Averting a full-blown gas crisis in Europe

A study released in January 2022 by the Federal Reserve Bank of St. Louis concludes that 2.6 percent of the U.S. inflation rate for the 12 months ended February 2022 was due to COVID-related fiscal stimulus. This represents about one-third of the rampant 7.9 percent inflation experienced for the period.

The St. Louis Fed’s methodology did not include the inflationary impact of the increase in the supply of money due to Treasury borrowing and Federal Reserve monetization of this debt, but rather focused on the increase in aggregate demand caused by fiscal spending, which seems to be a relatively conservative approach to the data. Other economists argue that the enormous increase in the money supply caused by government spending is the major driver of the high inflation that we have experienced.

Three important conclusions can be derived from the St. Louis Fed study, the last and most important of which is that while the Fed has been battling to reduce inflation by raising interest rates, the Biden administration has been working at cross purposes to boost inflation by increasing government spending.

The first conclusion is that President Biden’s repeated denials in 2022 that government stimulus had any significant impact on inflation are simply incorrect. The period covered by the St. Louis Fed’s study ended in February 2022, the month in which Russia invaded Ukraine, and therefore did not include much of the inflationary impact on energy and other prices caused by the conflict. But prior to the invasion, the Biden administration attributed inflation largely to transitory supply chain problems. While supply chain issues undoubtedly added to inflation, and the invasion of Ukraine boosted it further, the Fed study makes it clear that fiscal spending had a major impact as well.

Some of this fiscal stimulus was necessary to stave off financial disaster after political authorities shut down the economy in 2020, causing businesses to close, workers to stay home and households to suffer huge income shortfalls. Our country had never before faced such a potentially dire situation — a health crisis followed by an almost total shutdown of the economy. Prices in almost every market plummeted.

Recall what a frightening time it was. First, we feared for our lives. Then, we feared for our livelihoods. In such an unprecedented situation, the government responded appropriately by increasing stimulus spending in the form of the $2.9 trillion dollar aid packages passed by Congress in 2020 and the 36 emergency Treasury and Federal Reserve programs designed to pump liquidity into the economy. These actions taken by the Trump administration prevented an economic and human catastrophe. But when the crisis had largely abated in early 2021, the Biden administration elected to further increase stimulus through its $1.9 trillion American Rescue Plan and its continuation of stimulus programs that were no longer needed. The rise in inflation caused by the 2020 stimulus was necessary but the continued increase resulting from the 2021 stimulus was not.

The second lesson we can draw from the Fed study is that the claim of progressives who embrace so-called modern monetary theory, which holds that governments using fiat currency can borrow, print money and spend freely without significantly raising inflation or suffering any other adverse consequence, is the nonsense that it sounds like. Any consumer with a household budget or any person with common sense could tell you that and the St. Louis Fed study underlines this important point.

Apologists for modern monetary theory argue that had taxes only been increased, inflation could have been contained. This ignores the fact that raising taxes was not politically feasible and that in view of the large segments of the population that received government stimulus, for tax increases to lower demand for goods, such increases would have to have been broad-based and not just applicable to the wealthy. This is something no progressive would advocate. It, therefore, comes as no surprise that proponents of modern monetary theory have been largely quiet for the past year. In economics, nothing is free and there is always a price to be paid.

Finally, and most importantly, in 2023, we are in a period when the Federal Reserve is raising interest rates at a record pace to decrease inflation. At the same time, the Biden administration is doing all that it can to deliver further stimulus to the economy, by among other things, plans for forgiving payments on student loans, extending the child tax credit, increasing health care subsidies and subsidizing “green energy.” These increases in spending, if implemented, are certain to increase the rate of inflation just as the St. Louis Fed found the COVID stimulus did. This raises the unfortunate image of the federal government at war with itself. While the Fed seeks to lower inflation, the Biden administration is pursuing policies that will inevitably cause inflation to rise.

A Conservative prime minister’s tortuous Brexit negotiations are in their endgame. Brexiteer Tory MPs are on tenterhooks, and Westminster is on resignation watch. And just to up the ante a further notch, the Labour Party is offering the government its votes.

As MPs wait to see the fruits of Rishi Sunak’s top-secret negotiations with Brussels, Tory veterans of brutal Brexit battles of recent years fear serious trouble lies ahead.

Publicly, Downing Street still insists no deal has been done over the Northern Ireland protocol, the most contentious part of the Brexit agreement. U.K. Foreign Secretary James Cleverly said Monday there would be more talks “in the coming days” with the EU’s chief negotiator Maroš Šefčovič.

Sunak is taking his time to finalize the deal, knowing his political fortunes rest on his ability to sell it to an ever-fractious Conservative Party.

But one former government adviser closely involved in previous Brexit negotiations warned that a strategy of keeping things close until the last minute, and then trying to sell a deal at high speed, comes with “significant risk” for Sunak.

“He’s repeating the tactics that were used by [David] Cameron in negotiating the package prior to the referendum, and by Theresa May, and there is risk in that,” the former adviser said, cautioning that Tory MPs and ministers don’t like feeling they are being “bounced into something” by their leader.

May, of course, eventually resigned in 2019 after repeatedly failing to get the backing of her party for her Brexit plans. Cameron had been forced to quit three years earlier after losing the referendum, having failed to win over much of his party to his cause.

Sunak is acutely aware that his own Cabinet already hosts three prominent Leave-supporting ministers with track records of resigning over Brexit.

Home Secretary Suella Braverman, Deputy Prime Minister Dominic Raab and Northern Ireland Secretary Chris Heaton-Harris all resigned as Brexit ministers from the May government during 2018 and 2019 over her handling of Britain’s EU departure. A fourth Sunak minister, Steve Baker, who now works alongside Heaton-Harris in the Northern Ireland Office, also resigned as a Brexit minister in 2018.

