Buck: Welcome back to the show everyone. Today my guest on Wealth Formula podcast is Dr. Barry Eichengreen. Dr. Eichengreen is the George C. Pardee and Helen N. Pardee professor of Economics and Political Science at the University of California, Berkeley. He is also the author of In Defense of Public Debt in 2021 and Globalizing Capital: A History of the International Monetary System in 2019. He’s also been named one of the 100 most important public intellectuals by Foreign Policy magazine. Thanks for joining us, Dr. Eichengreen.
Barry: Pleasure to be here. You can call me Barry.
Buck: Okay, Barry. Thank you. I felt like I was in class, so I had to make sure it was okay. First. I did my residency training at UC San Francisco. So not too far away from your institution there. Berkeley. You know, what we’d really like to talk about today is the 900 pound gorilla in the room, specifically with regard to this conflict in Ukraine. I’m curious, have you ever seen economic sanctions like the ones we’re deploying against Russia right now? Is this unparalleled, or have we seen this before?
Barry: Well, economic sanctions have been tried in a variety of times and places, but I don’t think that we’ve seen this kind of comprehensive financial shock and awe sanctioned on a medium sized country like Russia before. So there have been sanctions on Iran, there have been sanctions on North Korea. But the current episode, I think, is exceptional, extraordinary, unprecedented.
Buck: Let me back up and ask the obvious question, like, how does this affect day to day Russian people? We know that there’s some stories about how Putin had been stockpiling some funds in preparation for something like this, but in reality, you can’t really protect the people of Russia from the implications of something like this.
Barry: Right. So it’s certain now that inflation in Russia is going to accelerate. The ruble has lost a third to half of its value on the foreign exchange market. So that will make everything imported more expensive to the extent that it’s still available and domestic substitutes for imported goods more expensive as well. There’s going to be rising unemployment in Russia because a lot of companies that rely on inputs from abroad that utilize machinery purchased abroad are not going to be able to find those spare parts and so forth. Internal Airlines are not going to be able to fly for lack of spare parts. So Russia’s misery index, the combination made up of the combination of inflation and unemployment will go up now quite significantly.
Buck: One of the things that I found curious, Barry, was that amidst these crippling sanctions, there was one thing that really until today was not really restricted, and that was oil exports from Russia, which maybe you could talk a little bit about why that was. And then now maybe the implications of the fact that now there is a sanction against oil exports as well.
Barry: So oil exports are important. Natural gas exports from Russia are important as well, especially to certain Western European countries. So Germany, Italy, Hungary rely heavily on exports of natural gas and oil from Russia. And there’s an element of shooting themselves in the foot economically. If they are those imports, there are circumstances where self inflicted pain is worthwhile. Maybe they should be shooting themselves in the foot economically, given what’s at stake. But their hesitancy, their reluctance is understandable. In the longer term, these supplies are fungible. In other words, they can be rerouted without a lot of consequence for the global economy. So Russia can export energy to China. China can buy it from Russia rather than buying it from the Middle East. And Middle Eastern energy can then go to Western Europe instead. But if you’re going to import liquefied natural gas, you either need a pipeline or you need terminals where the tankers can unload it. And we know that pipelines and terminals are not built in a day.
Buck: Curiously, in the US, the efforts of the last couple of decades of increasing our oil or energy independence has resulted in us being one of the biggest oil producers, if not the biggest oil producer in the world, isn’t that correct?
Barry: Yeah. We also consume. We’re one of the biggest consumers in the world, but we are now, I think, very modest net exporters.
Buck: Does that in a way shield us from some of the implications of the energy issue?
Barry: It very much does. So I think something on the order of two to 3% of US oil imports come from Russia, which is very different from one third to one half in the case of a number of Western European countries. So President Biden’s ban on importing oil from Russia is largely symbolic and symbolism has value here. But it’s the Europeans who are going to really be paying the cost economically. So that’ll be a burden on the European economy. I think they’re at risk of a recession, but more than that, it’s an uneven burden on the members of the European Union. And they’re going to have to set up another fund like they did in response to the pandemic that compensates the countries where the countries that are not hit compensate the countries that are.
