The War in Ukraine—The Impact on U.S. Inflation
Tony Roth, Chief Investment Officer, Wilmington Trust Investment Advisors
Benjamin Jensen, PhD, Senior Fellow, Future War, Gaming, and Strategy, and International Security Program, Center for Strategic & International Studies
TONY ROTH: This is Tony Roth and welcome to Capital Considerations. Probably more than anything else this year in this crazy world that we’re living in, the war in Ukraine has driven the global economy and the markets. The devastation has been just absolutely heart-wrenching and the ongoing potential for further disruption in the economy is pretty significant. his is a conversation that I think that it’s just so relevant to what we’re living right now. And what we’re going to talk about today is what are the potential outcomes for the war, where do we see it going in light of a lot of different factors, the military factor first and foremost, but also the actual objectives and balance of power and geopolitical issues or vectors, if you will, that are all working on this situation.
So, with us today is Dr. Benjamin Jensen, Senior Fellow for Future War Gaming and Strategy in the International Security Program at the Center for Strategic and International Studies.
He’s also Professor of Strategic Studies at the Marine Corps University School of Advanced War Fighting. Dr. Jensen has spent the last decade studying the changing character of war, working alongside various governments and agencies across our government to develop war games and scenario-driven military exercises. He is the author of four books on military strategy and armed conflict. He’s also a reserve officer in the US Army. So, I want to start by thanking you, Dr. Benjamin Jensen, for your service to the country and thank you so much for being here.
BENJAMIN JENSEN: Well, thank you and your listeners for paying taxes and voting. That’s a two-way street.
TONY ROTH: So, as I said at the outset, this is critical on so many levels and I want to just frame things up from an economic standpoint and make it really clear why this is so important to us as investors.
We have inflation and largely speaking the inflation was the result of a lot of fiscal stimulus and a lot of, I’m going to call it, over-focus on goods consumption when we were locked down, we couldn’t do anything else, and it really took a hit on the manufacturing base of the world. And so, it’s what I’m going to describe as primarily demand driven inflation. On top of that, we now have some supply-chain problems that risk to be very persistent. But now we’ve got another supply chain problem around energy, which is coming from the situation in Russia and Ukraine.
And so, depending on where this war goes, if it further pushes the price of global energy upwards, then that’s got a real impact on inflation. And, frankly, as the Fed works to try to address the demand driven inflation, by raising rates, they can largely be successful with that, and demand driven inflation is also largely self-correcting through demand destruction as prices go up. But they can’t do much about supply.
So, we’ve got to understand, right. It’s just so important. We’ve got to understand what’s going on in Russia and what are the likely outcomes, what maybe is our base case scenario for what’s going to happen with the war and how that may impact global energy supply.
We’re going to evaluate the military balance between the two sides in this conflict. And then, we’re going to go and we’re going to pivot in the second half of the conversation, which is really the part that’s going to be the most critical. And we’re going to talk about the strategic objectives and the ultimate outcomes. And the military balance is just one factor, right? There’s so many other things that are going on here that impact how this turns out.
So, Dr. Jensen, everyone thought going into this – and I’m one of them just through my own layperson’s assumption, frankly; it was really sheer ignorance – that we’d get into this war, and it wouldn’t even be a war. It would just be sort of a walkover, right? And this was sort of the stage one of the war where the Russians, you know, jumped in and it was going to be lightning-fast, quick-footed, just take over the country, the Ukrainians were going to capitulate. That’s not what happened. So, tell us about the actual military capabilities on both sides that prevented that outcome.
BENJAMIN JENSEN: First let me start by saying one of the challenges you have in analyzing war, just like you have if you had to develop an analysis of a company to invest in, are intangibles. And the key intangible in war sometimes is human will, right? So, you can count tanks, just like you can count supply inventories, that you can count personnel, just like you can count soldiers. But there’s a certain coefficient that you have to multiply by the size of the force with the will to fight and also the overall competency. Human capital I think is a common term that cuts across both military practice and business practices.
So, I think the first thing that most people discounted was the will to fight and human capital, because it’s so hard to quantify. It’s not that there wasn’t a tremendous amount of time and energy spent, invested in analyzing both the Russian order of battle, the Russian military, less in the Ukrainian of battle, the Ukrainian military. But because it’s easy, we default to counting tanks, counting planes, counting missiles, never bothering to see that that coefficient of human capital multiplied by the number really produces your aggregate combat output.
TONY ROTH: So, to that point, when we started this, the broad numbers just seemed to be overwhelming. I mean 10,000 to 12,000 Russian tanks. I don’t know what the numbers were from a troop standpoint. But, you know, suited up and ready to go. Were they that unwilling to fight or were the Russian tanks that decrepit? I mean what happened?