On Monday, Braverman fired the first Cabinet warning shot over Sunak’s handling of the negotiations, backing ex-prime minister Boris Johnson’s view that the controversial Northern Ireland Protocol Bill — which threatens to unilaterally override parts of the Brexit deal — should not be dropped at the behest of Brussels. Braverman told the BBC the bill, currently on pause in the House of Lords, was “one of the biggest tools we have in solving the problem on the Irish Sea.”

“It’s certainly a resigning matter,” one Brexit-supporting ex-Cabinet minister said of any deal which did not allow Northern Ireland complete control over its own laws, and U.K. courts to be the final arbiter of those. “Given all that many of the Cabinet members have said in the past supporting Brexit. The point is, when push comes to shove — will they stick to their principles, or to their ministerial cars?”

Advisers close to all three Cabinet ministers refused to engage on the question of whether they would resign over a potential deal. Baker also declined to comment. An official close to Heaton-Harris said he was focused on sorting the protocol.

While one Sunak supporter pointed to the loyalty shown by the PM toward Braverman in reappointing her just a week after she was forced out of the Cabinet, and toward Raab over a flurry of allegations of bullying behavior, as evidence they are unlikely to resign.

Heaton-Harris is seen by colleagues as “quite sensible,” while Baker’s “complete Damascene conversion” on Britain’s previous approach to negotiating, as one former Cabinet minister put it, will fuel Downing Street hopes that he is prepared to remain inside the tent this time round.

But they and other senior Brexiteers within government will come under intense pressure from hardline colleagues to take a stand if Sunak’s deal fails to win the all-important support of the Democratic Unionist Party in Northern Ireland, or to remove the role played by the Court of Justice of the European Union in settling disputes.

Others believe any Cabinet resignations would be cynical attempts by Sunak’s rivals to curry the support of the right of the party ahead of a future leadership bid.

“If he does get resignations, it will be somebody using it as an excuse to blow things up to keep the ERG on board,” a second former Cabinet minister said, referring to the European Research Group caucus of hardline Brexiteers.

The European Research Group and Democratic Unionist Party might “scupper a deal anyway,” they added.

No. 10 has been caught in something of a communications trap as it tries to secure a deal.

While the U.K. negotiating team has treated the DUP’s seven tests for any deal as its top priority, according to one British official involved, clamping down on leaks has also been a key part of trying to build trust with the EU. This approach left members of the ERG complaining Friday that they had not had sight of the draft deal, and were feeling left out in the cold.

Another side-effect of No. 10 holding the process so close was that high-profile ERG veterans who have since been put on the frontbench were not privy to any detail before Friday and therefore unable to start providing reassurance to jumpy colleagues.

There are signs, however, that careful efforts were made to start bringing DUP politicians into the fold last week. No. 10 foreign policy adviser John Bew traveled to Northern Ireland two days before Sunak’s surprise visit in order to brief DUP leader Jeffrey Donaldson, according to well-placed officials.

Donaldson was shown a draft text during meetings on Thursday and Friday, accompanied by colleagues Gordon Lyons and Emma Little-Pengelly, even while most MPs were kept in the dark, the same officials said.

Like May in 2019, Sunak knows his chances of getting a majority of his MPs on board will be heavily influenced by the verdict of the Democratic Unionist Party, which has frozen power-sharing arrangements in the province over its opposition to the Northern Ireland protocol.

“Unless this deal is satisfactory to all communities in Northern Ireland, it won’t be possible, it’s not going to work,” House of Commons Leader Penny Mordaunt told Sky News on Sunday.

Other high-profile Euroskeptic MPs, including the former Business Minister Jacob Rees-Mogg, have already backed the DUP position.

Without DUP support, and the Conservative MP support it would likely bring with it, Sunak would probably require the backing of opposition MPs to get any deal through the House of Commons.

Labour officials are already planning on the basis that Sunak will hold a parliamentary vote, even if one is not technically needed to implement a protocol deal. One said: “It will create more problems if he tries to force it through without one.”

Labour leader Keir Starmer reiterated Monday that his party will support Sunak’s deal if and when that vote comes, though a senior Labour aide warned: “If he has to pass it on the back of Labour votes, that will prove just how weak this prime minister is. It will be a huge embarrassment. There’s no hope of spinning themselves out of that.”

The precedents for Sunak are not good. In 2019 Theresa May faced fury from her backbenchers when she opened negotiations with Labour about winning their support for her deal. Tory MPs are equally clear this time round that a deal with the opposition should never be countenanced.

Speaking to Times Radio, Simon Clarke, a Conservative backbencher and close ally of former Prime Minister Liz Truss, said Monday he thought it would be “a desperately ill-advised course of action for the government” to rely on Labour votes to get the deal through.

The second former Cabinet minister quoted above was blunter in his assessment. “If they try to do this on Labour votes, the prime minister is finished.”

“The Russian economy is on track to be cut in half,” Joe Biden said in March last year, as he heralded sanctions brought against Russia after its full-scale invasion of Ukraine.

Annalena Baerbock, the German foreign minister, vowed that sanctions were “hitting the Putin system … at its core of power”. Liz Truss, her counterpart in the UK at the time, forecast that Vladimir Putin’s oligarchs would have nowhere to hide. EU sanctions, the European Commission president, Ursula von der Leyen, said, “are working to cripple Putin’s ability to finance his war machine”.

The language before the invasion had been no less assertive. At a briefing in January 2022, US state department officials said Washington was prepared to implement sanctions “with massive consequences that were not considered in 2014 [when Russia annexed Crimea]. That means the gradualism of the past is out, and this time we’ll start at the top of the escalation ladder and stay there.”

The Institute for International Finance (IIF) predicted a 15% fall in Russian GDP in 2022. JP Morgan envisaged a 12% contraction. Russia’s own technocrats privately warned Putin of a possible 30% fall.

The reality was somewhat different, reflecting what analysts say was a hubristic over-confidence in the west about the speed with which sanctions that were agreed with unprecedented coordination by the G7 could damage Russia.