Buck: We have been in this country even before this conflict, dealing with the highest levels of inflation that we’ve seen since the 80s, 70s. How does this play out now? Obviously the war, the energy crisis that’s coming out of there. Do you see this just adding on to a situation where we may end up with double digit inflation?
Barry: Well, answering that question requires a bit of a Crystal ball because we don’t know how long the war is going to continue. We don’t know, therefore, for how long energy prices and food prices as well, wheat prices and barley prices will remain high. If this is a temporary phenomenon, then the Fed will just look through it. It will focus on domestic inflation without it looking at what economists call core inflation as opposed to headline inflation. It will look through or strip out increases in energy prices and increases in food prices on the grounds that those increases are temporary. I think that is still the working assumption at the Fed, and that’s what the markets apparently think as well, because they haven’t altered their view of what the Fed is going to do. The Fed is going to proceed with a series of modest measured one quarter of 1% interest rate increases seven times, probably over the remainder of this year in the expectation that inflation will begin to come down later this year and continue to come down towards, say, 3% in 2023 if things get worse on the geopolitical front and energy and commodity prices continue to rise, all bets are off. Nobody knows whether that could happen or not.
Buck: Speaking of inflation, the things that we feel at home a lot of times are reflective in daily activities, like getting some gas in your car and we’re at about $130 a barrel. I don’t know. It seems like where you’re at, it’s always a little bit more expensive than other places in the country, but even down here in Central Coast, it’s five and a quarter per gallon. I’m curious, is some of that Opportunistic for the people selling us the gas because we are a net exporter in energy, as you mentioned earlier, should we be seeing these increases in prices of energy, or is this just an Opportunistic situation? Can you explain that? It seems probably a very basic question, but as an everyday consumer, I wondered that myself. It’s like, well, I thought we were a net exporter and then Russia’s gas oil situation doesn’t really affect us. So why is gas so expensive?
Barry: It’s so expensive because the prices of energy are determined on world markets and not only here at home. So we export natural gas now, but still import Petroleum. And it’s the refined Petroleum that you pump at the gas station. And OPEC and world markets influenced the price of a barrel of oil. Not only how much tracking we do at home
Buck: Well let’s shift a little bit towards global supply change. Is the US going to have to turn away from some of the Eastern hubs for a period of time, or how do you think the supply chain gets affected?
Barry: There are stories already about oil tankers being stranded in the Black Sea and questions about whether Russian tankers that are under sale, as it were, will be able to dock and unload. So it could be that there will be additional supply disruptions affecting the United States as well as other parts of the world. Again, we don’t know how long the conflict will continue, so it’s hard to forecast the economic fallout. You know how China is dealing with this? How is it affecting them? They’ve sort of taken a necessary position of not necessarily condoning Putin, but they certainly have not taken a hard stance away from him. They’re still doing business with Russia. How is China coming out in this?
Barry: Well, China is trying to position itself, I think, as a neutral player, not aligned, if you will. I haven’t seen much of an impact on the Chinese economy. In other words, the annual meetings of the People’s Congress earlier this week, I believe, issued a forecast for economic growth in the coming year of 5.5%, which is down a little bit from the 6% average they were looking at before the Pandemic, but not much. China’s exchange rate hasn’t moved to speak of. Financial markets haven’t moved to speak of. They don’t do much business with Russia. Actually, if you look at it. Their trade is pretty well diversified between the US, Europe, and other parts of the world. So from their point of view, the impact hasn’t been severe. But I emphasize that despite the discomfort we all feel when we go to the grocery store or go to the gas station, the impact here in the United States hasn’t been severe either. Wall street fluctuates, but Wall Street always fluctuates in response to news. So far, the US economy appears to be continuing to do okay.
Buck: We’re not going to war. Presumably war has a different impact on a domestic economy than this kind of, I guess, Cold War sanctions and stuff. What would our involvement in that conflict militarily be, what kind of implications would that have for the domestic economy?
