The US Cost of ‘Defending Freedom’ in Ukraine

Americans might be tempted to view the war in Ukraine as an unfortunate but distant crisis. As an economist, I know the world is too connected for the United States to be unaffected.

On February 22, 2022, President Joe Biden warned Americans that a Russian invasion of Ukraine — and American efforts to thwart or punish it — would come at a price.

“Defending freedom will have costs, for us too and here at home,” Biden said. “We have to be honest about it.” His statement came a day before Russian President Vladimir Putin ordered an attack on targets across Ukraine, including in the west of the country.

Now that war has broken out, the biggest costs to the United States are likely to be higher prices — on top of what is already the fastest pace of inflation in 40 years.

Whether inflation gets worse will depend on how far Putin goes, the severity of the sanctions imposed on Russia, and how long the crisis lasts. Will Putin cut off oil or gas to Europe? Will the invasion completely disrupt Ukraine’s ability to export food and other products to the rest of the world?

We know that Russia is one of the biggest energy exporters in the world and that the nickname of Ukraine is the “breadbasket of Europe”. And beyond that, the crisis has been rocking the markets for months, sending the price of oil and other commodities skyrocketing.

These higher prices will affect Europe, of course, but also many other countries, including the United States, which will make the Federal Reserve’s task of fighting inflation much more difficult and will be a greatest threat to the economy.

Pump pain

The most obvious costs for Americans will be at the gas pump.

Russia produces around 12% of the world’s oil and 17% of its natural gas. This makes it the world’s third largest oil producer and the second largest gas producer. It is also Europe’s largest natural gas supplier, which gets almost half of its supply from Russia.

The risk is that Russia will cut off gas or oil supplies to Europe or other countries that impose sanctions or otherwise condemn its actions in Ukraine.

Europe could face the most immediate effects if some of Russia’s energy supplies were withdrawn from the world market – which is why the United States is trying to assure its allies that it can supply them with liquid natural gas to make up for any shortfall. But global oil markets tend to be highly integrated, so the United States will not be immune.

The crisis has already pushed the price of oil to its highest level since 2014, when Russia annexed Crimea from Ukraine, pushing the average gasoline price in the United States to over $3.50. the gallon.

The most serious sanction implemented against Russia to date is Germany’s freezing of the Nord Stream 2 gas pipeline, which would have brought liquid natural gas from Russia to Western Europe bypassing Ukraine.

A disruption in a regional market will eventually affect the global market. Since the invasion, crude prices have surged above $100 and are likely to go even higher.

Higher prices at the supermarket

While Russia is a major fuel producer, Ukraine is a major food exporter.

Ukraine produces 16% of the world’s corn and 12% of its wheat, in addition to being a major exporter of barley and rye.

While a large part of Ukraine’s exports are destined for countries in Europe and Asia, agricultural products, like oil, tend to be traded in increasingly integrated world markets. Again, the implication for US consumers is that while Europe may be hit more immediately in terms of shortages, prices will likely rise everywhere.

Food prices in the United States rose 7.4% in January from a year earlier. Since the demand for food is generally not very sensitive to price changes – people need to eat regardless of the expense – an increase in the cost of food production is usually passed on to consumers.

The biggest risk to the US economy

This brings us to the Federal Reserve.

The US central bank is very worried about the pace of inflation in the US and plans to raise interest rates to combat it. What is happening in Ukraine could complicate his plans. If the crisis in Ukraine adds to upward pressure on prices, it may fuel inflation and force the Fed to take more drastic measures.

Some economists believe that the United States could soon see inflation of 10% – compared to 7.5% currently – in the event of a full-scale invasion, as we are currently seeing. The United States has not experienced such high inflation since October 1981.

If the Fed decides it needs to act more forcefully to get inflation under control, it would not only increase borrowing costs for businesses and consumers — affecting everything from business loans to mortgages and student debt — but could put the economy at risk of recession.

At the same time, the crisis could have a moderating effect on interest rates. In times of crisis and uncertainty, investors often put their money in the safest assets they can find – in a so-called flight to quality. US government bonds and other dollar-denominated assets are often considered the safest, and increased demand for these assets could lead to lower interest rates.

The Ukrainians themselves will of course pay the highest costs of the Russian invasion, in terms of loss of life, economic costs and potentially the loss of their government. But the conflict, however remote it may seem, will impact people everywhere. And the blow to Americans’ wallets may be closer than you think.

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William Hauk, Associate Professor of Economics, University of South Carolina

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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