA expects natural gas storage withdrawals to total 1.9 trillion cubic feet (Tcf) between the end of October and the end of March, which is less than the previous five-year average winter withdrawal. A withdrawal of this amount would leave end-of-March inventories at almost 1.9 Tcf, 9% higher than the five-year average.
  • The Henry Hub natural gas spot price averaged $2.33 per million British thermal units (MMBtu) in October, down 23 cents/MMBtu from September. The decline largely reflected strong inventory injections. However, forecast cold temperatures across much of the country caused prices to rise in early November, and EIA forecasts Henry Hub prices to average $2.73/MMBtu for the final two months of 2019. EIA forecasts Henry Hub spot prices to average $2.48/MMBtu in 2020, down 13 cents/MMBtu from the 2019 average. Lower forecast prices in 2020 reflect a decline in U.S. natural gas demand and slowing U.S. natural gas export growth, allowing inventories to remain higher than the five-year average during the year even as natural gas production growth is forecast to slow. 
  • EIA forecasts that annual U.S. dry natural gas production will average 92.1 billion cubic feet per day (Bcf/d) in 2019, up 10% from 2018. EIA expects that natural gas production will grow much less in 2020 because of the lag between changes in price and changes in future drilling activity, with low prices in the third quarter of 2019 reducing natural gas-directed drilling in the first half of 2020. EIA forecasts natural gas production in 2020 will average 94.9 Bcf/d.
  • EIA expects U.S. liquefied natural gas (LNG) exports to average 4.7 Bcf/d in 2019 and 6.4 Bcf/d in 2020 as three new liquefaction projects come online. In 2019, three new liquefaction facilities—Cameron LNG, Freeport LNG, and Elba Island LNG—commissioned their first trains. Natural gas deliveries to LNG projects set a new record in July, averaging 6.0 Bcf/d, and increased further to 6.6 Bcf/d in October, when new trains at Cameron and Freeport began ramping up. Cameron LNG exported its first cargo in May, Corpus Christi LNG’s newly commissioned Train 2 in July, and Freeport in September. Elba Island plans to ship its first export cargo by the end of this year. In 2020, Cameron, Freeport, and Elba Island expect to place their remaining trains in service, bringing the total U.S. LNG export capacity to 8.9 Bcf/d by the end of the year.
Electricity, coal, renewables, and emissions
  • EIA expects the share of U.S. total utility-scale electricity generation from natural gas-fired power plants will rise from 34% in 2018 to 37% in 2019 and to 38% in 2020. EIA forecasts the share of U.S. electric generation from coal to average 25% in 2019 and 22% in 2020, down from 28% in 2018. EIA’s forecast nuclear share of U.S. generation remains at about 20% in 2019 and in 2020. Hydropower averages a 7% share of total U.S. generation in the forecast for 2019 and 2020, down from almost 8% in 2018. Wind, solar, and other non-hydropower renewables provided 9% of U.S. total utility-scale generation in 2018. EIA expects they will provide 10% in 2019 and 12% in 2020.
  • EIA expects total U.S. coal production in 2019 to total 698 million short tons (MMst), an 8% decrease from the 2018 level of 756 MMst. The decline reflects lower demand for coal in the U.S. electric power sector and reduced competitiveness of U.S. exports in the global market. EIA expects U.S. steam coal exports to face increasing competition from Eastern European sources, and that Russia will fill a growing share of steam coal trade, causing U.S. coal exports to fall in 2020. EIA forecasts that coal production in 2020 will total 607 MMst.
  • EIA expects U.S. electric power sector generation from renewables other than hydropower—principally wind and solar—to grow from 408 billion kilowatt-hours (kWh) in 2019 to 466 billion kWh in 2020. In EIA’s forecast, Texas accounts for 19% of the U.S. non-hydropower renewables generation in 2019 and 22% in 2020. California’s forecast share of non-hydropower renewables generation falls from 15% in 2019 to 14% in 2020. EIA expects that the Midwest and Central power regions will see shares in the 16% to 18% range for 2019 and 2020.
  • EIA forecasts that, after rising by 2.7% in 2018, U.S. energy-related carbon dioxide (CO2) emissions will decline by 1.7% in 2019 and by 2.0% in 2020, partially as a result of lower forecast energy consumption. In 2019, EIA forecasts less demand for space cooling because of cooler summer months; an expected 5% decline in cooling degree days from 2018, when it was significantly higher than the previous 10-year (2008–17) average. In addition, EIA also expects U.S. CO2 emissions in 2019 to decline because the forecast share of electricity generated from natural gas and renewables will increase, and the share generated from coal, which is a more carbon-intensive energy source, will decrease.

Essay 79: Past and Present Thinking

History is “forever new” and we keep asking “what’s new?” but the past is “forever suggestive” and so we inquire here as to whether the past gives us interesting echoes of the more recent.

Specifically, we juxtapose the “closing of the gold window” in August 1971 (Nixon) and the British gold standard gyrations between 1925 and 1931, when England left gold (i.e., September 1931).

At the time, under Nixon, the U.S. also had an unemployment rate of 6.1% (August 1971) and an inflation rate of 5.84% (1971).

To combat these problems, President Nixon consulted Federal Reserve chairman Arthur Burns, incoming Treasury Secretary John Connally, and then Undersecretary for International Monetary Affairs and future Fed Chairman Paul Volcker.

On the afternoon of Friday, August 13, 1971, these officials along with twelve other high-ranking White House and Treasury advisors met secretly with Nixon at Camp David. There was great debate about what Nixon should do, but ultimately Nixon, relying heavily on the advice of the self-confident Connally, decided to break up Bretton Woods by announcing the following actions on August 15:

Speaking on television on Sunday, August 15, when American financial markets were closed, Nixon said the following:

“The third indispensable element in building the new prosperity is closely related to creating new jobs and halting inflation. We must protect the position of the American dollar as a pillar of monetary stability around the world.

“In the past 7 years, there has been an average of one international monetary crisis every year …

“I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold or other reserve assets, except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.

“Now, what is this action—which is very technical—what does it mean for you?

“Let me lay to rest the bugaboo of what is called devaluation.

“If you want to buy a foreign car or take a trip abroad, market conditions may cause your dollar to buy slightly less. But if you are among the overwhelming majority of Americans who buy American-made products in America, your dollar will be worth just as much tomorrow as it is today.

“The effect of this action, in other words, will be to stabilize the dollar.”

Britain’s own experience in the twenties is explained like this:

“In 1925, Britain had returned to the gold standard.

(editor: This Churchill decision was deeply critiqued by Keynes.)

“When Labour came to power in May 1929 this was in good time for Black Friday on Wall Street in the following October.

“After the Austrian and German crashes in May and July 1931, Britain’s financial position became critical, and on 21st September she abandoned the gold standard.

London was still the world’s financial capital in 1931, and the British abandonment of the gold standard set off a chain of reactions throughout the world.

“Strangely enough Germany and Austria maintained the gold standard…”

(Europe of the Dictators, Elizabeth Wiskemann, Fontana/Collins, 1977, page 92-93)

Nixon’s policies gave us the demise of Bretton Woods, while the economic gyrations of 1925-1931 were part of the lead-up to World War II.

The setting is both “infinitely different” across the decades but the feeling of “flying blind” applies to both cases: U.S.A. “closing the gold window,” August 1971 and Britain’s overturning Churchill’s 1925 return to the gold standard, by 1931. One gets the sense of “concealed turmoil” and a lot of “winging it” in both cases. Policy-makers disagreed and they all saw the world of their moments “through a glass, darkly.”