Barry: Our direct involvement in the conflict? You’re asking about Buck? It would have dramatic effects on all aspects of our lives, including the economy. But even without direct involvement, we can already see the writing on the wall in terms of increased defense spending. So we have grown accustomed in the US to talk about the peace dividend and how we could use the money we were saving from reductions in defense spending for infrastructure investment and early childhood education and a variety of other things that are good for people and good for growing the economy as well. And if we have to ramp up defense spending again now because we realize we live in a less safe world, that’s going to make achieving those other economic and social objectives more difficult.
Buck: Yeah, I would think that would be a major issue in Europe as well. Right. You have a bunch of countries who essentially decidedly not spend a whole lot of military spending that are probably starting to think that maybe they might need to, after all.
Barry: Indeed. And in addition, the Europeans are more committed than we are in the United States to what they call the green transition, zero carbon emissions by 2050 and net zero and moving entirely to sustainable energy, that’s going to be more those investments are going to be harder to make if they’re at the same time investing in defense and if they’re at the same time trying to curtail their reliance on Russian natural gas. So in Germany, they had, of course, moved away from nuclear power as unsafe. They now move back. They want to move away from coal as climate unfriendly do. They now move back. They have some difficult choices. We qualitatively have the same choices here, but they had been moving faster in those directions.
Buck: I know you have an interest in economic history as well, and I’m curious, when you look at what’s going on in Russia now and you’re going to have a lot of pain with those people, what can you see historically that can help us perhaps understand Putin’s ability to hold on to power, an authoritarian, perhaps the world hasn’t. I mean, perhaps in modern times, we haven’t quite seen such a powerful authoritarian? I don’t know. But historically, what is this parallel to, if anything?
Barry: Well, let me import a phrase from the literature on financial crises. Great economist Rudy Dornbush described financial crises as always occurring later than you thought. But when they occur, they’re even more violent than you expected. So I think the history of these strong men suggests that they typically hold on to power for longer than you expect. But then when their downfall occurs, it’s swifter than anyone can imagine. So if you look at Nicolau Ceausescu and Romania in the 1980s, he held on for a very long time. He put his people through immense hardship, partly because he saw other countries and other strong men brought down by debt crises. So he tightened the screws. Economically, people starved, but he paid back the debt to Western banks. Then he was ejected from office and hung from a lamppost, literally in 1989. So there are entirely plausible scenarios, hopeful scenarios, where there’s an uprising in Russia against Putin and the people around him. But my guess would be it will take longer to develop than we might wish. But when it comes, it’ll be more violent than we expected.
Buck: Yeah. It’s interesting, though. I’ve thought about this a little bit and understand it contextually that he is so powerful and people have called him some indication that he’s ultimately the wealthiest man in the world. But who’s the power in the Soviet Union, they had the political Bureau, right, and they ultimately had a way of getting rid of the guy, so to speak. In the 80s, it seemed like every once in a while the Soviet premiere would get a cold and they would die a few days later or something like that. And maybe this isn’t really your focus, but I’m curious in terms of understanding, checks and balances in Russia seem very different from even in the Ceausescu era.
Barry: And who might be the checks and balances in Russia, the security service?
Buck: Well, that’s what I’m trying to understand. Who would be the checks and balances now, since in the Soviet Union, it seemed fairly clear there was the party and the party was in charge. But now Putin is the party.
Barry: Right. And Putin comes from the security service, which is on side, as it were, the military. So that’s an interesting question going forward, whether the military will end up being disenchanted with Putin as a result of getting bogged down in Ukraine, whether the powerful industrialists with yachts were in Barcelona, remain loyal to Putin or see the downside of their allegiance.
Buck: They’re not getting to use the yachts.
Barry: Those are the three countervailing forces. I can imagine the oligarchs, the military and the security service. So that doesn’t leave one terribly hopeful.
Buck: I’m just curious what you think is ultimately if you had to predict how’s this going to end up in the Ukraine and Russia, how do you think? Just out of curiosity, I know you’re an economist. But I’m curious what you think is going to happen.