BENJAMIN JENSEN: Yeah. So, let’s unpack that coefficient and talk about how a number like 1,000 becomes 10. You know, so, one of the things I … first is, remember, the troops that were mobilized along the Ukrainian border were subject to what’s called an extended mobilization from the large-scale Russian exercise called Zapad. So, every year Russia got very good at doing these large-scale mobilization exercises and moving from military to strategic has a strategic signaling mechanism designed to keep us and other NATO countries guessing. Wow. Russia can move 200,000 people within a month to a border. That’s really scary, right?
Well, it turns out they spent all their time practicing mobilizing and not practicing fighting, because there’s an opportunity cost to time. If I’m doing one, I can’t necessarily be doing the other. And what that meant is they were very good at moving forces into position, but they didn’t necessarily have the type of intense, realistic combat training built-in and they also didn’t, almost like a management structure, build in a role for noncommissioned officers and junior officers to take initiative, to see a problem and solve it at the lowest level, which meant for like a comparison back to a C-suite, it’d be as if the CEO or the COO had to make every decision to and including when to load toner into a printer. It would paralyze any organization.
So, you have this combination of they practiced mobilizing, but they didn’t necessarily build the organizational structure for detailed initiative at echelon is the military term for it. How do you have small unit tactics that take advantage of the situation? And then, contextually, what they had done in Ukraine is they basically left their troops in the field, in some cases for as long as six months.
Remember being young, right? You’re 18-19-years-old. You don’t really know what you’re doing. And now, you’ve been living in a tent with other stinky guys for six months, probably fighting over cigarettes and homemade vodka, not allowed to use your phone, talk to your loved ones, talk to your sweetheart, 
and you’re pissed. Your morale, morale is one of those, the morale is to the physical as three to one, as Napoleon said, starts to really decline. So that gives you the two ways that coefficient turns a large number actually into a smaller number of combat power.
Structurally and organizationally, they weren’t training for the right thing. And then also, at just the very human level, they don’t have a lot of trust in there. They were also angry. There was low morale. So then, when it’s time to actually cross the border, you can overwhelm, and it was in many cases a ten to one combat ratio, but it didn’t matter because now you’re attacking people who are fighting for their country and are fighting to win. So, it’s that morale and the physical kind of coming together with bad organizational practices.
And we can break that down more detailed. I just think it’s important to establish that conceptual reason of why numbers can be misleading.
TONY ROTH: As investors, the environment’s always changing in ways that we don’t expect. You know, for example, a war breaks out in Eastern Europe.
BENJAMIN JENSEN: Yeah.
TONY ROTH: Right? But what we do is we course correct, and we say, gee, maybe we should increase our investment in deep value energy stocks or materials, for example. Okay. So, how have the Russians course-corrected? Do you think that they are improving their situation, or do you think that they’re actually so far behind the curve that the stress of the conflict is actually causing net further deterioration in their fighting capacity? How is it evolving?
BENJAMIN JENSEN: So, first, let me just give you a quick summary of what Russia has to adapt with, right? Because you’re right. When you want to alter your portfolio balance or switch the either time horizon or composition of investments in relation to different sectors. The key thing you have to have as an investor is the capital to do that, right, or at least a line of capital to do that.
The only line of capital Russia has is energy sales and those don’t automatically transfer overnight. It’s not like I get one ruble of, you know, oil sales and it automatically becomes one ruble of combat power. It takes time to move through their industrial base, to build new equipment.
So, the only thing they really have to adapt with at this point are fires assets and nuclear weapons, which should actually cause people to be a little concerned. When I saw fires assets, I mean artillery, missile barrages, ground launched missile barrages, and ballistic missiles that are non-nuclear. And while their inventories are starting to run low on those, you don’t need to use high concentrations to just keep friction and tension up on a notional line of contact.
So, and you saw this, right? So, Russia’s first gamble, Russia’s first investment concept here and a bid for victory was if I have a lightning-fast invasion after a prolonged mobilization, the shock of it will cause the Ukrainian political establishment and military and population to say we don’t want to fight. That’s why you only saw 45-minutes of what are called joint shaping fires. Usually in US military planning, we would have weeks of long-range missile and airstrikes that actually wore the enemy down before we went in.
And that didn’t work, right? They did that. The Ukrainians fought. And so, they thought, well, I can just mass my way through. That was this huge 70-mile long, 70-kilometer-long column of tanks just trying to force its way into Kyiv and dying in a series of ambushes.
TONY ROTH: That was sort of what we thought of as the second stage of this war. First stage was the lightning-quick attack, capitulation. Didn’t work. So then, they went after Kyiv, right?
BENJAMIN JENSEN: Yeah.
TONY ROTH: With just mass numbers and, you know, the 70-mile convoy.
BENJAMIN JENSEN: And that didn’t work.
TONY ROTH: And that didn’t work.
