Balanced unemployment, inflation and GDP growth signify a healthy economy. In America, that balance looks increasingly shaky and puts Egypt’s exports to the United States at risk.
Much like the pandemic accelerated emerging trends in 2020, including hybrid workplaces and reliance on digital communication, the war between Russia and Ukraine is amplifying the economic aftermath of COVID-19.
The most significant fallout from the pandemic is runaway inflation due to product shortages, supply chain bottlenecks, and rising energy prices. Those factors jeopardize economic recoveries worldwide, as importers and exporters lose business due to late deliveries and increase consumer prices to account for spiraling costs. “Mounting inflationary pressures and the lurking specter of recession come as no surprise,” Mahmoud Mohieldin, a World Bank Group senior vice president, wrote in an October op-ed on Ahram Online. “When following current global economic developments … one term that often comes across is stagflation [stagnant GDP growth coupled with inflation].'”
The Russia-Ukraine war further disrupts food and energy supplies from both countries. A Bank of America Securities survey published in April shows GDP growth expectations at their lowest, with 71% of respondents pessimistic. Meanwhile, inflation in the United States continues to rise beyond the Federal Reserve’s 2% benchmark, reaching an annual rate of 6.3 % in April after it reached 8.5% in March, its highest level in 40 years. “Expectations of stagflation have risen to the highest level since August 2008,” noted the bank’s analysis accompanying the survey.
So far, rising prices haven’t hurt U.S. consumption. “Retail sales are roughly 10% above their pre-pandemic level. New home sales are about 6% above their January 2020 level … Low sales as the single biggest concern [for SMEs] has rarely been lower than it is today: 4%,” wrote Neil Dutta of Renaissance Macro Research in a March op-ed for Business Insider. “This current level of growth is simply unsustainable.”
If and when stagflation hits, it could be a significant blow to Egypt’s foreign currency inflows in the long term. According to the Central Bank of Egypt, the United States was Egypt’s biggest non-oil export market in the first quarter of the fiscal year 2021/2022, accounting for over 21.8% of outgoing non-oil goods.
Balancing act
In economic literature, when GDP grows rapidly, unemployment rates drop as companies make more money and expand their operations. As more businesses become more competitive, they give higher wages to attract the best talent. That results in more employees earning higher incomes who can afford more luxury and non-essential goods and services.
That results in rising prices of goods and services to compensate for higher demand and payrolls. Eventually, inflation will become too high, making those non-essential goods and services less affordable, ultimately reducing consumption. That cools GDP growth and could result in slightly higher unemployment.
The cycle repeats itself when prices of luxury and non-essential products and services are low enough to encourage more consumption.
Central banks can exercise control over this cycle by setting inflation rate targets. In Egypt, a fast-growing emerging economy, that target is 9%, plus or minus 2%, while in the United States, an advanced slow-growing economy, the inflation target is 2% or less.
When inflation increases, central banks raise interest rates to maintain those targets — enticing individuals to save. That reduces consumption and, therefore, inflation. The balancing act ensures that interest rates don’t increase too much, making credit to businesses and individuals expensive and causing consumption to dwindle further — leading to a recession.
Worst-case scenario
In 1973 and 1974, the United States saw oil prices rise after GCC countries halted supplies to Europe and America in support of Egypt during the Six-October War with Israel. In addition, then-President Richard Nixon ended price controls on essential food commodities, and extreme weather during those two years reduced crop yields. The Iranian Revolution in 1978-79 further disrupted oil supplies to those advanced economies.
Those food and energy supply shocks caused inflation to rise from 5% in 1972 to 15% by 1980, according to the U.S. Bureau of Labor Statistics. Meanwhile, GDP contracted by up to 4.8% at its worst in 1974. It recovered in subsequent years, but was consistently below its historical averages until 1980.
Economists characterized that period as stagflation. “It happens when there is a so-called negative supply shock,” Veronika Dolar, an economist at SUNY Old Westbury and visiting professor at Stony Brook University, told Yahoo! News in March. “That is when something that is crucial to an entire economy suddenly becomes in short supply or … more expensive.”
“Households feel the sting of a weakening economy … but don’t see the corresponding relief on costs … because shortages or other problems cause businesses to keep their prices high,” said Dutta of Renaissance Macro Research.
