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A key part of Vladimir Putin’s effort to rebuild the Soviet empire is his attack on Western economies. By exploiting Europe’s dependence on Russian oil and gas, Mr. Putin is deploying energy inflation as a weapon. This lets him take advantage of a world economy on the brink of recession. He aims to sap the will of the U.S. and its allies to buttress the Ukrainian resistance. Unless the West takes supply-side measures to combat high energy prices, Mr. Putin could succeed.
Mr. Putin’s ability to finance the war in the face of massive sanctions has been undergirded by cutting natural-gas supplies to Europe and expanding oil exports to China and India. Aided by production cuts by the Organization of the Petroleum Exporting Countries, Russia has enjoyed export profits that are significantly higher since the war began. Mr. Putin may be flailing on the ground, but his economic-warfare strategy remains effective.
The effects of Western sanctions and Russian manipulation of flows of natural gas and oil have turbocharged the price inflation already under way because of expansionary monetary and fiscal policy. Central banks, led by the Federal Reserve, have responded with comprehensive and fast-moving monetary tightening. But European authorities especially are outgunned by inflation, as the European Central Bank’s target rate at 1.5% is no match for headline inflation of 10.7% in the eurozone and even higher in the east.
The combination of higher interest rates and reduced oil and gas supplies in the West could be lethal. Britain is in recession and faces historic political instability. Most European countries are in recession. Germany has thrown all budgetary caution to the wind. France is facing a new round of gilets jaunes protests and union-led actions. Japan has the world’s highest level of debt as a percentage of gross domestic product and can’t deploy fiscal stimulus. The U.S. is may soon be in a recession, and its Treasury market, according to Secretary
Janet Yellen,
is threatened by a “loss of adequate liquidity.”
According to the World Bank, debt distress in low-income countries is at its highest in more than 50 years. China was the global engine of growth after the Great Recession, but it is on the verge of at best lower growth and at worst a financial crisis. In the recent Communist Party Congress,
Xi Jinping
doubled down on the zero-Covid and command-economy policies responsible for the slowdown.
In these circumstances, as former Treasury Secretary
Larry Summers
recently argued, another spike in oil and gas prices represents “a downside wild card . . . both with respect to inflation and with respect to recession.” It is this risk that Mr. Putin is exploiting with his manipulation of oil and gas supplies and threats to escalate the war, including with nuclear weapons. Such threats are weighing on global financial markets, and following through on the threats would raise the chances of a deep recession.
The European Union has announced a firm cutoff of Russian oil and gas imports and is trying to get an agreement among Group of Seven nations and other allies on price caps on these commodities. But the Biden administration wants to keep enough Russian oil on the market to avoid further price increases and is even considering a windfall profits tax on oil and gas companies. Instead of tacitly facilitating the continued flow of Russian oil, the U.S. should step up production and other supply-side measures. The most urgent shift in policy is to encourage production domestically and among reliable partners.
The U.S. could do so by granting financial incentives and issuing the necessary permits. Europe could offset the loss of Russian supplies by supporting the financing and building of infrastructure for more liquefied natural gas imports or pipeline imports from North Africa and Central Asia. The U.K. and Norway could ramp up production of offshore resources. Both the U.S. and EU ought to rethink their tilt toward Iran and find ways to bring Saudi Arabia to a more helpful outlook on oil supplies and prices. Revenues from oil and gas sales now account for about half Russia’s budget, so replacing their exports would make it harder for Mr. Putin to prolong the war.
Second, both the U.S. and Europe need to stimulate the supply side of the economy by reducing regulatory impediments to the private sector. Helpful measures include easing permits for infrastructure and mining development, leasing land for energy development, and reducing antitrust barriers to efficient consolidation of firms.
Third, instead of engaging in autarkic policies to build the technologies of the future and produce the raw materials needed for them through industrial policy, the U.S., EU, Japan, and other allies ought to use comparative advantages to build these technologies. Instead of starting another trade war over domestic content requirements for electric vehicles or subsidizing solar and wind equipment, Western allies should combine efforts to ensure the Russians and their Chinese allies can’t further undermine their economic strength.
These policy shifts are unlikely under the current one-party rule in the U.S., but changes after the November election may open a window to a supply-side course correction. With a brutal war on its doorstep, an economic downturn looming, and a growing recognition of Chinese ambitions to aid Russia, Europe is becoming disposed to a new approach, including openness to producing more oil and gas and nuclear power.
Messrs. Duesterberg and Asher are senior fellows at the Hudson Institute.
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