The Investment Scientist

The Ukraine War and Inflation

Posted on: April 13, 2022

The US inflation numbers for March just came out – it’s 8.5%, another 40-year high. I am afraid that, with the Ukraine War still raging, inflation will get worse before it gets better.

Shortly after the Russian Invasion of Ukraine, the West adopted the “Nuclear Option” of economic sanctions – expelling Russia from the SWIFT system. SWIFT is the payment system that undergirds international trades. Now that  Russia is no longer part of this, it can not sell its energy and agricultural products to the world market. 

How Would That Affect Global Commodity Prices?
Russia is one of the top three exporters of the following commodities: oil and gas, wheat, maize, sunflower seeds, sunflower oil, and fertilizers. On average it accounts for about 15% of world supplies. When these supplies are pulled out of the global market, the price of these commodities will skyrocket as they already have. Since these are basic commodities, and many products use them as inputs. The price shock is going to filter through downstream products as well. 

Why Will Dollars Come Back to America?
As of this writing, Russia’s Ural oil is quoted at a 30% discount compared to Brent and WTI oil, meaning Russian oil is 30% cheaper than the prevailing international prices. You can bet that some countries, especially poorer ones, will want to take advantage of that. As long as they don’t pay with dollars, they are able to. 

⅔ of all US dollars in circulation are actually outside of the country being used for international trades. If a significant part of the world chooses to no longer use the dollar for international trades, these dollars will flow back to the US. This will result in the dire condition of more dollars for fewer goods, a perfect recipe for inflation.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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