The economy appears to have expanded by 0.5% year on year, with strong growth in construction (4.5%) and services (0.7%). This suggests a positive performance overall, offset by a 2% fall in manufacturing. Part of the drop in manufacturing, reflects a return to trend rate, following a period of over expansion, peaking in the second quarter of 2021. We expect a stronger performance in the rest of the year.
Within the service sector, strongest areas of growth were in Administration (5.9%), Accommodation and Food, (3.8%) and Professional and Financial Services (3.8%).
So what of the year as a whole? In our presentations, we forecast growth of 0.4% this year. At present there appears to be no reason to adjust the forecast. The Bank of England now expects the U.K. to avoid recession in 2023, projecting growth of 0.0% this year. The latest NIESR forecasts in the Spring update are forecasting growth of 0.3% in the current year.
Growth in 2024 is expected to be around 1%. The Bank of England slightly more pessimistic than the conservative NIESR numbers.
We always considered the Bank and the OBR to be too gloomy. An aspect compounded by the gloomy over view from the IMF in Washington. We model in growth of 1.5% in 2024 and 2.0% in 2025. We expose our optimism bias perhaps.
In the first quarter of the year, inflation CPI basis averaged 10.2%. Producer output prices averaged 11%. Producer output prices averaged 13.4%. Both producer indices had fallen to average 8.5% in March.
In the U.S. the trend is in the right direction. Consumer price inflation was down to 4.9% in April. Producer output prices were down to 2.3%..
Energy prices have fallen. Gas prices have collapsed. Oil prices Brent Crude averaged $82 in the first quarter compared to $100 dollars in the same period in 2022.
Food price inflation is expected to fall significantly from April onwards. The overall rate of inflation (CPI basis) is expected to fall to around 5% by the end of the year. The 2% target for headline inflation may remain elusive into 2025.
Employment and Earnings
Unemployment was 1.3 million in the first quarter. The unemployment rate was 3.8%. The number of vacancies averaged 1.1 million, the challenge of recruitment persists into the New Year. We expect inflation to drift slightly higher to 1.45 million by the end of the year. The u-rate rising to 4.1%.
Earnings in the first quarter averaged 5.8%. We expect this to peak in April, drifting slightly lower to around 5.2% by the end of Q4. The underlying rate of wage inflation will underpin the forward outlook for prices despite the hopes of the Bank of England.
Total employment in the first quarter increased to just under 33 million. This was slightly ahead of the pre covid level at the beginning of 2020. The number of people self employed increased. The number of UK citizens in work fell. The number of foreign workers increased. Workers from outside the EU hit a new record of 4.2 million. The number of workers from within the EU area increased to 2.5 million, almost back to the pre covid peak in the first quarter of 2020.
UK Base rates were increased in the first quarter, to average 3.85%, rising to 4.25% in April and 4.5% in May. Ten year gilt rate average 3.54% in the quarter rising to 3.65% in April and trading at 3.77% over the weekend.
We may have seen the peak for interest rates in this cycle as the Bank adopts a wait and see approach. A further 25 basis point rise may yet be a possibility in the U.S. and the U.K. This is not our central forecast scenario. We expect base rates to remain higher for longer than markets currently expect.
We still expect US ten year bond yields to average 4.00% in the final quarter of 2023. U.K. rates will rally to average 4.00%. The hard yards now gained in life after Planet ZIRP. There will be no return to the forbidden planet.
In the UK, prior to the Great Financial Crash [2000 - 2008] the average inflation rate was 2.0%, the average UK bank rate was 4.50%. Ten year bond yields averaged 4.50%.
Want to know more
Stay up to date with our Friday Forward Guidance Features on Rates and our Monday Morning Markets updates on equities, bond yields, exchange rates, and commodity prices. Available on The Saturday Economist web site.
To understand the markets, you have to understand the economics … and we do.
Notes on Data Presentation
At the Saturday Economist we use the year on year comparison to present the rate of change on principal indices.
