The soaring oil and food prices, which began well before Russia invaded Ukraine, could push the global economy into 1970s-style stagflation.
Stagflation is a situation of slowing economic growth and rising inflation. It begins with a precipitous increase in the cost of producing goods and services due to a spike in the prices of economic resources used to make these goods and services, like raw and energy materials.
Then it advances with a rise in the price of these goods and services, as producers pass the higher production costs to consumers (cost-push inflation). But it does not stop there. Unable to afford the higher prices, consumers scale back purchases, slowing the economy down. Thus, the coexistence of rising inflation and slowing growth.
The stagflation of the 1970s, during the Middle East war, is an excellent example of stagflation. It began with a spike in oil prices due to an oil embargo by the Organization of Petroleum Exporting Counties (OPEC) against America and Israel’s European allies. In just a few months, the price of crude oil more than tripled, from around $3 to $11 per barrel, fueling a wave of cost and price hikes around the world, followed by slowing growth and rising unemployment.
Things look pretty similar these days, but the source of the problem isn’t a Middle East war, but the Russian invasion of Ukraine.
“Vladimir Putin’s attempt to reconstruct the Soviet Union has hit a hard patch, with President Zelensky of Ukraine inspiring his people and the world to stand up to the Russian bear,” said Eric Leve, chief investment officer at Bailard, a $5 billion asset and wealth manager. “Prior years’ sanctions have had [evidently] little deterrent effect, but the severity and global coordination of this latest round may give the Kremlin pause – or make continued aggression cost dearly.”
But sanctions will cost the rest of the world, too.
“The world, and most critically, Europe, risks 1970s-style stagflation as commodity prices spike in response to escalating sanctions and counter-sanctions,” he adds. “This is likely to elevate prices generally, exacerbating supply chain issues and slowing economic growth.”
Johan Palmberg, a senior quantitative analyst at the World Gold Council, subscribes to the thesis of stagflation, too, especially for Europe, which is already growing at a slow rate and relies on oil and gas imports for its energy needs.
“The risk of stagflation around the world is rising. Europe appears to be feeling it most acutely, fueled by soaring commodity prices and a weaker economic and financial environment,” he said. “This is also being exacerbated by the war in Ukraine. The U.S. is not reeling to the same extent. Both hard and soft economic data still signal that the economy is resilient.”
Still, there’s something that worries Palmberg for the U.S., the flattening of the yield curve, spread between long- and short-maturity Treasury bonds, which usually signals an impending economic contraction.
“Should energy and food prices stay high, stagflation risks might just be realized,” he adds.
Palmberg sounds the alarm for equity investors while making a case for gold, a conventional hedge against inflation.
“Equities are historically hit hardest, while commodities and gold have done well,” he says. “We are already seeing these dynamics play out at the beginning of 2022, and gold appears to be doing exactly what investors would expect it to, performing well as a hedge when other assets are not.”