The Russian economy contracted by only 2.2% last year. Unemployment, according to admittedly dubious official figures, now stands at 3.7 %. The construction sector has been able to grow significantly even if the car and electronics industries have suffered. A bumper harvest has driven growth in the agricultural sector.

Russia is now forecast by the International Monetary Fund to grow faster in 2023 and 2024 than the UK. It is hardly financial apocalypse now.

As the war approaches its one-year anniversary on 24 February, the debate about whether sanctions are effective has intensified.

Defenders of sanctions say the ruble and headline gross domestic product are dreadful indicators, partly because Russian statistics are either classified or manipulated as part of the war effort. “Please do not ask me about GDP figures. They do not matter,” said Elina Ribakova, the deputy chief economist at the Institute of International Finance, a global industry body.

Vladimir Milov, a former Russian deputy energy minister and author of a Martens Centre report on sanctions, said it may be more instructive to track a dozen or so “soft indicators” such as alcohol sales, divorce rates, shoplifting, spending on food, opinion polls, bank customer sentiment or tax revenues.

“Don’t look at the watch every five minutes to see if sanctions are working. Exercise strategic patience,” said Milov, who is also an ally of the jailed Russian opposition leader Alexei Navalny

Agathe Demarais, the author of Backfire, a study of US sanctions, said: “This is a marathon rather than a sprint, but financing the war is getting more difficult.”

Economists at the Kyiv School of Economics go further, arguing that a decisive turning point may already have been reached as a growing Russian fiscal deficit – spurred by extra defence spending and collapsing hydrocarbon revenues – forces Russia’s central bank to eat up its reserves.

“It is understandable that the west got carried away at the beginning, leading to false expectations of a palace coup,” said Charles Lichfield, a deputy director of the Atlantic Council, a US thinktank.

After all, Russians started to rush for the cash machines, fearing a run on the banks. The rouble tanked, falling from from about 70-75 against the dollar to nearly 140.

The gates to the oligarchs’ European playgrounds were padlocked, their ostentatious toys put into dry dock. The loss of mobility and respectability was a heavy blow, particularly in London where the Conservative government suddenly turned on the Russian rich after decades of laxity and reputation laundering. Within about four months, Russian assets worth about €13.8bn (£12.3bn) had been frozen.

Even the smallest transactions were at risk of getting stuck in correspondent bank accounts for weeks if not months, as international banks became wary of facilitating transfers by Russian clients. In total the EU put sanctions on 1,386 individuals and 171 entities.

Hundreds of the larger western firms from McDonalds to BP to IT multinationals “self-sanctioned” themselves by suspending or winding down their Russian operations, even if some did not actually leave. The German chemical firm BASF suffered a $7.9bn (£6.5bn) writedown in the process, even if it hopes to pass it on to the taxpayer.

But in the key opening exchange of the sanctions battle, the Russian central bank, ironically largely staffed by liberal pragmatists opposed to the invasion of Ukraine, got the better of the west. On 28 February, the west tried to ambush Russia by simply freezing what was reported by the country’s central bank to be roughly $300bn or (40%) of its total foreign exchange reserves held overseas. The remainder was not held in western currencies. “The aim was to make it harder to defend the currency, increase the cost of financing the war and fuel inflation,” said Demarais.

But the Russian central bank’s governor, Elvira Nabiullina, responded decisively, raising the key interest rate to 20% on 28 February, effectively shutting down mortgages and corporate lending but making deposits extremely attractive. It deterred citizens from panicking and withdrawing all their money from their accounts. On 7 March, for the first time in the modern Russian history, the central bank completely banned the sale and withdrawal of dollars and euros deposited before 24 February. Russia also negotiated for some its banks – notably Gazprombank – to remain in the global financial messaging system Swift because they handled payments related to oil and gas exports on which the EU were heavily reliant. After a short period of stress in March 2022, structural liquidity returned more or less to pre-sanctions levels. By June the rouble had stabilised.

Once its initial financial blitzkrieg – prepared in secret in the US Treasury in the months before war – had been repelled, the west had to revise its strategy, accepting implicitly it had not quite started at the top of the sanctions ladder and there were further rungs to climb. The second phase was going to be more a war of attrition, constant adjustment and consensus-building across the EU.

The European Commission went on to a sanctions war footing, according to a study by the Danish Institute for International Studies. “Formal processes that would traditionally take several weeks were concluded within a day,” it found.

But flaws in the process appeared. Since EU sanction packages require unanimity, ideological outliers like Hungary held massive leverage. Viktor Orbán’s personal connection with specific Russian oligarchs became apparent. For instance, in September last year the Hungarian prime minister asked, probably in return for favours by Putin, for three Russian oligarchs to be removed from the EU sanctions list. Before the 15 March renewal deadline, Orbán has lobbied to remove the same trio plus an other six. At successive European Council meetings, his ministers have threatened use of the veto, delaying key sanctions decisions. Most recently, Orbán breezily insulted Ukraine as “a no man’s land akin to Afghanistan”.

Some EU states found they did not have the laws, compliance departments or procedures to implement the sanctions agreed in Brussels. Only now is the European Commission working with member states for instance to establish a single contact point for enforcement and implementation issues with cross-border dimensions.

Differences in the vigour with which sanctions were enforced became striking. EU figures show Greece had frozen only €222,000 in Russian assets and Malta only €200,000. The same two countries in April had tried to block a ban on Russian flagged ships entering EU ports. Austrian companies have hardly rushed to leave Russia. One estimate says 43 Austrian firms have stayed and only two left completely. Belgium has lobbied to keep the 500-year-old diamond industry in Antwerp open to Russia’s Alrosa mining company.

Among Nato members, Turkey’s refusal to join the sanctions coalition has become a major problem.

By the third quarter of 2022, Russian imports from Turkey had surged to over $1bn a month, roughly double the figure for the same period the previous year.

