The war in Ukraine has gone global. Rising commodity prices are on their way to seeing theirs strongest increase since 1970, sending a shockwave of suffering across the world as the prices of essential goods every human being needs to survive skyrocket. Wheat prices are up 60% since February. Food prices are now higher than they were during the 2008 global food crisis 155 million people pushed into extreme poverty. Cheap Ukrainian wheat that vulnerable nations like Egypt, Libya, Somalia, Syria and Lebanon depend on is stranded. If we’re not careful, the “Ukraine shock” could quickly reach the massive scale of the OPEC and Iran shocks that rocked the 1970s.
But the “shock” metaphor is misleading. This is not a momentary explosion; all warning signs indicate that this could become an avalanche. If that happens, we will only be at the beginning of a decade-long deluge.
Two historical episodes provide a guide to these turbulent times: the 2010s and the 1970s. In both periods, commodity spikes triggered a cascade of crises that happened year after year. The tedious disruption was driven by a feedback loop between chaos in the markets and chaos in the real world. Conflicts triggered price shocks, and those high prices triggered more conflicts, causing prices to rise again, and so on.
The first avalanche began in 1973 with the Arab-Israeli War. In retaliation for US support for Israel, newly confident energy cartel Opec deployed the “oil weapon” by doubling – and then quadrupling – the international price. Around the world, inflation soared, unemployment soared, and stock markets suffered their biggest collapse since 1929. Faced with extortionate import bills, many countries turned to Wall Street banks to borrow dollars to pay for the oil their economies desperately needed required.
But in 1979, with the Iranian revolution driving prices even higher, Fed Chairman Paul Volcker raised interest rates to 20% to combat a new surge in inflation. The indebted countries defaulted on their payments, triggering the Third World debt crisis. The bailout package that the IMF offered to the defaulting countries was tied to government spending cuts, particularly food and fuel subsidies. The people of these countries could not afford to live, and Protests broke out. Eventually, the governments of Peru, Brazil, Argentina, Mexico, Jamaica, the Philippines, Panama, Sudan, Tunisia and Haiti were either voted out or overthrown.
Chaos had spread from a war in the Middle East, to the international price of oil, to a global recession, to a Wall Street bonanza, to a default by developing countries, and to a revolutionary wave. Disorder in the markets and disorder in the real world fed each other. As a result of this economic dysfunction, the post-war Keynesian economic theories that had been hegemonic were invalidated and a free-market revolution ensued. And when these free-market revolutionaries deregulated commodity markets in 2000, they allowed financial speculators to dominate pricing. Now only the dealers anticipation of future real-world chaos was enough to bring chaos to the markets as traders began to “price in” perceived risk. Perception might trump reality.
The second avalanche began in the summer of 2010 as wildfires raged across Russia’s farmlands and speculators feared a global wheat shortage. Those fears were ultimately unfounded — American farms had a bumper harvest that year — but panicked wheat futures deals almost doubled the international price. A wave of demonstrations swept one of the world’s largest regional importers – the Middle East – trigger the Arab spring revolts. In Syria and Libya, these revolutions fueled civil wars and awoke the dormant Islamic State in neighboring Iraq. By 2015, the refugee crisis that had caused these conflicts had gone global, fueling a right-wing populist insurgency across Europe that pushed Britain toward Brexit and gave Trump ample ammunition for his presidential campaign.
As these civil wars raged in a region populated by oil-exporting nations, commodity traders “priced in” a disruption in world oil production that never materialized. After a brief outage in Libya, oil continued to flow. But the speculative oil bubble of 2011-2014 showered a massive wave of black gold on Hugo Chávez just before his re-election campaign, IS as his white Toyotas advanced through Iraq, and Vladimir Putin as he prepared for his first military invasion Ukraine. Many of these petrodollars were also invested in Western real estate, leading to huge wealth inequality that coincided with the refugee crisis further fueled the rise of right-wing populism across Europe and led to a crucial constituency of former Obama voters voting for Trump in 2016.
Putin’s invasion of Ukraine triggered the third avalanche. Market reactions were so chaotic that the London Metal Exchange had to stop trading. In the coming weeks, the rise in commodity prices could lead to a rise in inflation, a global recession and a rising tide of hunger and poverty. If this crisis is not averted, the approval ratings of incumbent politicians in advanced economies will fall as the cost-of-living crisis deepens. For the many countries already on the brink of chaos, this means protests, riots and maybe even revolution, as we have seen earlier this year Kazakhstan. Some of these conflicts will turn into civil wars, as happened in 2011.
Oil exporters like Saudi Arabia and Iran – and even Russia if it can find buyers for its oil – will be enriched and encouraged, free to escalate their existing military adventures and embark on new ones. Mining communities across sub-Saharan Africa will see an increase in violence As the metal deposits hold them, they increase in value. The cartels will seek to expand their activities into high-priced agricultural commodities such as Mexican avocado farmers can attest. These conflicts, whether realized or anticipated in the future, will raise prices as traders factor in the “risk premium”. And these high prices, in turn, will fuel the very conflicts that the premium is intended to protect against.
Three other global currents could further fuel this chaos engine. Commodity wealth can flow into financial assets, particularly real estate in the West’s most desirable cities, and increase inequality, which we saw in 2016 could be fueling political polarization and populism. Dollars to pay for these commodities must also flow from US financial institutions to vulnerable countries, raising the possibility of a new debt crisis in the developing world with austerity and instability to follow. Insecurity – be it from hunger or violence or both – creates flows of people: the 2 million who have it already fled Ukraine will soon be joined by others as new crises and new conflicts break out.
These doomsday scenarios are based on one assumption: that market prices are free to react to events, real or imagined. Wars, by definition, are times of extreme volatility. In such volatile times, policymakers have historically found it necessary to control prices until normality returns. The sooner politicians accept this necessity, the sooner this chaos engine can be dismantled. With every day of delay, the potential avalanche gets bigger. We must act to stop him now.