Shock Waves Hit the Global Economy, Posing Grave Risk to Europe
Russia’s invasion of Ukraine and the continuing effects of the pandemic have hobbled countries around the globe, but the relentless series of crises has hit Europe the hardest, causing the steepest jump in energy prices, some of the highest inflation rates and the biggest risk of recession.
The fallout from the war is menacing the continent with what some fear could become its most challenging economic and financial crisis in decades.
While growth is slowing worldwide, “in Europe it’s altogether more serious because it’s driven by a more fundamental deterioration,” said Neil Shearing, group chief economist at Capital Economics. Real incomes and living standards are falling, he added. “Europe and Britain are just worse off.”
Just how steep a challenge was sharply underlined on Thursday. The European Central Bank, which oversees economic policy for the 19 nations that use the euro, took an aggressive step to combat inflation, matching its biggest ever rate increase of three-quarters of a percentage point. At the same time, it acknowledged the severe impact of the energy crisis and issued a dour forecast for growth. “It’s a really dark downside scenario,” Christine Lagarde, the president of the E.C.B., said at a news conference.
On Friday, ministers of the European Union are set to meet to debate a plan to intervene in the energy markets in a bid to tame prices. They will discuss strategies that could include price caps and mandatory cuts in energy usage.
Several countries, including Germany, the region’s largest economy, built up a decades-long dependence on Russian energy. The eightfold increase in natural gas prices since the war began presents a historic threat to Europe’s industrial might, living standards, and social peace and cohesion. Plans for factory closings, rolling blackouts and rationing are being drawn up in case of severe shortages this winter.
The risk of sinking incomes, growing inequality and rising social tensions could lead “not only to a fractured society but a fractured world,” said Ian Goldin, a professor of globalization and development at Oxford University. “We haven’t faced anything like this since the 1970s, and it’s not ending soon.”
Other regions of the world are also being squeezed, although some of the causes — and prospects — differ.
Higher interest rates, which are being deployed aggressively to quell inflation, are trimming consumer spending and growth in the United States. Still, the American labor market remains strong, and the economy is moving forward.
China, a powerful engine of global growth and a major market for European exports like cars, machinery and food, is facing its own set of problems. Beijing’s policy of continuing to freeze all activity during Covid-19 outbreaks has repeatedly paralyzed large swaths of the economy and added to worldwide supply chain disruptions. In the last few weeks alone, dozens of cities and more than 300 million people have been under full or partial lockdowns. Extreme heat and drought have hamstrung hydropower generation, forcing additional factory closings and rolling blackouts.
A troubled real estate market has added to the economic instability in China. Hundreds of thousands of people are refusing to pay their mortgages because they have lost confidence that developers will ever deliver their unfinished housing units. Trade with the rest of the world took a hit in August, and overall economic growth, although likely to outrun rates in the United States and Europe, looks as if it will slip to its slowest pace in a decade this year. The prospect has prompted China’s central bank to cut interest rates in hopes of stimulating the economy.
“The global economy is undoubtedly slowing,” said Gregory Daco, chief economist at the global consulting firm EY- Parthenon, but it’s “happening at different speeds.”
In other parts of the world, countries that are able to supply vital materials and goods — particularly energy producers in the Middle East and North Africa — are seeing windfall gains.
And India and Indonesia are growing at unexpectedly fast paces as domestic demand increases and multinational companies look to vary their supply chains. Vietnam, too, is benefiting as manufacturers switch operations to its shores.
Even so, China, the eurozone and the United States together account for roughly two-thirds of the planet’s economic activity, and if those powerhouses all slow down, it will be hard for any country to remain insulated from the fallout.
Poorer people, who spend much more of their total incomes on food and energy, are being hit hardest.
In Europe, anxiety about frigid living rooms, shuttered production lines and head-spinning energy bills this winter ratcheted up this week after Gazprom, Russia’s state-owned energy company, declared it would not resume the flow of natural gas through its Nord Stream 1 pipeline until Europe lifted Ukraine-related sanctions.
Some European leaders are becoming more confident that Russia’s attempts to use gas exports for leverage will have diminishing returns. European Union nations have been aggressively seeking alternative sources of energy, making progress in reducing their reliance on Russia, while stocking up their reserves to make it through the winter.
But few believe the economy will be spared pain. Daily average electricity prices in Western Europe have reached record levels, according to Rystad Energy, surging past 600 euros ($599) per megawatt-hour in Germany and €700 in France, with peak-hour rates as high as €1,500.
In the Czech Republic, roughly 70,000 angry protesters, many with links to far-right groups, gathered in Wenceslas Square in Prague this past weekend to demonstrate against soaring energy bills.
The German, French and Finnish governments have already stepped in to save domestic power companies from bankruptcy. Even so, Uniper, which is based in Germany and one of Europe’s largest natural gas buyers and suppliers, said last week that it was losing more than €100 million a day because of the rise in prices.
In recent days, Germany, Sweden, France and Britain all announced sweeping billion-dollar relief programs to ease the strain on households and businesses, along with rationing and conservation plans.
The cost of all these measures would be enormous, at a time when government debt levels are already staggering. The worry about perilously high debt prompted the International Monetary Fund this week to issue a proposal to reform the European Union’s framework for government public spending and deficits.
Still, a pitiless and unyielding reality remains: a lack of energy that countries can afford.
At current prices, there is simply not enough to produce the steel, lumber, microchips, glass, cotton, plastic, chemicals and electricity that go into making the food, home heat, garage doors, tampons, bicycles, baby formula, wine glasses and more that consumers want.
The root of the shortage predates the Ukraine war.
Commodity prices started rising in 2020 as countries began emerging from pandemic restrictions, noted Sven Smit, a senior partner at the consulting firm McKinsey & Company. In the United States alone, consumers were, in effect, buying $1 trillion more goods than expected, based on spending patterns before coronavirus hit.
And the sudden switch in spending on products like new kitchen tiles and cars rather than services like restaurant dining and entertainment added to the problem because more energy and materials are needed to make them.
There is a “depleted supply chain,” more than a broken one, Mr. Smit said. “This is a physical crisis rather than a psychological crisis,” which is different from those that most people remember.
In the past, “you got scared of something, you stopped spending, and then you got more comfortable and spending came back,” Mr. Smit said. “That’s not what’s happening right now. To solve this puzzle, we have to restore supply.”
That puzzle is complicated by the need to produce energy that not only is quickly available and affordable, but also won’t aggravate the calamitous climate change already endangering the planet.
Achieving that goal will take years, rather than months.
In the short term, a limit on energy prices could offer struggling households and businesses relief, but economists are concerned that caps blunt the incentive to reduce energy consumption — the chief goal in a world of shortages.
Central banks in the West are expected to keep raising interest rates to make borrowing more expensive and force down inflation. Following the European Central Bank’s decision to increase rates on Thursday, the U.S. Federal Reserve is likely to do the same when it meets this month. The Bank of England has taken a similar position.
The worry is that the vigorous push to bring down prices will plunge economies into recessions. Higher interest rates alone won’t bring down the price of oil and gas — except by crashing economies so much that demand is severely reduced. Many analysts are already predicting a recession in Germany, Italy and the rest of the eurozone before the end of the year. For poor and emerging countries, higher interest rates mean more debt and less money to spend on the most vulnerable.
“I think we’re living through the biggest development disaster in history, with more people being pushed more quickly into dire poverty than has every happened before,” said Mr. Goldin, the Oxford professor. “It’s a particularly perilous time for the world economy.”