Turkey became a route for Russia to import vital western-produced goods such as manufacturing parts. Some economists for instance have noticed a mini boomlet in trade between Italy and Turkey, suggesting enterprising Italian traders regard Istanbul as a useful access point into forbidden Russian markets.

US Treasury sources say they have now elevated Turkey’s approach to trade with Russia to an issue of prime importance in the bilateral relationship.

The US is also looking askance at another ally, the United Arab Emirates. Research by a team of Berlin-based data analysts examining more than 500,000 bank transactions after the war started found that, in terms of value, 66% of withdrawals by non-resident customers of Russian banks went to beneficiaries located in the UAE. This represents a 40% rise on the previous year.

The surprising resilience of the Russian economy is not primarily due to the technical professionalism of central bank officials or murky sanctions busting, but instead a blindingly obvious structural flaw in the sanctions: Europe’s reliance on Russian oil and gas exports, the source of 40% of Russian budget revenue.

“Not imposing a Russian export embargo early on led to record high trade and fiscal surpluses that gave Putin’s regime a huge financial cushion, enough to sustain many months of the war,” said Oleg Itskhoki, a Russian-American economist. “Only Putin’s imports were boycotted, while his exports continued. As a result the Russian car and electrical industry collapsed, but not the export of oil and gas.”

Various groups of western economists, including Rüdiger Bachmann, Moritz Schularick, Ben Moll and Christian Bayer, tried through March and April to persuade German politicians that cutting off the supply of Russian energy would not lead the German economy to crash.

Moll recalled: “Soon after the war started, statements were being made by German politicians that an energy embargo would have dramatic economic consequences. For instance, the economics minister said there would be mass unemployment and poverty.

“We just thought it was important to look at the data and think this through systematically so we put together a team of energy economists as well as micro- and macroeconomists and concluded it might lead to a recession between 0.5 and 3 % but not economic Armageddon. Not all of us agreed with an energy embargo. But the unions and industry lobby denounced our analysis and the chancellor called us ‘irresponsible’ on national TV, a reflection of the large influence of corporate Germany.”

Moll believes in retrospect his analysis of the system’s flexibility and adaptability has been proven right.

But the EU could decouple itself from Russian energy only at the speed Germany, the major economy most vulnerable to Putin’s energy blackmail, was prepared to tolerate.

It took until June, after private lobbying by the US and evidence of war crimes in Ukraine, for the EU in its sixth sanctions package to agree to an EU-wide ban on Russian oil exports. But the ban was only to come into force in two delayed phases. The ban on the purchase, import or transfer of Russian seaborne crude oil was not to apply until 5 December and the ban on other refined oil products such as diesel came in on 5 February.

The price of Europe’s caution is well known. With the exception of 2020 and 2018, oil and gas had provided 60% of Russian goods exports in every year since 2002. But the early summer of 2022 was a total bonanza for the Russian treasury, as it benefited from the record surge in energy prices. In March, Russia was making €1bn a day from energy exports. Oil and gas increased to 60% of Russian fiscal revenues, up from 40%. Germany alone has bought €24bn of Russian fossil fuels since the invasion.

Europe funded the Russian war machine that it denounced. The surplus on Russia’s current account for the year was $227.4bn – a 86% increase on the previous year and more than double the previous record. That helped strengthen the rouble, making imports cheaper. This in turn helped to gradually bring down inflation, taking some pressure off the real incomes of the ordinary Russian population.

By the summer Russian treasury coffers were so bloated that Putin felt confident enough to launch a counterattack by slowing gas supplies to Europe. With 40 % of Europe’s gas coming from Russia, he demanded in April that any country refusing to pay for its gas in roubles would be cut off. Europe huffed but complied. By June he started tampering with the gas flow through the Nord Stream 1 pipeline from Russia into Germany. He first cut deliveries through the pipeline by 75%, from 170m cubic metres a day to roughly 40m. In July, the pipeline was shut for 10 days, citing the need for essential maintenance work. On reopening, the flow was reduced to 20m cubic metres a day.

Then on 26 September an as yet unidentified intelligence service blew up the pipeline and the neighbouring Nord Stream 2 pipeline – which had yet to go into service - leaving a mangled wreck and an unsolved crime scene at the bottom of the Baltic.

“Putin shot himself in the foot because by turning off the gas tap, he completely changed the calculus in the European Union and gave the impetus to Europe to diversify away from Russian gas,” Demarais said. “He made the decision for Europe a lot easier.”

Through a mixture of planning and good fortune, Europe has, in the space of six months, largely weaned itself off Russian gas. Renewables have been boosted, the lives of nuclear power stations extended and liquid natural gas terminals built at lightening speed. The European Commission sent out search parties for alternative sources of energy ranging from Morocco, Qatar, Angola, Venezuela, Norway and Nigeria. It was a form of Putin-inspired “shock therapy”.

In another blow to Putin, “General Winter”, once assumed to be Russia’s greatest ally, failed to report for duty. Temperatures averaged well above the norm with record highs for winter broken in the Netherlands, Liechtenstein, Lithuania, Latvia, Czech Republic, Poland, Denmark and Belarus. That lowered demand for energy, as did the self-restraint of European consumers rocked by record bills. Gas storage levels in Germany in January were at 90%, the highest level ever for the month.

Russian gas exports to Europe tumbled by more than 75% compared with the prewar period. The daily price of natural gas on the stock exchange Amsterdam Euronext which had peaked at more than €300 a megawatt hour after the invasion, has now fallen well below 100 again, to under €60, still high by the standards of 2020 . Inflation is slowly descending across Europe, and Germany looks to have avoided the widely predicted recession.

Putin had played his best economic warfare card – cutting gas exports to Europe – and it was a dud, and will remain so next winter if the EU controls demand. In the space of a year, Putin destroyed Russia’s gas bridge to Europe, the centrepiece of Russian postwar economy.