Barry: And I’m not a military specialist either. So like you, I’ve been reading about rushing tanks and trucks getting bogged down in the mud and what kind of tires with what kind of tread they have, how competent or not the Russian air force is, those of us who are not specialists and that are operating in the fog of war. But I think the most plausible scenario is one that for the time being, Ukraine is partitioned, that the legitimate government moves to Lav in the west. It is resupplied from Poland by NATO. It controls significant territory, but only in the west of Ukraine, that some kind of puppet government is installed in Kiev and that the Russian Army controls the Eastern part of the country. So I think that’s likely what the short term future holds and how it plays out after that. I can’t quite see if what I just described is plausible, then that may well restrain Putin’s ambition to do something similar in Moldova or the Baltics or whatever. If he gets bogged down in this way in Ukraine and there is permanent resistance to Russian occupation, then he’ll have his hands full. And that’ll limit his incursions elsewhere.
Buck: Yeah, absolutely not quite Afghanistan, because you’ve got a different terrain, but massively resistant people as an ongoing problem doesn’t seem like very sustainable. The most recent book is In Defense of Public Debt, obviously not about Ukraine, but let’s talk a little bit about that. Tell us what it’s about.
Barry: Yeah. So we started on the book before the Pandemic and obviously before this problem in Ukraine, and we wanted to articulate Mount Defense of Public Debt, really, for two reasons. Number one, the economic and financial situation had changed in ways that the debt and deficit Hawks hadn’t recognized. So interest rates had and have and had come down tremendously. So even when the debt to GDP ratio, debt relative to the size of the economy in the United States had doubled since the turn of the century, the share of GDP we devoted to servicing that debt had fallen because interest rates have come down so grammatically. So we argue that it’s necessary to rethink how much debt is prudent, how much debt is sustainable, how much debt is safe. And number two, the capacity to issue debt is critically important, exceptionally valuable in emergencies. So that was evident in Covet when we issued a lot of additional public debt in order to keep businesses open, food on people’s table, and so forth. Government didn’t have enough tax revenues to do that. So we borrowed and issued debt to meet that kind of public health and economic emergency is a valuable capacity. Last week, the government of Ukraine issued, I believe it was about $280,000,000 worth of new government bonds of public debt to meet its military and economic emergency. And throughout history, we’ve seen governments borrowing in order to defend their borders, fight pandemics, deal with natural disasters. And it’s important, we think, for the critics of government borrowing to see this other side of the coin, if you will.
Buck: I’m curious on your take on this, on modern monetary theory.
Barry: Yeah. So modern monetary theory is a slippery doctrine. It means different things to different people. But it was developed over the last ten years in an environment where there was no inflation by people who basically argued that governments could borrow unlimited amounts and central banks could buy the bonds that those governments issued without causing inflation. And that’s a valid point of view if you’re in this non-inflationary environment in what economists refer to as a liquidity trap, where indeed, central banks can buy bonds hand over fist and issue money and credit without limit. And inflation doesn’t result because the economy is calm. So no sooner did modern monetary theory become fashionable or gather a following than that noninflationary period ended. And now we’re in conditions where their doctrine no longer applies.
Buck: Yeah. And it’s different. Obviously, it’s different from what you’re talking about. But you’re talking about changing the perception of what we think those safe limits of debt are. Not that we should somehow turn debt into something completely defined differently.
Barry: Right. We’re very much of the view that there do exist limits on how much governments can and should borrow, how indebted they should become. And we do believe that there is a time not very far off now where steps need to be taken to repay some of that debt, restore and enhance the government’s ability to borrow because there will be another emergency in South China Sea or some climate related disaster or another novel coronavirus or something that will require that kind of fiscal response by governments.
Buck: Fantastic. Dr. Barry Eichengreen, thank you very much for being on Wealth Formula Podcast today. Your book, again, is In Defense of Public Debt. And if we want to learn more about some of your writings, Where’s the best place to go?
Barry: I have a website at Berkeley Economics Department on the Berkeley Economics Department page.
Buck: Yeah. And that is actually https://eml.berkeley.edu/~eichengr/
Barry: I’m glad one of us remembered that.
Buck: But we’ll also put it in the show notes for people if they want to click on it. Thanks again, Barry. I really appreciate your time and we’d love to have you on again at some point.
Barry: Okay. We’ll do it. Thank you.
Buck: We’ll be right back.