ONS GDP monthly estimate, UK March 2023 16th May 2023
ONS Employment by country of birth 16th May 2023
Later this week, we will be updating our analysis "So just what happened in the first quarter of the year". The economy appears to have expanded by 0.5% year on year, with strong growth in construction (4.5%) and services (0.7%). A positive performance overall offset by a 2% fall in manufacturing. Part of this drop reflects a return to trend. In our presentations, we forecast growth of 0.4% this year. At present there appears to be no reason to adjust the forecast. The Bank of England now expects the U.K. to avoid recession in 2023. We always considered the Bank and the OBR to be too gloomy.
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The Fed hiked rates by 25 basis point this week. The ECB followed suit. The Bank of England is expected to join the 25 basis point club next week.
The target range for the Fed Funds rate is 5.00% to 5.25%. UK base rates will hit 4.5%, possibly 4.75%. In Europe the interest rates on the marginal lending facility are at 4.00%.
Christine Lagarde has suggested, although the rate of increase has slowed, there a more increases to follow.
In the UK markets would like to believe 4.5% will be the peak for this stage in the cycle. With more to come in Europe, 4.5% (MLF) may well also be the case in Europe.
In the USA, the doves believe we have seen the top of the curve. It seems unlikely there will be further rises in Fed rates for the moment. Jerome Powell is ruling out any cuts to base rates in the current year.
The markets are not convinced. Ten year bond yields trade at 3.4% this morning. UK ten year gilts trade at 3.75%. Manna from heaven. Markets require a softening of yields to restore value to the bond market.
“When the Fed hits the brakes, someone goes through the windscreen.”
When the Fed hits the brakes, someone goes through the windscreen, It was almost the Fed itself. A cluster of regional banks have “hit the hood” including Signature, Silicon Valley Bank and First Republic. Combined assets of $550 billion are splattered over the windscreen.
JP Morgan has mopped up some of the blood with a hefty clean up fee. Jamie Dimon is convinced ”We are past the worst”. Traders continue to torment Pac West and Western Alliance. Pac West is weighing its options. Shares fell despite assertions by the Federal Reserve, the recent bank crisis is contained.
First Republic collapsed despite a $30 billion lifeline from fellow bankers. $100 billion of deposits were withdrawn in one day. The Fed maintain the US banking system is sound and resilient. Yet banks “faced with unrealized losses face significant safety and soundness risks”. The fear is the deficit exposure will spread from bonds to the commercial property sector.
At the Fed briefing on the 14th February, one page was devoted to Silicon Valley Bank.
At the Fed briefing on the 14th February, one page was devoted to Silicon Valley Bank. There was nothing about the risk of a bank run. The situation was not presented as urgent or alarming. Less than four weeks late SVB collapsed.
The Fed’s own Barr review pointed the finger inside the regulator. There was a clear need to “address rules of engagement and supervisory conditions”.
At the end of 2021, no one including the Fed expected rates to rise in 2022. Regulators were testing the implications of a further fall in rates and interest spreads.
Stress tests for life after Planet ZIRP and a rapid rise in base rates were off the agenda. By the beginning of 2023, the staff report stated, “SVB has significant interest rates risk, the risk measurement process has failed within the bank.”
Maybe they should have been following the Saturday Economist! Much more on this to follow ...
That's all for now. Have a Great Bank Holiday weekend,
The Silicon Valley Bank Case Study
Friday Forward Guidance
SVB : The Bank From Planet ZIRP ... A focus on deposits.
SVB deposits had increased from $49 billion dollars in 2018, to $189 billion dollars by the end of 2021. "Hot money" of course, two thirds of the deposits were non interest bearing demand deposits. Over 90% were above $250,000 and not insured under FDIC rules.
Deposits increased from $49 billion to $62 billion by the end of 2019, as the Fed eased base rates to 1.75% from 2.00% in the year. In the following year, the Fed dropped rates to 0.1%. Deposits soared to $102 billion in 2020 and $189 billion at the end of 2021.
SVB's rapid growth created several stresses. The bank had to invest substantial cash deposits at a time of rock-bottom interest rates. To maximise returns, the company purchased longer-term mortgage and government-backed securities paying higher interest but of longer duration
But time was up for interest rates at the zero bound. The flight from Plant ZIRP was brought onto the runway. In 2022 the Fed began to hike rates aggressively. Rates moved from 0.1% to 4% by the end of 2022.