The question now is how quickly he can construct a different bridge to the east, and so keep the Russian finances afloat.

Russia exports natural gas from eastern fields to China through the 2,500-mile Power of Siberia 1 pipeline, but the western fields, which had served the European markets, are not connected to this export route and cannot be easily redirected to China. Eventually a Power of Siberia 2 pipeline will connect the two fields, but the estimated completion date is 2030. China is also not such a profitable market. Russia was estimated to be charging $3 a metric million British thermal unit (MMBtu) for deliveries to China via the Power of Siberia pipeline, while the estimated charge for deliveries to Europe had been sold at $10-$25/MMBtu.

Putin is also in danger of being screwed to the floor over oil, his crown jewel. After persistent US Treasury lobbying, the west supplemented the EU ban on Russian crude oil exports by introducing an unprecedented market intervention that seeks to set a world wide price cap of $60 a barrel for Russian seaborne oil. From 5 December, the same date as the EU import ban, any firm providing payments, insurance, financial services, or brokering, bunkering, piloting services to a ship carrying Russian oil could not receive insurance cover if the oil was being purchased for more than $60 a barrel. If the US or EU catches any company misrepresenting the price or submitting a fraudulent attestation, the G7 can impose sanctions on that company. The UK proposes fines of $1.2m.

Putin blustered, saying he would not supply oil to any country for five months that complied with this price regime from 1 February. But this may be a bluff. For China and India do not need to endorse the cap explicitly, but they can take advantage of its existence and their purchasing power to negotiate heavy price discounts in comparison with Brent crude.

The price cap is in its infancy, and since the price of seaborne Urals crude averaged $49.48 in January, below the $60 cap, EU tankers – mainly Greek – can legitimately carry on transporting oil to China and India. Reports suggest crude oil loading from Russian ports have reached a multi-month high. At best the cap has had the effect of institutionalising price discounts. At worst it is proving toothless. Ukraine and its expert team advisers on sanctions led by the former US envoy Michael McFaul say the cap needs to be halved especially if its purpose is to blow a hole in Russia’s budget.

But the US Treasury, in setting the cap, was balancing different objectives: reducing Russia’s income and keeping enough supplies on the seas to avoid another spike in oil prices. That requires a perilous assessment of the price at which Putin decides it is not profitable to extract or export oil. The US is trying to postpone a review of the cap level until March to allow more evidence to be collated.

The Kyiv School of Economics insists the numbers on the Russian dashboard are flashing red. Russia’s monthly fiscal deficit reached a record 3.9tn roubles (£43.3bn) in December and its total budget deficit for 2022 was 3.3tn roubles – or 2.3% of GDP – set against a projected an annual surplus of 1.3tn. Overall spending in 2022 was 7.3tn roubles higher than forecast, presumably due to vast defence spending.

Putin plans to spend 6.3 % of GDP on defence and national security in the 2023 federal budget alone, doubling defence spending to more than 10tn roubles. The question then becomes how long this level of spending can be sustained if energy revenues are falling so fast.

Demarais said the first signs of serious strain would be unplanned debt issuance and the sale of some of its 310bn yuan (£37.5bn), the only currency in Russia’s reserves that can be used for interventions in the foreign exchange market.

Various estimates exist, but some say Russia’s planned spending is probably sustainable on an assumed Urals crude oil pice of $70 a barrel. Russia won’t burn through its stock of yuan assets this year unless the Urals price halves and averages $25 a barrel, according to Bloomberg Economics.

The US bank Citigroup estimates it would only take an average price of $35 to deplete the available yuan resources already in 2023.

But as the past year has shown, Russia is not sitting idle in the face of a price cap. Learning from its growing ally, Iran, it has assembled an ageing dark fleet of smaller, older ships carrying crude oil mainly to China and India. Evasion will be attempted through multiple means: flags of convenience; the blending of crude; Russian insurance schemes; or the simple manipulation of documents. New crude oil transfer hubs are already emerging. It will depend on whether this covert market grows into a viable alternative to the G7 cap, and the price at which the oil is bought by China.

In the end an international sanctions war is a game of cat and mouse in which both sides look for clues amid the disinformation to try to pre-empt the other’s moves.

Ultimately it is not as decisive as the battlefield, but if the west can stay the course, Putin may yet find his options narrowing. If he survives it will be a huge blow to the power of the dollar, and one that will not go unnoticed in Beijing.

When President Joe Biden was asked recently whether the U.S. would provide F-16 fighter jets to Ukraine, his response couldn’t have been clearer.

“No,” he said.

Given the issue, some skepticism is understandable. After all, for months U.S. officials demurred on sending M1 Abrams battle tanks to Ukraine — citing the difficulties involved in maintaining, fueling and training troops to operate them — before reversing course as part of a deal that will also allow European countries to send their German-made Leopard tanks. Before that, these officials repeatedly made the case that Patriot missile interceptors — another weapons system that was high on the Ukrainians’ wish list — were inappropriate for Ukraine’s needs. Until suddenly they weren’t.

So it’s little surprise that Ukrainian officials, who began lobbying allies for fighter jets almost as soon as the tanks decision was made, are confident that it’s “only a matter of time” before they receive the F-16s. The Washington Post has reported that officials within the Pentagon haven’t taken Biden’s “no” very seriously and suspect that the decision will be “M1-ed” — a new term meaning the White House will eventually overcome its reluctance. The Ukrainians are still waiting for that: There were no announcements about planes at a high-level meeting of Western defense ministers in Brussels on Tuesday.

A decision to send F-16s started to look more likely last week during Ukrainian President Volodymyr Zelenskyy’s visit to the United Kingdom, when the British government announced it would begin training Ukrainian fighter pilots on NATO jets and would “investigate what jets we might be able to give.” The U.K. was similarly out in front on the tanks decision, agreeing to send Ukraine some of its Challenger 2s several days before the U.S. and Germany decided to send their own tanks.

