Russia attacks Europe with ‘the energy card’, says economist

Simon Johnson, former IMF chief economist and professor at MIT’s Sloan School of Management, joins Yahoo Finance Live to discuss recession risks, Europe’s energy crisis and the Central Bank’s continued rate hike European.

Video transcript

Well, despite better polls for President Biden lately, American voters may remember James Karvell’s famous quote when he went to the polls, saying exactly, it’s the economy, stupid.

Well, people’s extremely high cost of living will no doubt be one of the main drivers heading into November. But is the pessimistic view of the economy exaggerated? Let’s introduce Simon Johnson, former chief economist at the IMF and professor at MIT’s Sloan School of Management.

Simon, it’s good to talk to you today. It sounds like you’re a little more optimistic about the outlook, at least as far as the US economy is concerned.

SIMON JOHNSON: Yes. That’s right, Akiko. I think we are making progress on some really important issues around innovation, job creation and how opportunity is distributed across the country.

These are issues that have really hampered growth for a few decades. And now, partly because of the pandemic, partly because of how people have reacted to this and how they view work now, and also because of recent bipartisan legislation, I think we’re making progress.

So some progress in terms of, as the president said, a more equal recovery, instead of some of the divisiveness that we’ve seen before. But the reality is, as Kevin just pointed out, inflation is still a top concern for many Americans. And we’re still looking at over 8%.

How low do you think that can go? I mean, what do you consider to be the key drivers, or the key levers, outside of monetary policy?

SIMON JOHNSON: Well, when it comes to inflation, Akiko, I think the key question is the global economy and how tight the global economy is or not. And as you know, there’s a lot of talk about a global recession or slowdown. This takes some pressure off the demand.

However, if this slowdown is concentrated in China, if it is accompanied by more supply bottlenecks, it is going to ripple in the other direction. It is therefore a little too early to comment on inflation.

I really don’t think we’ve overheated the economy in general. I think a lot of the reactions from central banks have been a bit over the top. And I think that will become clear over the next three to six to nine months.

In Europe, certainly, many people also see energy prices rising. Certainly, concerned about how things might look in the winter during these critical months.

We saw the ECB raise rates today by 75 basis points. I mean, how do you see all of this unfolding, especially considering that a lot of this has been driven by what’s going on between Russia and Ukraine and there’s no solution in sight.

SIMON JOHNSON: Well, that’s right, Akiko. Russia attacks Europe. There is no other way to say it. Ukraine is on this perimeter which is under attack.

But if you listen to what Mr. Putin and his spokesmen are saying, they have much more expansionist aims. It’s destabilizing. And they want to play the energy card, which obviously they’ve built a real deadly grip, or a hard grip, on Europe’s throat through natural gas and to some extent oil as well.

And they are determined to use it. It’s going to be difficult for Europe, the European Union and other European countries, over the next year. But they’re going to have to get rid of the Russian energy because they can’t live with Putin holding a dagger to their heart.

The European economy will therefore, I think, slow down for these reasons. Yes, it is some inflationary pressure. Most of this pressure on energy prices through gas is felt in Europe.

What happens to oil, of course, matters to the global economy and to the United States. And that’s why the G7 is proposing a Russian oil price cap, which I think will come into effect in early December.

Yeah. How effective do you think this price cap can be? We are talking about the G7 countries that have already imposed quite strict sanctions on Russia. There are still two big outliers in China as well as in India.

SIMON JOHNSON: It’s true. These are the key questions, how China and India will react to the price cap. But the G7 and its friends and allies, obviously the Europeans, South Korea and Japan, have the ability to set a differential price for Russia.

Russia already receives a significantly lower price for its Ural-grade oil than Brent, for example. So that increases that discount. It is certainly doable. Details and implementation are being worked out. And they have a few months to do it.

Whether China and India will want to pay more than the going price for Russian oil remains to be seen. Well, they can if they want. I don’t know why they would want to do that. They usually don’t do that. They usually pay the market rate.

And the G7 has the purchasing power to introduce this differential discount on Russian oil. So I think the outlook here is quite promising.

What do you think is the only risk when we talk about risks to the global economy that the market overlooks? I mean, we’ve addressed some of the key issues.

We talked about what is happening in China with the Zero-COVID policy, in Europe, here in the United States as well. But what do you think we may be missing here in terms of significant risk?

SIMON JOHNSON: Well, I think the risk is that the Europeans will capitulate to Putin. Now, they obviously won’t like it if I say that. They say that’s not what they do.

But if you look at how they implemented some of their sanctions, for example, the fourth sanctions package that came into effect in May and June, it was really weak, Akiko.

And they had a lot of exemptions. They allowed the Greek shipping companies to do whatever they wanted. They also left a lot of leeway to British insurance companies.

So I think there’s still potential for a lot of downside. Now, it would be, I think, in the medium term, quite self-destructive for Europe to do that. Putin is not just going to take over part of eastern Ukraine or even all of Ukraine.

There is a fundamental threat to European security and prosperity, and therefore to the world. If the Europeans really work together, and I think price caps are their next opportunity to do so, Putin can be stopped.

If the Europeans crack, and if they play against each other, or if they put money above safety, then we have another order of problem.

Well, Simon Johnson, good to have you today, former chief economist at the IMF and professor at the MIT Sloan School of Management.