In that year, SVB deposits fell by $16 billion as investors were lured away by the prospect of higher yields. It was a harbinger of problems to follow for the bank in 2023.
In December 2022 The Federal Reserve Board forecast assumptions were for rates to average 5.1% in 2023, falling to 4.6% in 2024, 4.1% in 2024 and 3.1% in 2025. The long run rate thereafter would be for rates to average 2.5%.
Our basic log model would suggest SVB deposits would fall by a further $40 billion over the next two years and $10 billion in 2025 before stabilising at around the $120 billion level. The balance sheet impairment would provide further write downs of around $4 billion before some write back was possible. Total Equity would take a further big hit.
Depositors would not wait. By the close of business on March 9th, customers had withdrawn $42 billion dollars. A further $100 billion was up for withdrawal the following day. The Bank had run out of cash and options. Silicon Valley Bank was placed into receivership..
Major depositors included Roblox and Roku. Roblox (RBLX.N) The online gaming firm says about 5% of its $3 billion cash and securities balance, or about $150 million, as of Feb. 28 were held with SVB. Roku (ROKU.O) The streaming devices maker says it has about $487 million, or 26% of its cash and cash equivalents, held in deposits with SVB.
The Risk Model Flashed Red ... So Executives changed it.
An internal model showed that higher interest rates could have a devastating impact on the bank's future earnings.
Instead of heeding the warning, SVB executives simply changed the model's assumptions, according to the former employees and securities filings. The tweaks, which have not been previously reported, predicted that rising interest rates would have minimal impact on deposits and revenue.
The new assumptions validated SVB's profit-driven strategy but they were profoundly misplaced. Over the past year, interest rates had climbed nearly four percentage points, the fastest pace since the 1980s. The tech industry has entered a post-pandemic swoon, causing SVB's elite clientele to withdraw cash far faster than bank executives had expected.
The episode shows that executives knew early on that higher interest rates could jeopardise the bank's future earnings. Instead of shifting course to mitigate that risk, they doubled down on a strategy to deliver near-term profits, displaying an appetite for risk that set the stage for SVB's stunning meltdown.
SVB's new projections took effect during the year and assumed that cash flow from deposits would stay consistent for longer, softening the projected bite of higher interest rates. Before changing the model, an interest-rate hike of two percentage points would drop a measure of future cash flows by more than 27 percent; afterward, the hit was less than 5 percent, according to the bank''s securities filings.
In an apparent bet that interest rates would go down last fall, SVB sold for a profit the financial instruments it used to hedge against the risk of higher rates. Instead, the opposite happened: The Federal Reserve began to raise interest rates more aggressively over the summer to tamp down inflation. That reduced the value of SVB's securities portfolio, meaning the bank would take a loss if it had to sell.
Silicon Valley's Risk Model Flashed Red ... So Executives changed it. Washington Post April 2
Our Latest Case Study : Silicon Valley Bank : The Bank from Planet ZIRP ...
Don't Miss Our case study Silicon Valley Bank : The Bank from Planet ZIRP . It will be published for an Easter read. Charts, spreadsheets and 20,000 word text will provide a full background. Don't miss that! Sign Up Here ...
Our Live Presentations this month. An update on UK and world economics the principal theme. The focus on interest rates of great interest. The disruption to financial markets and the banking sector was brought into focus by the collapse of Silicon Valley Bank.
A lot of interest in the demise of SVB. The rise in interest rates and the collapse of bond prices had already created problems for pension funds with LDI exposure in the U.K. Rate hikes by the Fed and the rise in bond yields created fatal challenges to the balance sheet of SVB in the U.S.A. There have been many warnings about the problems to follow the eventual "Escape From Planet ZIRP". Bonds not gilt edged but razor edged. They really are the peaky blinders of investment.
In June 2013 Andy Haldane Chief economist at the Bank of England warned : “Let’s be clear, we have intentionally blown the biggest government bond bubble in history”. Andy Haldane was then the director of financial responsibility at the Bank of England.
In November 2015 we wrote "Over the medium term, we expect bond yields (after Fisher) to reflect a hedge against inflation plus a real risk return. Hence we consider the normalized yield on ten year gilts to be between 4% to 4.5% if the plausible inflation target is 2%. There is a real risk of capital collapse as bond yields rise and capital prices fall as yields return to normalized values." Warnings From Planet ZIRP November 2015"
The SVB Balance Sheet Too Heavy for the Flight ...