Even if a decision to send F-16s does come soon, Ukraine is unlikely to stop pressing for other high-end weaponry. Other systems on Kyiv’s wish list include ATACMS — a long-range missile that can be fired from the already provided HIMARS launchers — and advanced offensive drones.

For Ukrainians, this dynamic — in which each individual weapons system is subject to months of political debate in Western capitals and ultimately cleared for delivery — is deeply frustrating. As Ukrainian Foreign Minister Dmytro Kuleba put it last month, referring to Germany, “It’s always a similar pattern: First they say no, then they fiercely defend their decision, only to say yes in the end.”

Ukrainians are now asking for an end to this pattern, arguing that the only way to bring the war to a close is to give the Ukrainian military everything it needs to win. They see the arguments against more ambitious military aid as excuses, if not something more nefarious.

“The pattern of stop-start arms transfers is because we are fighting enemy disinformation,” Hanna Hopko, a former member of the Ukrainian Parliament who now runs the International Center for Ukrainian Victory, told Grid in an email. “The need now is to think in terms of great power and great responsibility. We have to focus on the victory of Ukraine (defeating Russia faster), not on inflation, energy security, and poll numbers in western nations.”

Ukraine’s staunchest supporters in the West are starting to lose patience as well. In a recent piece in Foreign Affairs, former U.S. ambassador to Russia Michael McFaul made the argument that “at this stage, incrementally expanding military and economic assistance is likely to only prolong the war indefinitely” and that “rather than providing ATACMs in March, Reapers [drones] in June, and jets in September, NATO should go for a Big Bang.”

The idea of a massive military aid package that would allow Ukraine’s armed forces to quickly go on the offensive and overwhelm Russian resistance certainly sounds more appealing than the slow-moving and bloody trench warfare that now seems to be the most likely scenario for the next few months of this war. But the “Big Bang” approach has drawbacks as well.

The Biden administration’s argument when it comes to Ukraine aid is that with each new system, it makes a cost-benefit analysis to determine whether the Ukrainians need the specific weapons, and whether the U.S. and its allies can afford to provide them.

In a recent press briefing, State Department spokesperson Ned Price told Grid, “These are discussions that we have with our Ukrainian partners to determine, in the first instance, what it is that they need. We then have these conversations between and among partners and allies to determine what it is that any given partner has and what would be appropriate for us to do.”

Ukraine’s needs have changed, U.S. officials say, because the war itself has changed. During a recent event sponsored by the Defense Writers Group, Sen. Jack Reed (D-R.I.), chairman of the Senate Armed Services Committee, told Grid, “It was a different fight a year ago, as small, decentralized teams of Ukrainians attacked Russian supply lines that are bogged down on a single road because of poor logistics, poor planning. Now we’re looking at much larger forces dug in and making all-out assault against Ukrainian forces.”

Back then, shoulder-mounted anti-tank weapons like the Javelin and Stinger were critical. Now, heavier armor is needed — not only due to the nature of the fighting but also because Ukraine has lost so much heavy equipment during the war. At the beginning of the conflict, tanks were less of a priority because Ukraine already had around 800 Soviet-model T-64s and T-72s. It may now have lost as many as half of those.

Still, it would strain credulity to think such decisions are made solely with battlefield needs in mind. Both Secretary of Defense Lloyd Austin and Chairman of the Joint Chiefs of Staff Gen. Mark Milley reportedly advised Biden against sending M1 Abrams tanks to Ukraine, citing how difficult they are to maintain and how long it takes to train personnel on them. (Given all the shortcomings of the M1 cited by U.S. officials over the past few months, one might reasonably ask why the American military is still using them.) As late as Jan. 20, following a meeting with allied defense chiefs in Ramstein, Germany, Austin batted away questions about the tanks, saying, “What we’re really focused on is making sure that Ukraine has the capability that it needs to be successful right now.” Five days later, Biden announced that the U.S. would provide 31 M1s to Ukraine.

It’s doubtful that Ukraine’s battlefield needs had changed dramatically in less than a week; more likely, the political incentives — namely, giving German Chancellor Olaf Scholz the political cover he needed to provide the Leopard tanks — had become overwhelming.

On the first day of the war, Russian President Vladimir Putin threatened any countries that might “hinder us, and … create threats for our country” with “such consequences that you have never experienced in your history.” By “consequences,” it was fairly clear he was referring to Russia’s nuclear arsenal — the world’s largest. But it was less clear how he defined “hinder” or “create threats.”

From the beginning, the U.S. and other NATO countries have sought to balance the goals of helping Ukraine fight back with concerns about sparking a wider — and potentially nuclear — conflict.

It’s debatable which of these goals takes precedence. According to the Washington Post, Milley carried a notecard in his briefcase for several months listing U.S. strategic goals in Ukraine. The first was “Don’t have a kinetic conflict between the U.S. military and NATO with Russia,” while “Empower Ukraine and give them the means to fight” was fourth.

In a December joint press conference with Zelenskyy, during the Ukrainian president’s visit to Washington, Biden was asked by a Ukrainian reporter, “Can we make a long story short and give Ukraine all capabilities it needs and liberate all territories rather sooner than later?” The U.S. president stressed the importance of maintaining the support of all NATO allies and said, “They’re not looking to go to war with Russia. They’re not looking for a third World War.”

This “third World War” argument is why the U.S. quickly ruled out sending troops to Ukraine or setting up a no-fly zone that could lead to direct fire between U.S. and Russian aircraft.

But it’s also true that Washington’s comfort level with sending heavy weaponry has increased dramatically since the early days of the war.

So the gradual amping up of support, one weapons system at a time, can be viewed as a form of “salami tactics”; as in, a slice of something (Javelin anti-tank weapons) in one month; another weapon system a couple of months later and so forth. The thinking being, a major deployment of tanks and aircraft shipped to Ukraine all at once might provoke a catastrophic Russian response; each gradual increase in support does not.

