Powell versus Putin

He wants to raise interest rates. He needs to raise interest rates. He fully intended to raise interest rates. And then along comes a war and upsets the apple cart.

Consumer inflation in the US is now more than an annualised 6% (including food and energy bills), a full 4% above the former target, which is rapidly being lost sight of.

The ‘he’ is Jerome Powell, chairman of the US Federal Reserve. It’s the Fed’s job to conduct monetary policy “so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates”. The Federal Reserve is still expected to make the first of several interest rate rises at its meeting next week. The Biden administration has even said it is prepared to temporarily suspend the tax on gasoline, currently levied at 18.4 cents per gallon. National average petrol prices in the US have jumped to $3.50 a gallon, their highest in more than seven years.

Of course, the Ukrainian invasion and the response from the West are bound to give inflation a fresh kick higher, although the higher prices (such as for grains and base metals) will take a little while to feed through into consumer staples. Other price rises, particularly for fossil fuels like crude oil and gas, have immediately jumped. But it’s evident that this fresh war in Europe comes at a time when the West is economically (if not politically and militarily) ill-prepared. The Bank of England’s (BoE) deputy governor, Jon Cunliffe, has warned the war may hurt growth, spurring a drop in the value of the most risky assets and raising the level of uncertainty. The BoE’s policy maker Silvana Tenreyro said she expects “upside surprises on inflation”, which will deliver a shock to the terms of trade.

Raising interest rates — which might knock the gold price — has become much more problematic after this war. The war will impede economic growth, by how much cannot yet really be grasped, and the US and the West generally is not in a condition to tolerate growing job losses after the recent pandemic. In one sense this war matches two people who (some may say) are having a disproportionate influence over our life — it’s Powell versus Putin. A man facing a serious inflation surge against one who apparently doesn’t care.

Cooling growth

The one certainty of war is that it is economically damaging not just for the attacked party but for the aggressor too. The UK’s National Institute for Economic and Social Research (NIESR) reckons that the conflict in Ukraine could knock $1 trillion off the value of the world economy and add 3% to global inflation this year by triggering another supply chain crisis. It will also force European governments to borrow more to pay for the mass influx of more than one million refugees and strengthen their military forces. The collapse of the rouble will drive Russian inflation to 20% said the NIESR, and in the UK it will average 7% in 2022. Jagjit Chadha, director of NIESR, said: “Supply chains will be further fractured, and monetary and fiscal policies put under a severe examination”. Russia has been steadily building up its foreign currency reserves since it annexed the Crimea in 2014, from $368 billion then to some $630 billion today. The trouble is that around half of this expanded reserve is held overseas in foreign banks. Russia can’t get hold of it after Japan, the European Union and the US barred Russia’s central bank from tapping into the billions of foreign reserves Moscow had been saving up in their banks.

Cui bono?

Cui bono — who benefits from this war? Clearly Ukraine’s infrastructure has been seriously damaged and the loss of human life is no doubt currently under-estimated. But Russia too has lost, not just access to many financial markets and had its credit rating downgraded to junk status; its President Putin will never recover trust or credibility among Western leaders. Nor will the US and its NATO allies be beneficiaries; they risk looking impotent in the face of an authoritarian bully.

China however, which has not joined any Russian sanctions, and has said it will continue trading with Russia, is rubbing its hands in glee, although some commentators believe Beijing is involved in an “uncomfortable balancing act”. China takes just 2% of Russia’s exports and is not dependent on a single source for oil and gas.

What China has been quietly doing for years is to build up its own reserves in gold, and it must be thinking of Russia perhaps becoming a distressed seller of its gold reserves of about $137 billion. China’s ultimate ambition is to see its own currency displace the Dollar as the international reserve currency. Bringing about that change will need patient years — which President Xi Jingping has, unlike President Putin. And to persuade the world that the Chinese Yuan might be a credible challenger, a massive backing from gold could be useful.

Putin needs an escape hatch

“Putin doesn’t do humiliation well”, according to Bill Browder, formerly the largest foreign portfolio investor in Russia. In 2009, his Russian lawyer, Sergei Magnitsky, died after being deprived of medical care in a Moscow prison; he’d uncovered tax fraud linked to Russian officials. Browder was banned from Russia in 2005 and labelled a ‘threat to national security’. Putin’s response “is scorched-earth carpet-bombing with massive civilian casualties as a way of showing everybody he’s not a guy to be messed with”. The war in Ukraine is turning ugly, with Russian forces failing to sweep the opposition aside with ease. Military stagnation may be on the cards, as stagflation is on the cards for the global economy. While stagflation will be uncomfortable, a military stagnation may encourage Putin to double-down and use those scorched-earth tactics. He needs to be permitted a face-saving escape hatch. We only need to remember how humiliation served the victors of the First World War very badly to realise that.

Whatever the outcome, the prospects for safe-haven assets — including gold — have dramatically improved. It seems a little cold-blooded to be thinking of assets to protect oneself while many people are thinking how to protect themselves against bombs; nevertheless, we all need to take what cover is possible, literally and metaphorically.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.

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