A balance sheet too heavy for the flight, SVB was ill equipped for the transition. Deposits had increased from $49 billion dollars in 2018, to $189 billion dollars by 2021. "Hot money" of course, two thirds of the deposits were non interest bearing demand deposits. Over 90% were above $250,000 and not insured under FDIC rules. In 2022 deposits fell by $16 billion as investors were lured away by the prospect of higher yields. It was a harbinger of problems to follow for the bank in 2023.
Much attention has been focused on the asset disposition on the balance sheet. Assets under management had increased from $57 billion in 2018 to $212 billion by the end of 2022. In 2022 almost $40 billion dollars were held in cash ($14 billion) and Assets for Sale ($26 billion) including $16 billion held in U.S. Treasuries. Total Assets For Sale were marked to market with a $2.5 billion impairment.
The Net Asset Value or Total Equity in the bank was $16 billion. Unchanged from the year before, the balance sheet had absorbed the hit from deposit withdrawals and the asset write down.
More ominous was the position on Assets Held to Maturity. Over $90 billion by the end of 2022, 90% of the assets were held in the alphabet soup of mortgage debt. MBS, CMOs and CMBS. Mortgage Backed Securities, Collateralized Mortgage Obligations and Colllateralized Mortgaged Backed Securities featured. Illiquid and vulnerable to rising rates, echoes of 2008 would create concerns for some. The balance sheet note of a $15 billion loss should the HTM assets be marked to market, extinguishing Total Common Equity, would cause depositors to head for the exit.
The SVB 10k Annual Return was filed on the 24th February ...
The SVB 10k Annual Return was filed on the 24th February. At the beginning of March, Moody's reportedly informed SVB Financial, the bank's holding company, it was facing a potential downgrade of its credit rating because of its unrealized losses.
On March 8, 2023, SVB announced it had sold over $21 billion of investments, borrowed $15 billion, and would hold an emergency sale of its stock to raise an additional $2.25 billion. investors were reluctant. The markets were unconvinced. By the close of business on March 9th, customers had withdrawn $42 billion dollars. A further $100 billion was up for withdrawal the following day. The Bank had run out of cash and options.
SVB was placed into the FDIC receivership. The Bank of Planet ZIRP could no longer escape. Perhaps It was never designed to make it.
Our Latest Case Study : Silicon Valley Bank : The Bank from Planet ZIRP ...
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Sign Up Here ... Silicon Valley Bank
Want to know what's next for interest rates ? Don't listen to the Governor of the Bank of England ...
Andrew Bailey was speaking at an event in London this week, hosted by Brunswick, the public relations firm. What next for monetary policy? What was the Governor saying? The press reaction was mixed, confused and slightly controversial.
According to Mehreen Khan in the Times the Bank of England hinted at more rate rises to tame inflation.
According to Larry Elliott in the Guardian, the Bank of England boss signalled that interest rates may heave peaked after ten successive increases in the official cost of borrowing since December 2021.
In the Telegraph, "Andrew Bailey down played talk of a sharp rise in interest rates" according to Szu Ping Chan.
For Sky News "Bailey suggested interest rates may rise less than previously thought signalling there is no urgent need for hikes" and in the FT "Andrew Bailey signals no pressing need for more UK interest rate rises."
Some were even led to think the Governor was saying interest rates may have peaked.
So what did the Governor actually say? Bailey may have hinted that more interest rate rises may be "appropriate" to contain inflation but made it clear that no decisions had yet been made ahead of the next meeting of the MPC.
He said the monetary policy committee would wait for an extra round of data on inflation and the labour market before making a judgment on raising rates again at the meeting on March 23rd.
"I would caution against suggesting either that we are done with increasing Bank rate or that we will inevitably need to do more. Some further increase in Bank rate may turn out to be appropriate but nothing is decided. The incoming data will add to the overall picture of the economy and the outlook for inflation and that will inform our policy decisions."
However the governor did warn the Bank was alert to the risk of repeating the mistakes of the 1970s and would not hesitate to raise rates further should inflationary pressures embed.