Putin or other senior Russian officials have typically threatened some response to each of the Western weapons shipments, but the retaliation has never materialized. As nuclear analyst Joe Cirincione has written, by gradually ratcheting up aid, “Joe Biden has carefully threaded the nuclear needle.”

Mark Cancian, a senior adviser with the Center for Strategic and International Studies, told Grid, “The Russians have laid down two red lines: One is no NATO troops in Ukraine, and the other one is no invasion of Russian territory. And the U.S. and NATO have respected those red lines. Tanks and Patriots and HIMARS and everything else don’t contravene those two red lines.”

Arguably, fighter jets would be in a different category, as they would give Ukraine greater capability to strike within Russian territory. But Ukraine already has some Soviet-era aircraft in its arsenal and has already used drones to strike within Russia. It seems unlikely that F-16s would push Putin to start World War III when previous weapons upgrades did not. But given the stakes, NATO governments are treading very carefully.

Another limiting factor in the pace of weapons deliveries to Ukraine may be the ability of the Ukrainians to absorb them.

To be fair, Ukraine’s armed forces have shown repeatedly that they are able to speed up the normal training timetables for NATO weapons systems. Lt. Gen. Ben Hodges, former commander of the U.S. Army in Europe, recently told Grid that “the Ukrainians have demonstrated time and time again that they can learn how to use anything in about one-third the time the rest of us can.” With the Polish military’s assistance, they are currently working to reduce the training time on the Leopard tanks from 10 weeks to five, and Ukrainian officials say their pilots could learn to fly the F-16 in about six months, rather than the typical nine.

Still, six months is a long time in a war as fast-changing as this one. U.S. officials clearly worry that Ukrainian troops won’t be ready to use these systems in time for them to make a difference. The counterargument is that if Western countries had agreed to send jets and train Ukrainian pilots six months ago, they’d be ready for action now. This seems to be what motivated Britain’s decision last week to begin training Ukrainian pilots on their Typhoon jets before actually agreeing to send them.

In the specific case of the F-16, there are concerns that the significant infrastructure and support systems these jets require to operate effectively, particularly given Russia’s extensive network of air defenses and surface-to-air missiles, would divert scarce resources from other Ukrainian goals.

There’s also the challenge of getting all the various vehicles, artillery and air defense systems from various countries to work together as one cohesive system, and how to make sure there are trained personnel to maintain each system and keep them all running. The Ukrainians have sometimes referred to their multinational arsenal as a “petting zoo.” A slow but steady flow of new systems — rather than everything, all at once — gives Ukrainian logistics specialists time to integrate all the new hardware.

Before the war, Western countries avoided giving so-called offensive weapons to Ukraine out of fear of provoking a Russian invasion. Besides, many experts argued that Western weaponry would make no difference in the face of Russia’s clearly superior military. Even after Russia’s initial attempt to take Kyiv failed and it became clear that this would be a fairer fight than many anticipated, it seemed plausible that it would end quickly either in Ukrainian defeat, Russian military collapse or a negotiated settlement. Sending some of the world’s most advanced and expensive military systems to Ukraine, where they could be destroyed or captured, was not a no-brainer until the Ukrainians demonstrated they could effectively use them.

Now, it’s clear that both sides are dug in for a long war absent some unexpected development.

Over time, Western nations have gradually provided more and more advanced weapons systems in hopes of breaking the stalemate. And, politically, each successive weapons system debate has become a sort of litmus test for the West’s willingness to support Ukraine.

In the end, however, it is unlikely that any individual system will be a silver bullet that breaks the stalemate. Rather than who is fielding the most advanced military technology, victory in this conflict is more likely to come down to which side can continue to supply simple things like artillery shells to the battlefield for longer. That will be less a matter of risk calculation than of how much Western countries are willing to mobilize their arms industries to keep the flow going. NATO Secretary-General Jens Stoltenberg warned on Tuesday that “the current rate of Ukraine’s ammunition expenditure is many times higher than our current rate of production.”

Meanwhile, the gradual ratcheting-up dynamic may soon come to an end simply because — beyond fighter jets and long-range missiles — there aren’t many more weapons systems the West is holding back. After that, the question will not be what weapons the West is giving to Ukraine, but how many of them and for how long.

1. Biden shows up in Kyiv.

2. Saudi Arabia's crude oil exports rebounded from a 5-month low in December.

3. Market expectations lean toward the Fed.

4. Russia's GDP declines 2.1% in 2022.

5. Recent US economic robustness cannot save the economy from recession risk.

U.S. President Joe Biden made a sudden visit to Ukraine on Monday, appearing in the center of Kyiv and promising to stand by Ukraine all the time. In response, Zelenskiy said that the visit of the US president to Ukraine, the first in 15 years, is the most important visit in the entire history of U.S.-Ukrainian relations."

While Biden was in Kyiv, the U.S. State Department announced it would provide Ukraine with a further $460 million in assistance, including $450 million worth of artillery ammunition, anti-armor systems and anti-aircraft radar, as well as $10 million for energy infrastructure. Specific details will be announced within the day.

Saudi Arabia's crude oil exports rebounded in December after falling to a five-month low the previous month, according to data released Monday by the Joint Oil Database JODI. they rose about 2.2 percent to 7.44 million BPD from 7.28 million BPD in November. Earlier this month, Saudi Arabia raised the price of its flagship crude for Asian buyers for the first time in six months, as the market expects oil demand to recover. Although OPEC previously raised its forecast for global oil demand growth in 2023, its monthly report showed that crude production in Saudi Arabia, Iraq and Iran all fell as part of the organization's agreement.

After a series of far more expected U.S. economic data cloth, the market expects the upper end of the federal funds rate target range to increase by about 40 bps to 5.25%, and the arrival point is expected to change from June to July. The question at hand, however, is whether the ultimate rate will be higher. Initially the market simply pushed back the timing of the rate cut, but in the recent week, it can be seen that market pricing expectations are not simply postponing the timing of the rate cut, but more systematically retracting the expectation of a rate cut. In addition to the change in money market pricing, we also look at the rise in market implied inflation expectations and US interest rate volatility. The market is having to turn to the greater likelihood that the Fed will maintain "higher rates for longer".