As a result, recovering from stagflation is complex. “In this scenario, the tradeoffs are worse than what we’d normally see in a recession, making it tricky to break a streak of stagflation,” said Dutta. Reducing interest rates to spur GDP growth and employment would encourage further spending and inflation. Meanwhile, rising interest rates would further plunge the economy into stagnation or even recession. “This makes a difficult needle to thread for policymakers,” he said.
History repeating
Some experts see the war in Ukraine as a precursor to stagflation in America. “There are enough similarities between our current moment and the 1970s disaster that it’s time to take stagflation seriously,” said Dutta.
Those signs appeared long before the conflict in Ukraine. “The past few months have brought successive price increases in a variety of goods and commodities,” said Mohieldin of the World Bank in his October 2021 op-ed. For example, cotton prices increased 43.9% from July until the war began. Meanwhile, IBISWorld, a market research firm, estimated the cost of semiconductors and electronic components has jumped by nearly 10% in 2022, compared to a fall in prices in 2020. Since rising in 1986, semiconductor prices have increased only three times: 1988, 1989 and 1993, with the highest annual jump less than 2% annually.
One cause of those hikes is that companies limited or halted production throughout 2020 and 2021, in line with lockdown measures. That disrupted the flow of exports, as evidenced by the ongoing global microchip shortage. As a result, cargo spent more time at the docks waiting to be loaded and that ultimately caused logistics bottlenecks, which further delayed deliveries, simultaneously causing inflation and slower sales.
Additionally, government policies contributed to trade disruptions and spiraling global inflation. “It is easy to cast the blame for the problems in supply chains and logistics on COVID-19,” Mohieldin wrote. “This only makes it easier to overlook the protectionist practices that existed before and after the pandemic and that continue to hamper the movement of trade, drive up prices and reduce supply.”
In 2022, the rift between the United States, EU and other rich countries, on the one hand, and Russia will only add to the disruption of the global flow of goods. For example, U.S. sanctions ban the sale of any Russian-made products and the import of oil and natural gas. That could hurt American importers who had business with Russian producers.
Nearly 345 U.S. companies froze business operations in Russia after the conflict started. They operate across numerous sectors, including energy, food, textiles and clothing, banks and entertainment, according to Yale School of Management information updated April 20.
“Firms are cutting ties and, in doing so, earning good press,” Joel Naroff, president and founder of Naroff Economic Advisors, a consulting firm, told the Philadelphia Inquirer in March.
Soon, though, those companies, their suppliers, and supply chains may see revenue shortfalls. A case in point is Shell Oil, which cut all ties with Russia starting in April, including not buying oil or natural gas and pulling out of a joint venture with Gazprom, Russia’s state-owned oil and gas company. Experts told the BBC in April the move could cost Shell $5 billion. “Sometimes, firms slip up and don’t understand … a potential tradeoff between corporate image and the short and long-term financial impact of certain actions,” wrote Naroff.
The conflict also affects exports of food and energy commodities, such as oil, wheat, sunflower oils, and other grains from Ukraine and Russia. That resulted in skyrocketing prices and their biggest importers, including Egypt and Germany, scrambling to find alternative suppliers.
To calm global oil prices, the United States said it would release 180 million barrels from its strategic reserve over six months starting in March. It is the first such move since the reserve’s creation in 1974 — one year after the GCC’s oil embargo to the West ended. The announcement dropped international oil prices from nearly $120 to $93.60 a barrel. At press time, crude oil stood at $103.20 a barrel, up from $90 before the war.
Meanwhile, India, the world’s second-largest wheat producer with exports accounting for 1% of international wheat trade, is looking to replace Ukraine as a global supplier. “We are working with several other ministries … as well as exporters and state governments to increase our wheat exports significantly,” Piyush Goyal, minister for commerce and industry, told the media in April. After the announcement, wheat dropped about 11.7% from its all-time high on March 7. However, the press-time price was still 40.6% higher than before the war.
Those price jumps were happening as the International Monetary Fund (IMF), in April, downgraded its global GDP growth forecasts from 4.4% in 2022 and 3.8% in 2023 to 3.6% for both years. “We are still some ways away from stagflation and are only looking at its early warning signs,” said Mohieldin. “We still have opportunities to avert it.”