So what's next for monetary policy? Rates may go up, they may go down, they may increase dramatically or not as dramatically as some expect.
Obfuscation, the action of making something obscure, unclear, or unintelligible, is an art form of the central banker.
Alan Greenspan 13th Chairman of the Federal Reserve would say, "If I appear to be particularly clear, then you have clearly misunderstood what I have said".
Bailey may have been slow to pick up the lingo, but he appears to be in the swing of it now. Want to know what's next for interest rates ? Don't listen to the Governor of the Bank of England. Read our Friday Forward Guidance in the Saturday Economist instead. JKA
Should we be ready for $150 dollar Oil …
It was a fair call a few weeks ago. Oil trades at $94.81 dollars a barrel Brent Crude Basis as we write. West Texas WTI trades below $90 dollars. It’s a tight spread. Despite the forecasts of a slow down in world growth from the World Bank, the OECD and the IMF, demand for oil remains strong and looks set to continue for the rest of the year. Fears of a China slowdown hit prices this week.
The shortage of refining capacity is exacerbating retail fuel prices. Refinery capacity was hit during Covid. Capacity has not yet been replaced. Investment intentions are subdued. Oil companies are concerned about tight margins. They are not entirely sure about future demand patterns and the sustainability of higher prices. Investor pressures, with an ESG agenda, are inhibiting investment plans.
Supply Side Constraints Continue …
OPEC it is argued has less than 2 million barrels per day in spare capacity. In the USA, despite the surge in prices, the oil rig count remains well below historic levels.
The Baker Hughes US oil rig count was 601 last week as oil prices Brent Crude averaged $100 dollars. A strong recovery from the drop below 200 in 2020 but still well below the 800 count pre Covid, when prices averaged $70 per barrel. Go back ten years and $120 oil would bring 1400 rigs into action.
Material constraints and labour shortages are blamed for the tardy response. Investors are concerned about the ESG agenda and the vagaries of future returns. Principal producers are not entirely convinced about the sustainability of $100 plus oil into the short and medium term.
The Shock of War …
The OECD explained this week, “limiting Russia’s ability to finance the war In Ukraine, by an embargo on Russian oil exports, is essential for speeding up an end to the devastating conflict”. European economies are struggling to wean themselves off Russian fuel. Alternative energy sources may not be so easy to ramp up quickly. There is a risk of higher prices or even shortages. It is argued.
The U.S. Energy Information Administration estimates that 2 million bpd could be lost as Russia winds down production. This is a greater amount it is suggested, than new production in the USA and OPEC may be able to cover.
The Biden administration is keen to ease prices pressures at the pumps. Stocks have been released from the U.S. Strategic Petroleum Reserve, with plans for further releases in the Autumn. Overtures to OPEC have been made. The Saudis have agreed to a modest boost to output in July and August.
Traders are unconvinced. OPEC will be keen to harvest inflated margins as long as demand destruction doesn’t follow from the price hikes.
The U.S. EIA Short term energy outlook (June) expects the Brent Crude price to average $108 dollar per barrel in the second half of 2022 falling to $97 dollars in 2023. For the moment $150 dollar oil may be just a traders dream. $20 dollar oil in April 2020, a long distant memory. Our money is on $95 dollar Brent Crude for now.
In January this year, the IMF were forecasting world growth of 4.4% in 2022. This was a modest slow down from growth of around 6.0% in the prior year.
Growth in the U.S. and Europe was expected to be around 4.0%. Growth in the UK and China was expected to be about 4.5%. Concerns were expressed around Covid continuance, energy price rises, supply side disruptions, transport costs, tight labour markets and higher inflation.
"Risks to the global baseline are tilted to the downside". The IMF stated. "The probability of a major natural disaster remains elevated".
Then in March, Russia invaded Ukraine. Sanctions were imposed on Russia. The ruble collapsed by 30%. Domestic interest rates were hiked to 20%. Capital controls were imposed. The Iron Curtain was redrawn albeit with a gas leak for now. The concept of Cold War returned. Moscow placed on ICE, a policy of Isolation, Containment and Exclusion in prospect.
So What Now of World Growth?