Russia's gross domestic product fell by 2.1% in 2022, according to data released by the Russian Federal State Statistics Service (Rosstat) on February 20, local time. The data from the Russian Federal State Statistics Service are better than the expectations of the Russian Ministry of Economic Development and the Central Bank of Russia. Last September, the Russian Ministry of Economic Development forecast a 2.9% decline in the country's economy in 2022, and the Central Bank of Russia predicted a 2.5% decline.

The U.S. economy has started the year strongly, with better-than-expected data on employment, retail sales, industrial production, and even the housing market. This follows two months of weak data at the end of 2022 that prompted a general reassessment of the economic outlook and financial markets. However, year-end and early-year data tend to be very volatile, and seasonal factors and temporary idiosyncrasies seem to have played a key role in the economic situation in recent months. By the second quarter, U.S. economic activity will have slowed significantly, signaling a mild recession for the rest of the year.

After taking a battering in 2020, the Southeast Asian economy appears to be finding its feet. In its latest forecast, the International Monetary Fund (IMF) expects Southeast Asia to be the world's fastest growing region, with the five largest economies expanding at 4.3 per cent in 2023 and 4.7 per cent in 2024. The Asian Development Bank (ADB) is more optimistic. It places regional growth in 2023 at 4.7 per cent (Table 1).

The pertinent question here is whether there are risks that could derail the regional recovery. In 2022, the Southeast Asian economy gained momentum as growth reached 5.5 per cent. The growth came despite several external risks: the escalation in the trade and technology war between the United States and China; the Russian invasion of Ukraine and the resultant geopolitical risks and spike in agricultural and energy prices, and monetary tightening. At the height of the pandemic in 2020, Southeast Asia's economy had contracted by 3.2 per cent. In 2021, the region returned to growth of 3.3 per cent as lockdowns eased.

The prospects for Southeast Asia's recovery hinge crucially on what happens in China, as well as the global economy. China has experienced a massive decline in growth since the pandemic began and prolonged lockdowns due to its zero-Covid policy. After several downgrades, the IMF has recently revised upwards its projection for China's growth to 5.2 per cent in 2023 and 4.5 per cent in 2024. China's decision to finally reopen underlies this upgrade, although there are still a number of domestic uncertainties in the banking and property sectors that could impinge upon growth, including the possibility of a severe Covid-related health outcome.

Another key factor is how the U.S.-China trade war evolves. The trade war is escalating and now includes bans on technologies and controls on exports of advanced semiconductor chips to China by U.S. companies, for instance. The switch from tariffs to non-tariff barriers is concerning as the latter are opaque, and their impacts can be profound. The escalation could have a major impact on Southeast Asia since their regional supply chains remain China-centered. The conflict has already resulted in some labour-intensive industries and activities relocating from China to Vietnam, Thailand and Malaysia. Capital-intensive components of the key supply chain industries — electronics, electrical and other machinery, and automotive parts — have not been much affected as yet. That is not to say they will not be affected should the conflict continue to escalate.

Compounding matters, there is a kinetic war following the Russian invasion of Ukraine in February 2022. This has driven up energy costs and caused a spike in geopolitical risk and major agricultural and other commodity prices. The war increased the urgency for ASEAN countries to transition their energy policies while managing other risks and keeping an eye on inflation.

The U.S. Federal Reserve responded to inflationary concerns with aggressive monetary tightening following years of loosening in the form of quantitative easing. The aggressive response affected global interest rates and could induce a recession in the U.S. and Europe. But there are signs that the tightening may end soon. Reflecting this, the IMF's assessment in January 2023 is less pessimistic about a global recession, with global growth revised upwards to 2.9 per cent from 2.7 per cent in October 2022. This is also due to adverse risks moderating with a stronger boost emerging from pent-up demand and a faster fall in inflation expected. Nevertheless, the balance of risks remains tilted to the downside, so a global recession cannot be ruled out entirely.

The major concern for Southeast Asian countries from a possible recession in the West is the impact on exports and growth, and indirectly on debt levels, which are projected to rise. All Southeast Asian economies saw their fiscal positions worsen after massive government spending related to Covid-19. A rise in service costs of external debt through rising interest rates, as well as the valuation effects of a stronger U.S. dollar, will increase the debt burden and could induce debt distress in some countries, such as Laos.

Although prospects for the region will be heavily influenced by global developments, given its heavy reliance on international trade and investment, domestic factors should not be discounted. On the political front, Malaysia and the Philippines have newly elected administrations that are still finding their feet. Thailand and Cambodia will hold elections in May and July, respectively. Although Indonesia will only go to the polls in February 2024, the fate of the US$34 billion project involving the relocation of the capital could be affected. Until the new President is elected, some policy paralysis can be expected. The political and economic turmoil in Myanmar is a grave concern for its citizens and also ASEAN.

These uncertainties and the pandemic have contributed to an increase in anti-globalisation sentiment that could further threaten the recovery. For instance, there is increasing discussion of the need to improve the resilience of supply chains, emanating from the U.S. but spreading quickly to other countries. The calls for reshoring, friend-shoring, and nearshoring of supply chains, which is in one of the four pillars of the US-led Indo-Pacific Economic Framework for Prosperity (IPEF), is not just about limiting capital outflows, but reversing them. This is basically protectionism in new clothing. The shift toward so-called self-reliance comes at a time when the need for liberalisation is increasing but the appetite for it is waning. The disparity between need and appetite further weakens the ability to address the impacts of digital disruption, divergent demographic trends and the rise in all forms of inequality. Unless these protectionist tendencies are curbed, Southeast Asia's recovery as well as its long-term growth and prosperity will be at risk.