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How conflict in Ukraine could impact inflation in the US and Europe?

Less than 24h ago, Russia’s armed forces entered the territory of Ukraine.

Our thoughts go out to our teammates in Ukraine, who are talented developers and seemingly unbreakable people, always looking at the bright side. A few days ago, they were telling us that the western media exaggerate the conflict. It must have seemed that way when living with this looming threat and occasional annexations for years.

Ukrainians are the first in line directly affected by this conflict, but the repercussions are already spreading globally, affecting the oil and energy prices midst the highest inflation in decades, the all-time-high global debt, and post-pandemic supply chains congestion. They could translate to ever-higher inflation, recession, and according to some, eventual loss of the reserve currency status by the US.

The EU depends on Russia’s natural gas.

Europe, which is now forced to introduce sanctions against Russia, found itself dependent on Russia's natural gas after phasing out nuclear plants and experiencing poor performance from wind farms this year.

Throughout the winter, the situation deteriorated across Europe, hiking prices of oil, gas, energy, and even fertilizer, with many greenhouses shutting down their food production and the fears of impending shortages and rising food prices.

With the invasion exacerbating the ongoing energy crisis and related inflation, the EU now faces a choice: to impose sanctions that are not severe enough for Russia to care, or ones that will hurt Europeans worse than they hurt Kremlin.

The USA is experiencing an oil price shock.

The invasion immediately affected the USA as well, when the price of oil increased to $100 per barrel.

This is likely to pile onto already 40-year high US inflation, as President Biden warned the public ahead of the attack.

“I will not pretend this will be painless. There could be impact on our energy prices, so we are taking active steps to alleviate the pressure on our own energy markets and offset raising prices.” — President Biden about the potential Ukraine invasion, source: NBCNews.

Historically, oil prices and inflation rates have been eerily correlated due to the oil’s effect on both production and transportation cost. The US is considering releasing some of its petroleum stockpiles to mitigate prices. However, the latest November release lowered prices for December, but the oil bounced back in January.

The Fed might need to choose: Inflation or Recession

According to Von Mises Institute and Peter Schiff, the Federal Reserve was already facing an impossible choice whether to raise interest rates at the level that could actually curb inflation and cause a recession, the likes of which we haven’t seen since the Great Depression 1929–1930 or to let inflation run rampant. At this level of debt and inflated stock bubble, serious rate hikes could cause a market crash at the least.

Now that the geopolitical situation became unstable, the Federal Reserve might have gotten the excuse it needed not to go ahead with a more stringent fiscal policy. On the news about Ukraine, the markets lowered their expectation of potential interest rate hikes for the March FOMC meeting.

Conflicts legitimize more spending.

In today’s newsletter, Robert Reich, American economist and the former Secretary of Labor for the Clinton Administration mentioned the conflict’s potential effects on the US national debt, which only recently passed an ominous milestone of $30Trillion and continues to run on deficits.

“Wars and the threat of wars also legitimize huge military expenditures and giant military bureaucracies.” — said Reich.

Monetarists point to the national spending and credit issuance that add to the overall money supply as a main driver of inflation. For example, according to the Monetarist view, current inflation is a result of an additional >40% money supply created in 2020 to prop up the economy during the pandemic.

The increasing debt also gives the Federal Reserve less room to raise interest rates to tackle inflation without toppling the economy. Although, that ship might have sailed a few trillion ago.

The USD Global Reserve Status is Not Eternal

If the scenarios by the Austrian and Monetarist economists come to pass, it could lead to the US dollar losing its Global Reserve Currency status, which is a source of the US political influence and its ability to run a highly indebted economy.

In 2021, Central Banks held only 59% of their reserves in USD, the lowest amount in 25 years. China and Russia also continue to lower their exposure to USD, preferring to stockpile gold reserves and other value assets.

Source: IMF

In his recent newsletter and podcast, tech entrepreneur and crypto investor Anthony Pompliano said:

“We should continue to optimize for the production and distribution of the global reserve currency. There is safety and stability when you occupy that position. But we must also begin to hedge ourselves. It is time for insurance. Even if our leadership believes there is an incredibly small percentage chance that the US dollar may not be the global reserve currency in 50 years, we should position ourselves to be a leader in that small possibility.” — Anthony Pompliano, source.

Russia is hedged against issues the US is facing.

  • Russia is energetically independent, the 3rd largest exporter of crude oil, accounting for 10–12% of global supply, and the second-largest exporter of natural gas, providing for over 41% of European demand.
  • Russia has large reserves of gold, nearly 2300 tonnes and 7500 tonnes of unmined, which means they could increase gold supply to lower its global prices to further derail the US in case of a crisis.
  • Russia might issue a government-controlled, gold-backed digital currency and has been open to using cryptocurrencies in the past to circumvent previous EU and US sanctions.
  • Russia is one of the least indebted countries in the world. It doesn’t hold much in foreign currency reserves and has low exposure to the US dollar.

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About Truflation

Truflation is an independent daily inflation index offered on-chain via the Chainlink marketplace and available to smart contracts on various blockchains and layer 2applications. It takes the official Consumer Price Index calculation model and substitutes outdated, black-box survey data with current market price data from various data providers and aggregators.



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