In our Friday Forward Guidance this week, we outline the new monetary framework for the West. On Monday we will confirm our outlook for markets. Higher rates will lead to lower growth, achieving little impact on inflation in the short term. Bond yields are rising, pension deficits will be shrinking. The prospects for equities now positive, following the sell offs in Asia, North America and Europe.
The Economist Intelligence Unit suggested this month, the impact of the war will be a loss of some $400 billion dollars this year. That equates to a loss of 0.4% of GDP. The downside, however, could be as much as a full one percentage point or $1 trillion dollars.
"The economic impact of the conflict will be felt mostly in Ukraine and Russia. Both will experience sharp recessions this year. Those eastern European countries most exposed to trade with Russia, such as Lithuania and Latvia, will also take a hit from the conflict. Elsewhere in Europe, the EU will suffer from an energy, supply-chain and trade shock."
Oxford Economics suggests the impact on global GDP will be muted in Asia and North America. The impact will be greater in Russia and Europe. The loss of global output this year is expected to be 0.6% in 2022 and 1.1% in 2023.
NIESR are more bearish. Using NIGEM, the global econometric model, NIESR suggests the impact of the war in Ukraine could reduce the level of Global GDP by 1%. That's about $1 trillion dollars. The conflict would also add some 3% to global inflation this year and 2% next.
Our own simulations suggest world growth will be 3.5% this year. This is based on changes to the January IMF outlook as follows. U.S. growth is downgraded to 3%, slightly above the FOMC forecast this week of 2.8%.
In China, the IMF forecast of 4.8% is upgraded to 5.0%. This is a slight discount to the official growth target of 5.5% in the current year. Covid restrictions and lock downs in Shenzen and Jilin could impact further on the full year outlook.
In Europe, Germany will be the most severely affected. The overall shock to growth is expected to be between 0.5% and 1.0%. We will update our UK forecasts in greater detail next week. The IMF were forecasting UK growth of 4.7% this year following growth of 7.5% last year. This month, the HM Treasury summary of forecasts for the UK economy, suggested growth would slow to around 4% this year. It would appear to be a fair bet for the moment. We await with interest the OBR updates next week.
So what of Inflation ...
In the West, we were already braced for the impact of rising energy and commodity prices. Oil Brent Crude trading at $98 dollars a barrel in February, gas prices spiking at over $5.00 per therm. Shipping costs on the rise again. Gold always an attention grabber, testing $2,000. We didn't really take a look at wheat prices hovering at $800 per tonne. Then came the leap to $1,300 as the tanks rolled into "The Bread Basket of Europe".
The OECD chart marks the spike in commodity prices following the conflict in Ukraine. Energy features along with the hike in metal prices, Nickel, Platinum and Palladium. Wheat and Corn are high on the list. [Not featured are the increases in rape seed oil and fertilizer.]
Russia and Ukraine account for almost 30% of the world’s wheat exports. Russia supplies 16% of the world’s fertilizer. Ukraine is a major producer of neon, a key input for the production of semiconductors.
Fears abound Russia could more aggressively restrict key exports to Western countries of grain, titanium, palladium, aluminum, nickel, timber, and oil and gas. Russia is a vital supplier. Restrictions would send shock waves throughout the global economy.
Concerns are rising over food and famine. Turkey, Egypt, Israel, Tunisia, Thailand, Indonesia, Greece and Morocco are particularly dependent on Russia and Ukraine for imports of grain. In Egypt and Turkey the dependency is over 70%.
So what of inflation? The OECD expects a substantial hit to inflation in the current year. For the world economy as a whole, the increase is expected to be 2.5%, in Europe just over 2%. In the USA, the impact slightly more muted at 1.5%. In the UK, the Bank of England now expects inflation to peak at around 9%, compared to just over 7% prior to the invasion.
In Russia, inflation is expected to surge to between 20% and 30%. The pressure on Putin is increasing. The President is lashing out at traitors and fifth columnists in Russian society. Arrests of key players in military and FSB are underway. In Ukraine, the death toll continues to mount. The shocking news clips continue ... the rise in inflation and lower growth, a modest inconvenience in comparison to real hardship ...
That's all for this week. Next week we will focus on the UK Economy following the Chancellor's Spring statement and the ORR updates.
