The Economics of Russia's Invasion of Ukraine

Russia has its ups and downs. It has been invaded at least four dozen times, and the invasions have typically come through nine gaps in the terrain on the edges of Russia. If the world was a peaceful place, the lack of Russian control of the gaps might not concern Putin. Russia has typically not known peace with the rest of the world during my lifetime. I think back, for example, to that period of 1995 to 1998. The Soviet Union had collapsed and so had the Russian economy. The ruble should have been devalued, but the IMF exerted pressure on Russia to maintain the ruble’s value, thereby choking its economy (Russian products were priced too high for export, while imports took the place of domestic consumption of Russian made goods). The poverty level went from 2% to 40% and the average life expectancy of the Russian male went from 78 years to 55 years. It is tempting to think that such was the crucible in which Putin’s ambitions were formed. I suspect he wants to make sure that the world can never dictate to Russia again. One way to do that is to plug those gaps. The biggest is the European Plain which is about 3000 kilometers wide in western Russia, but narrows in the north to about 250 kilometers just east of Warsaw, and in the south sees its narrowing where Moldova meets Romania. Bucharest sits in the middle of the southwestern opening to the gap. I think Putin’s aim is to take Ukraine so that he has easy access to Warsaw and Bucharest. Plug those gaps.

Taking Ukraine also removes an unfriendly border much further west. As it stands, Ukraine is less than 500 kilometers from Moscow. One can see why Russia does not want NATO forces on Ukrainian territory.

The implication of the foregoing is that Ukraine is a stepping stone and that eventually, Russia will kinetically clash with NATO countries. Poland was the line in the sand in advance of World War II. It seems it may be again. It is very important for the West to bog Russia down in the Ukraine so that invasion of Poland and Romania becomes impractical.

Hence the West sends weapons to Ukraine.  But there are problems with doing so. I see this Reuters report on Russia last week destroying a large cache of weapons from the west stored in Odessa: https://www.reuters.com/world/europe/russia-says-it-destroyed-odesa-terminal-where-foreign-weapons-were-stored-2022-04-23/.

Even when weapons are supplied, making them effective is a major challenge. What if they are destroyed in storage? What if logistics are such that the weapons don’t make it to the battlefields in time? What if the weapons arrive, but the troops do not know how to use them?  What if the troops know how to use them, but have taken so many casualties by the time the weapons arrive that there is not enough manpower to deploy the weapons effectively? Each of these problems can be magnified by Russian intervention. 

It is hard to see the war ending soon. A problem is that the longer the war drags on, the more it appears, particularly to Russia’s population, that Russia is losing. Putin cannot afford to lose. If he thinks he is losing, will he withdraw with his tail between his legs, or will he choose the nuclear option? But if he wins in Ukraine, he will likely continue into NATO lands, which also could easily lead to nuclear weapons usage.

In the meantime, Russia grows richer. Think of it: when Russia is earning billions of dollars monthly for its oil and gas exports, but not spending anything on imports, its monetary reserves are going to rise quickly. This enables Russia to afford war.

China is quietly becoming increasingly sympathetic towards Russia. Soon it may seem like Russia and China against the world. “Just you and me, Babe.” They have similar views on how to control their populaces. They are both ruthless in dealing with peoples they are oppressing. They have similar demographic collapses. They share a 4300 kilometer border. I am reminded of the prophecy of Daniel 11, where in verse 44 we find that “news out of the east and out of the north” leads to a great war that is elsewhere called Armageddon. To the east and to the north of the near east, which is the geographical focal point of the Bible, are China and Russia. Just saying…...

Government Induced Supply Chain Rupture

 

Here’s a link to an article from January: https://www.reuters.com/business/aerospace-defense/biden-administration-talks-head-off-5g-aviation-standoff-2022-01-18/

The article explains the problem of 5G towers being installed near airports interfering with avionics. In bad weather, pilots need to rely on their instruments, but have concluded that 5G transmissions will alter the readings obtained, particularly from altimeters. An altimeter tells a pilot how high he is. It measures altitude above sea level (ASL), and by subtracting the airport’s known ASL altitude from the altitude indicated by the altimeter, a pilot can approximate how far the plane is from the ground --- very important info when visibility is severely impaired.

So why don’t the altimeters get recalibrated to account for the interference from the 5G towers? It seems that the talent pool of avionics engineers able to do the calibrations are mainly in the area of Wichita, Kansas. Wichita is the avionics counterpart to Silicon Valley. Further, it seems that the covid vaccination rate in the Wichita area is rather low. The avionics engineers who are able to do the required work on civilian aircraft also work on military aircraft. The USA mandated that federal contractors must require those working on federal equipment to be vaccinated or fired. The result is that many of the engineers who could remedy the 5G interference problem have been fired or have quit in protest or perhaps disgust. So, once again a bottleneck is created in a supply chain on account of unreasonable interference by a government in the economy.

For decades the intellects of the Austrian School of Economics, as folks such as von Mises, Rothbard, and von Hayek are known, have warned us of the inefficiencies and misallocation of resources that occur from such interference. I am heartened that we finally have in Pierre Poilievre a candidate for the job of PM who understands the principles of freedom for which such intellects have long fought so hard.

Interest Rates and Next Steps

 The Bank of Canada first wanted us to believe that they could hold inflation to 2% per year. This was supposed to be a maximum, not a target. Even while they were expanding the money supply by 33%, they said with a straight face that inflation (by which they meant us to understand price inflation) would be held to 2%. Our Minister of Finance wanted us to believe that prices would actually drop, presumably because demand would drop. Of course, one might expect that when people are staying home and not working as much, they might pare down their purchasing. Yes, one might expect that……if money wasn’t falling into their laps from mailboxes across the land. Suppose you are at a cash auction with 49 other people and that each of you has brought $10,000 to spend --- $500k in total. The most the goods being sold can fetch is $500,000. Now suppose, someone flits through the room, handing another $10k to each of you. What do you think will happen to the prices the auctioned goods will obtain?

So now, price inflation is galloping to catch up to monetary inflation and the Bank of Canada wants to do something about it. It’s the same story in the USA with the American counterpart of the Bank of Canada --- the Federal Reserve. Both central banks are now set on raising interest rates. But when price inflation is running at historic highs (if you adjust for the changes made to how the CPI is calculated), even a fairly large increase in interest rates will still leave real interest rates negative. That means lower than the inflation rate. So the central banks are raising rates modestly to encourage people to save. Somehow, people should be motivated by a negative yield.

Paul Volker stifled inflation 40 years ago by raising interest rates to 20%. I remember a forecaster named Morgan Maxfield predicting those 20% interest rates, and then Maxfield was killed in a plane crash. Will interest rates go up again to 20%?  I don’t see how. The difference between 40 years ago and now is that back then, government debt tended to be 30 year T-Bonds. Now a huge portion of it is one year T-Bills. Back then, mortgages tended to bear fixed interest rates, but now many have variable rates. Raising interest rates to a point where they would actually bring price inflation back into line (by inducing people to save rather than spend, thereby slowing the velocity of money) would bankrupt governments and render a huge portion of homeowners insolvent.

I think we are in for a long period of price inflation. If we enter into an economic depression, which could easily happen, demand might drop enough to bring prices down, or maybe it would be an inflationary depression. It will be interesting to see what happens.