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Network News • 01-09-2022

Austerity follows Russian audacity to invade

Author: George Mangion - Senior Partner PKF Malta
Published on Business Today: 1st September 2022

Global political leaders have come to see Vladimir Putin as a threat to the entire West. Solidarity with the invaded Ukraine will show how with increasing audacity, the free world has rewarded Ukraine for its steadfastness with arms and cash.

Under Putin, Moscow spent the last two decades engaging in economic statecraft that resulted in the deep integration of gas supplies particularly in Europe. European policymakers also preferred to engage in business as usual with Kremlin rather than risk economic disruption. This was perhaps a natural extension following the policy of Ostpolitik - the normalisation of relations between West Germany and Eastern Europe beginning in 1969.

Now this friendship has drawn us closer to Russian energy dependency over the past decades. The Kremlin has insidiously encouraged corruption along the entire energy value chain in the process of cultivating close ties with utility firms that profited Europe’s dependency on Russia.  Notice how Germany has developed a predominantly commercial framework for energy security, which saw dividends in strengthening Russia’s integration into the European economy (quote the €8 billion North Stream 2 pipeline).

One recalls the previous two Ukrainian gas crises in 2006 and 2009 that resulted in the interruption of gas supplies to Europe, yet once bitten still European increased reliance on Russian hydrocarbons.  This commercial love/hate game has eventually entrenched German users in increasingly deep interdependence.  These are some factors that may help tip Germany into recession over the coming months, according to the country’s Bundesbank.

Sadly, as a consequence, European leaders have witnessed the economic pain of breaking these ties. Witness a sudden drop in value of the euro having fallen below parity with the dollar. This is a level never recorded in the past two decades. A weaker euro this increases the cost of imports, pushing up prices, notably for energy.

Perversely, self-sanctioning and open discussions of embargo of Russian’s oligarchs, have caused commodity prices to spike, resulting in higher consumer energy prices.  This policy has augmented energy hikes for the Putin regime and created an unprecedented landslide to boost his war chest.

Sharply rising commodity prices reminds us ominously of the 1973 extreme fallout from a global oil crisis. In 1973, OPEC had cut supplies to the US and demanded that foreign oil corporations increase prices and cede greater shares of revenue to their local subsidiaries.

In retaliation, the Nixon administration announced an energy strategy to boost domestic production to reduce US vulnerability to oil imports and ease the strain of nationwide fuel shortages. The onset of the embargo contributed to an upward spiral in oil prices with global implications. The price of oil per barrel first doubled, then quadrupled, imposing skyrocketing costs on consumers and structural challenges to the stability of whole national economies.

Since the embargo coincided with a devaluation of the dollar, a global recession seemed imminent.  European nations and Japan found themselves in the uncomfortable position of needing US assistance to secure energy sources. The United States, which faced a growing dependence on oil consumption and dwindling domestic reserves, found itself more reliant on imported oil than ever before, having to negotiate an end to the OPEC embargo under harsh domestic economic circumstances that served to diminish its international leverage.

With hindsight, one recalls how during the 1973 OPEC oil embargo the dollar plummeted and this directly hurt the OPEC producers which depended entirely on its value for government revenues.  All this points to the phenomenon of global inflation which crept up to double digit levels. It came at a vulnerable time for the global economy. In the US the effect was higher since domestic oil producers were running at full capacity and in the short term, they were unable to produce more oil to make up the OPEC induced embargo.  Furthermore, non-OPEC oil production had declined as a percentage of world output.  The ghost of stagflation became a buzz word.   

Economists define stagflation as what happens when runaway inflation occurs at the same time as a recession. The cycle is familiar: as prices rise, Labour expects an increase in wages to keep up, but higher wages raise the cost of production. This raises prices of goods and services again. It becomes a wage-price spiral when this cause-and-effect continues. Is this a harbinger that may repeat itself this winter? Will Europe succeed in avoiding a recession due to higher gas prices.

Obviously as commented earlier in reference to the OPEC embargo, then consumers had less money to spend on goods and services.This lowered demand. It also weakened consumer confidence. People were forced to change habits, making it feel like a crisis that the government tried unsuccessfully to resolve. This lack of confidence made people spend less.

Such hardship must not repeat itself now as a bleak reminder of consequences should Russian turn off the taps on European gas supplies. European drivers (except for Malta as fuel is being temporary state-subsidised) are seeing almost unprecedented prices at the pump, and natural gas prices already at historic highs prior to the war.

The EU is advising members to consider emergency measures to limit soaring electricity prices. In the early stages of the war, Europe was in denial about its costs: even asking citizens to adjust downwards the air-conditioner thermostat felt like too much of an imposition. That is changing and locally we are informed that Malta public offices are to dim cooling and heating. Public lighting is being dimmed, and some are even jokingly predicting that this winter Maltese will be taking cold showers.

According to guidelines issued to all government and public sector entities, air conditioning is to be set at a minimum of 24oCwhen cooling and no higher than 21o on heating.

As always, there will be an exception for hospitals and clinics. All façade lighting on public buildings and monuments to be switched off late at night. As a dire measure, the EU plans to cut gas consumption by 15 percent between August 1, 2022 and March 31, 2023 to cope with the crisis.

The latest local news talks volumes about a cut in the University’s budget. As a bolt in the blue, this brings along a reality that austerity is knocking on our doors. The public sector is already bloated with thousands of unskilled people collecting a salary as a gift. We’ll need more and better policemen, judges, administrators and regulators. Where will we find them if we slash our expenditure in education?

The spectre of inflation is tightening the screws of our cherished existence – aka “l-Aqwa Zmien” – so lovingly choreographed by party apologists unaware of Putin’s audacity.

Author: George Mangion - Senior Partner PKF Malta
Published on Business Today: 1st September 2022
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