Don't miss our Monday Morning Markets update out on Monday. Markets rallied this week. The overall bounce was around 5%.
Hang Seng bounced but still has a "buy in bundles" tag. China is softening the stance on tech. It is time to take a look again at mainland stocks.
Gold slipped to $1,929, Oil Brent Crude closed at $107 dollars. Sterling traded up against the Dollar. Bond yields strike our first level target. More in bond yields to follow by the end of the year ...
Have a great weekend,
Joe Biden made it clear this week, NATO will not go to war with Russia to defend Ukraine. "We are going to provide more support but we will strive to prevent a direct clash [with Russian forces]."
He went on to say, direct confrontation would lead to World War Three, something we must strive to prevent. However, the US would defend every inch of territory of its NATO allies if attacked, no matter the consequences.
It was a clear evidence of the resolve of western allies to resist further Kremlin aggression. It's also confirmation, the West needs a little more time to prepare for conflict.
World War III is also something President Putin will strive to prevent. Putin knows this would be a war, which he could not win. The numbers just do not add up for Mother Russia.
In 2021 the IMF ranked the Russian economy as eleventh largest in the world, squeezed out of the ten by South Korea and Canada. A GDP estimate of $1.6 trillion dollars for the Russian economy, contrasts with a combined NATO GDP estimate of almost $45 trillion dollars.
In military spending, it is estimated the Russian economy spent some $48 billion dollars in 2021. That compares with an estimated $750 billion in the same year for Uncle Sam. Germany has now vowed to increase spending to over $80 billion. Combined NATO spending last year on military defense was over $1 trillion dollars. That's twenty to one out spend for the would be aggressor.
Ukraine is demonstrating just what can be achieved with a more modest $5 billion spend. The beleaguered country will continue to receive substantial support in funding and military supplies as the war drags on. Russian military has demonstrated the vulnerability of infantry and armed vehicles to drone and anti tank attacks. The importance or air superiority critical to support of ground forces. In Putin's world, tanks are used in World War III, as cavalry was initially employed in World War I, with US jets as escort.
EU leaders have announced their intention to collectively rearm and become autonomous in food, energy and military hardware in a Versailles declaration that described Russia’s war as “a tectonic shift in European history”.
Putin and Russia face a period of Moscow on ICE. Isolation, Containment and Exclusion. The Iron Curtain is closing, albeit with a gas leak for now. Slowly but surely the leaks will be plugged. More importantly, in the short term, the future of the people of Ukraine is in the balance.
We continue to be deeply shocked and saddened as the terrible events unfold ...
The Ukraine Battle Map ...
So how will events develop in Ukraine"" Putin has made it clear this is not a war, it's a "Special Military Operation". Foreign Minister, Sergey Lavrov, stated this week, "We did not attack Ukraine". Of course not, presumably it was more of a joint military exercise with close neighbours.
It was a process of invasion, annexation and installation of a puppet regime. The process has failed.
Lavrov also went on to say, if there is a World War III, it will be nuclear. Putin has made several threats of nuclear force in recent weeks. He would consider wielding atomic weapons if NATO forces got directly involved in defending Ukraine.
Russia run a similar playbook in 2014. As Putin invaded Crimea and eastern Ukraine’s Donbass region, he said, “Russia is one of the leading nuclear powers. It is best, not to mess with us.” Russian officials relayed similar threats to Western leaders. Russia did not put its nuclear forces on high alert. Putin later bragged that he almost did.
So how will this end? Annexation of Ukraine unlikely. Partition of Ukraine possible. The lines may be drawn between Kyiv and Odessa or East of the Dnipro River or a reversion to the "Status quo ante bellum". Ukraine independence assured, Moldova Sweden and Finland may then seek security with NATO.
The Cold War returns. Europe develops an alternative energy policy. Energy costs rise, food costs rise, metal costs rise. Inflation rises, growth slows, recession avoided, perhaps not for Putin. This will be the last in our trilogy on Putin. Next week we really will try to put some numbers on growth and inflation ...
Thanks for Reading ...
Don't miss our Monday Morning Markets update out on Monday. Markets steadied this week, European stocks rallied. Most moved into oversold territory. Hang Seng had a "buy in bundles" sign as markets fear the worst for China tech.
