Despite the COVID pandemic, the ongoing Russian military assault on Ukraine could go down in history as the first major exogenous economic shock of the 21st century. Of course, one must heed the warnings against “making predictions, especially about the future” – a quip attributed to Mark Twain, physicist Niels Bohr and the great Yogi Berra of the Yankees. When the dust settles, things may not be as bad as many of us now fear.
Yet two weeks later, we are in a phase where the news is getting darker every day. The deaths of Ukrainians and the destruction of their property are getting worse, international outrage is growing. The attacking Russians and their enigmatic leader sink deeper into a hole of global political and economic isolation and grow more earthy. This could soon reverse or worsen exponentially in any way possible.
Yet regardless, a lot of damage is already done. As with all exogenous shocks, this damage will reverberate through the global economy over a long period of time. Effects may extend to Wayzata and Inver Grove Heights and will manifest in rural Minnesota from Worthington to Elbow Lake and beyond.
For economists, an “exogenous shock” is an external physical or political event outside of ongoing economic interactions themselves that suddenly alters the conditions under which economic production and consumption take place. Think typhoons, volcanic eruptions, pandemics and wars.
The effects of such shocks can be local: the 1900 tide that leveled Galveston, Texas, for example. They can be national, like the Fukushima earthquake-tsunami-nuclear meltdown in Japan in 2011 that greatly affected that country but did little globally. They can be global and long-lasting: the assassination of an Austrian archduke in June 1914 triggered the First World War, the consequences of which directly caused the most important economic and political events of the last century – and greatly influenced the social pact modern we live in. under today.
There are immediate international economic effects of a sudden and violent war in a major market region, such as Russia’s invasion of Ukraine. Other effects appear in the longer term. Some will become permanent. Immediate changes will include movements in commodity markets, particularly food and energy prices, and in financial markets.
The effects on the food sector will be the fastest and most widespread for Minnesota, affecting all farmers and all consumers. So let’s start with these.
Ukraine, as has long been historically true, is not only a major grain producer, but also a major exporter. As for North Dakota and Kansas, “grains” once meant only wheat, but now includes corn and soybeans.
150 years ago, Odessa on the Black Sea was already one of the largest wheat handling ports in the world and today is important for all three grains. It is on the strip of coast connecting Ukraine to Crimea now controlled by Russia, precisely the key area that Russian President Vladimir Putin wants to control and has already seized. Don’t expect normal shipping operations there for an extended period of time.
Grain markets are very efficient and everywhere prices react quickly to events. Corn prices in rural Minnesota rose 10% last week. This is true all over the world, including Brazil, Argentina and South Africa, which are also major exporters. This is also true for China, a much larger producer, second only to the United States, but also the world’s largest importer.
Ukraine, with 30 million tons per year, is sixth in world corn production, but it is only a 12th of that of our country and less than 3% of world production. Yet, price changes can be large because the production and consumption of all crops and food items are “inelastic”, meaning that even small changes in quantity can lead to large price changes.
Ukraine’s wheat production, ninth in the world, is slightly lower, around 28 million tonnes per year and 3.8% of world production. This represents half of Russian production and about 60% of American production. It’s smaller than Pakistan and barely bigger than Germany. But three major producers, China, India and Pakistan, which produce a third of all the world’s wheat and consume even more of it, are all large net importers of wheat. Thus, Ukraine’s exports are always a factor in world prices. And, to the extent that economic sanctions against Russia affect its international agricultural exports, the effects of the war will be even greater. To this extent, both producers are currently out of the world market.
On the soybean markets, the 4 million tonnes of Ukraine, eighth, represent just over 1% of world production. The soybean market is already skewed because Brazil and the United States together harvest some 70% of the world total. So expect the effect of the war on soybean prices to be less volatile than even that of the weather at these two giant growers.
These differential effects on the main cereals mean that the magnitude of the price impacts will not be the same on all farms. Larger price increases for corn than for soybeans will mean that, even at this late date, some planted acres will switch from soybeans to corn. This will mean a scramble on farms and among input suppliers. Seeds are largely already purchased and delivered, but growers will still make changes at the margin. Fertilizer requirements differ. In Minnesota, tillage will usually start in a month and corn planting around April 20, so things will be hectic. Southern hemisphere producers – now entering their fall – will have several months to adjust to changing military and political events.
For consumers, higher wheat prices mean more expensive flour and, by extension, higher prices on supermarket bread, pasta and baked goods. Rising corn and soybean prices will, over time, affect all meats, eggs and dairy products. How much we don’t know. Other factors remain at play in markets for animal products. But all this will certainly not help reduce inflation as a US political problem.
Minnesota-based grain companies such as Cargill and CHS may suffer war damage and will certainly have reduced volume, but they are well capitalized and likely well insured. In either case, the facilities in Ukraine represent only a fraction of the holdings worldwide. Neither is publicly traded, so don’t expect any news of their stock price volatility.
For most people, the possible impacts on financial markets, pension fund values, interest rates and even house prices may prove to be far more significant than hamburger fixations. But these are very hazy so far. We are in a new world of international financial interdependence and the monetary and debt sanctions imposed on Russia have yet to come into play.
The outbreak of World War I shut down the London and Paris stock exchanges for months and gave New York a huge boost. The financing needs of this war crippled European economies for decades and caused a huge sell-off of British holdings in American industry and transportation.
What will happen now is unknown, but may be significant, given the difficult conditions in the financial markets already before the invasion of Russia. More generally, expect effects on energy, including gas prices. Trade embargoes and the freezing of Russian bank accounts and international payments are big Pandora’s boxes. These will affect the Russian economy and the daily life of ordinary Russians. But they will inevitably reverberate here, perhaps in unpleasant ways that no one currently foresees. More on all of this later.
St. Paul economist and writer Edward Lotterman can be reached at email@example.com.