What next?
Predicting policies the U.S. Fed might enact to avert stagflation could prove vital, particularly for poor and less developed countries whose macroeconomic policies change with America’s. Egypt, for example, increased interest rates on March 21 by 100 basis points to 9.25%, four days after the Fed raised its interest rates by 25 basis points — doubling it to 0.5%.
That sudden increase was likely a lesson learned from a policy failure in the 1970s. “The Fed left interest rates too low for too long,” said Dutta. “The Fed assumed the U.S. economy could continue to accelerate without triggering runaway price increases … the error was costly: a decade of high inflation.”
Dutta believes the Fed should prioritize bringing down inflation. “The Fed should have the green light to keep hiking interest rates throughout the year … and cool off the economy,” he said. “Doing so should help tamp down inflation but not cause enough harm to the labor market to trigger a recession or inflict undue pain on workers.”
At the start of 2022, the Fed said it plans to increase interest rates several times this year and the next. After Russia invaded Ukraine in late February, the Wall Street Journal reported that unnamed Fed officials predicted interest rates to reach 2% by 2022. Meanwhile, “median projects show the rate rising to around 2.75% by the end of 2023,” noted the publication. That would be its highest since 2008.
In March, Nouriel Roubini, chief economist at Atlas Capital Team, highlighted a possible policy shift in a blog on Project Syndicate. “Governments … under pressure from disgruntled citizens … may be tempted to come to the rescue with price and wage caps and administrative controls to tame inflation,” he said.
However, that solution would likely backfire, plunging the U.S. economy into stagflation territory. “These measures have proved unsuccessful in the past (causing, for example, rationing) – not least in the stagflationary 1970s — and there is no reason to think that this time would be different,” noted Roubini. “If anything, some governments would make matters … worse by, say, reintroducing automatic indexation mechanisms for salaries and pensions.”
On the other hand, John Williams, president and CEO of the Federal Reserve Bank of New York, said the wave of rising prices and slowing GDP growth rates are temporary. Therefore, overcoming them won’t require significant policy alterations. “It may boost near-term inflation, but household savings and strong economic growth should help limit the damage,” he told Reuters in April.
His confidence stems from Americans receiving three stimulus checks between April 2020 and March 2021, worth a combined $3,200 per person. “The economy is coming into this with a lot of forward momentum,” said Williams. He likened the increase in oil prices to a “tax” on American consumers that limits spending. “But savings accumulated during the pandemic may help offset higher costs,” he added.
That should reduce consumption of non-essentials, dropping their prices, as a more significant portion of households’ budgets goes to pay for basics. “Inflation [should] come down later this year but remain well above the [Federal Reserve’s] 2% target,” he said.
In a February blog on Investopedia, Sean Ross, founder and manager of Free Lances Ltd., a hub for freelance editors, researchers and writers, said the solution that worked in the 1970s was to let stagflation resolve on its own. “Over time, the cost of oil returned to more normal levels, and the economy began to emerge from its slump,” he said.
Partial solutions
However, Roubini said this time “policymakers may [have to] abandon one of their objectives [of meeting inflation, economic growth, interest targets]” in favor of the other two. He added that would work in tandem with strict sanctions on Russia and accommodate a prolonged conflict.
Alternatively, the Fed could “settle for partially achieving each goal, leading to a suboptimal macro output of higher inflation, lower growth, higher long-term rates,” said Roubini. However, that would require “softer sanctions” on Russia, a speedy conclusion to the conflict, and poor stock market performance.
Regardless of the U.S. approach, a paper from Fitch Ratings in April warned that emerging markets “would face the highest risks of negative rating actions.” Middle Eastern and African countries with massive exposure to the United States will have to cope with higher commodity prices and weaker local currencies as America’s economy returns to normal. “In particular, Egyptian and Jordanian banks appear susceptible to rating changes,” said the report.
Mohieldin sees the best way forward for Egypt is for the government to resign itself to a U.S. economy with high prices and depressed GDP growth for the foreseeable future. “Ignoring [a stagflation scenario in America] or making generous assumptions about the corrective capacities of the market is not the way to go about it.”