Gold slipped below $2,000, Oil Brent Crude closed at $111 dollars. Sterling slipped further against the Dollar.
Have a great weekend,
Deeper and Deeper ...
At the NATO summit last year, the West gave encouragement to Ukraine to join the Alliance. Little thought was given to the reaction of Moscow to such a potential tectonic shift in the balance of power in the East.
In November last year, the U.S. and Ukraine signed the Charter of Strategic Partnership. America affirmed Kyiv's right to pursue membership of NATO. It was a step too far for Putin.
We outlined last week, the importance of buffer states from the Black Sea to the Baltic, from Crimea to Kalingrad, to an increasingly threatened Mother Russia. For Putin, the Charter was indeed a step too far. Preparations immediately began for Russia's so-called "Special Military Operation" in Ukraine.
Ukraine has long held a special place in Putin's buffer zone. In 2007 at the Munich conference, Putin had made it clear, his speech was a rant against Ukraine ever joining NATO. In 2021 he wrote "Ukrainians and Russians are one people", never to be separated.
Let's face it, the Ukrainians have long held a special place in Mother Russia. Millions were allowed to die from starvation in the early 1930s as Stalin imposed his authoritarian, agrarian adventure, at the cost of so many innocent lives.
Putin believed war could be avoided simply by the show of force along the Ukrainian borders to the North, South and East. Zelensky's government would bow to the threat of invasion by such a great global power. Kyiv would reach an accommodation with Moscow to avoid large scale destruction. Putin's ring of steel would be guaranteed. His reputation inscribed in history along with Ivan the Terrible.
Special Thanks to Robert Service "The Two Blunders That Caused the Ukraine War" Interview with Tunku Varadarajan Wall Street Journal 5th March 2022.
The Great NATO miscalculation ...
Putin underestimated Zelensky. He seriously underestimated how the leaders of the "Free World" and NATO would react.
Perhaps it was an easy mistake to make. Putin had enjoyed four years of laissez-faire with Trump. The U.S. President had demonstrated his disdain for democracy and the admiration of President Putin. A President in power twenty years had a certain appeal, especially with the bonus of a little crony corruption on the side.
Trump had also demonstrated indifference to the NATO Alliance. He berated close allies with long over due debts to Uncle Sam. More votes were on offer at home from an aggressive stance with China. Trump was struggling with the Thucydides trap. The rise of Sparta ensured war with Athens was inevitable. So too it was said, the rise of China would lead to inevitable war in the South China Sea.
Joe Biden appeared to offer even less of a threat. Walk tall and carry a big stick. Biden struggled to walk tall carrying a walking stick. In Germany, the retirement of Angela Merkel would create a leadership vacuum. The Germans were hooked on Russian Gas. Nord Stream two would guarantee a permanent fix. The European Union had been dealt a serious blow with the abdication of Britain from the economic alliance. Putin would have been unimpressed by Defence Secretary Williamson's, now Sir Gavin Williamson's remarks that Russia should go away and shut up.
The Tanks Rolled over the Border
The Tanks Rolled over the Border and into the abyss. Zelensky held firm. The Ukrainian people defiant. The invasion stalled. The Russians upgraded the levels of civilian attacks and large scale destruction. It is like watching a 1930's news clip. The annexation of a sovereign state, millions of refugees feeling across Europe, a dictator unchallenged at home, the West prepares for war, the threat of nuclear detonation returns.
Sanctions imposed on Russia and the Oligarchs. Russian central bank assets frozen. Putin achieved what Trump could not. The Germans vowed to increase spending to meet the NATO commitment. Georgia and Moldova apply for EU membership. Sweden and Finland may join the alliance.
Higher inflation and lower growth in prospect. Oil trades at $120 dollars his morning. Commodity prices are soaring. Russian stock markets are collapsing. The Russian economy will be badly damaged in the process.
In our next update, we will try to pull together the forecasts for growth and inflation in the year ahead. Meanwhile the tragedy in Ukraine continues ...
The Saturday Economist
John Ashcroft publishes the Saturday Economist. Join the mailing list for updates on the UK and World Economy.
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