BENJAMIN JENSEN: So now, the third pivot was they regrouped their forces in the east and they were going to try for a more limited objective of consolidating a land corridor to Crimea as well as securing the industrial heartland of the Luhansk and Donetsk. And, frankly, there it’s mixed results so far. They have finally, it looks like, taken over Mariupol. But it’s, you know, taking over a basically destroyed massive industrial area. And now, they’re trying to concentrate in the Donbas.
But I am highly suspect that they’ll be able to achieve a meaningful breakthrough, because they just, they have chewed up the majority of their combat-ready forces. Russia organizes by combat-ready tiers. And so, even though you’ll see sheets, again be weary of numbers that say, oh, a 900,000-person land force. Well, they only had 200,000 of those were combat-ready and they’ve had to pull additional forces in, forced conscription. They’re doing everything they can to keep up the land combat pressure and it’s just not working to make any large-scale gains.
TONY ROTH: I mean in order for them to improve the overall fighting capacity, as you’ve described it, number one, they actually have to be trained and have to be strategic on a level that they have not been. They have not been really set up to fight. They’ve been set up to mobilize and sort of overwhelm it sounds like, right?
BENJAMIN JENSEN: Yes. That’s very well said.
TONY ROTH: And how surprising was that? They were engaged in Syria, Afghanistan. I mean didn’t it seem as though they knew how to fight, they knew how to actually run a conflict on the ground?
BENJAMIN JENSEN: Well, again, the Afghan material is so dated that really most of your senior leaders might’ve had one time there as a platoon leader, if any time. And the Syria experience is very different. I think the hallmark military experience for them would be Chechnya actually, where a lot of the senior Russian officers fought. And if you look at how they fought in Chechnya, there are some similarities to the Russian playbook.
They are overconfident and mobilize and pour forces in to try to shock the system. They get decisively beaten and then they regroup and basically lay siege in a way that has no respect for property, human rights, or even anything, just lay waste, 21st century siege warfare. And that’s what they did after they regrouped in Grozny and that’s essentially what they’re trying to do on the eastern front.
That means they might be pulling their scheme of maneuver back from an encirclement or pocket warfare or also the old German term is Kesselschlacht, a cauldron battle, fire cauldron, which is also the heart of blitzkrieg, the idea to try to constantly encircle your enemy and force them to surrender or face annihilation. They don’t even have the position to do that in the east anymore. So, I think you’re just going to see artillery duels, massive shelling, and then a series of probing attacks to see if they can get lucky, because the longer this goes on, they didn’t have high will and morale to begin with. You have increased reports of Russian units refusing to fight.
Don’t forget, there’s still more Russians arrested for protesting than have been killed on the battlefield. So, you also have a war at home, even though the repressive state has proven able to lock people up faster than they can convince their friend to protest. It’s just creating a two-front dilemma for them. At the strategic level, how long can they prosecute a war even though they have cash flow coming in from hydrocarbon sales? And then, at the operational level, how much of their military are they willing to sacrifice for uncertain gains?
TONY ROTH: So, let’s talk about the other side, Ukraine. My impression is that Ukraine has the will. They have the edge in that it’s always easier to be defensive than offensive, although now that may be changing if they want to push the Russians out. But that in and of itself is a victory to even have that conversation.
And so, really their equipment and their capability is one that’s being built on the fly as a result of the inflow of weaponry from the West, not just the US but really the entire West. So, where do they stand today, given all of those dynamics?
BENJAMIN JENSEN: So, here is actually an interesting data point. I’m not sure we know. We can get a sense from all of the open-source intelligence, the aggregation, the analysis, which is happening often in real-time and reflective of modern society. I mean even using things like fire detection satellites to determine the front line. I mean it’s nothing short of amazing the type of data that’s being aggregated by civilian watchers of this war.
But what we don’t know, because the Ukrainians have been very careful not to report this and no one’s calling them on it, is actually the depth of their own casualties. And they don’t have an infinite number of people to fight. Clearly, they are not as high as the Russians and clearly the will to fight is there. I think one blind spot we have is actually their casualties and attrition.
Now, in the one sense, as long as we actually are emptying out magazines and inventories to keep the Ukrainians in the fight, that doesn’t matter for the next two-three months. But if this lasts up to a year, that could be a real issue. And I want to highlight this in a really specific way with a historical example and its contemporary parallel.
We forget that during the 1973 war in Israel, the Yom Kippur War, that the Israelis, one of the things that kept them in the fight was exactly what the US is doing with Ukraine now it did in a major operation to Israel, airlifting large stockpiles of weapons from Europe to Israel to help sustain that campaign. Well, after the war this caused a massive panic across the US military, because we realized, one, that inventory management in military art is really hard.
Wars aren’t frequent, thankfully. So, you always are struggling to know, well, how many missiles do I need in a magazine? How many should the industrial base be able to produce? And those are all really difficult calculations. And what historically happens, it happened in ’73, it’s happening in this war, is we underestimate the amount of carnage and the amount of munitions required to achieve a battlefield success.
And so, the longer this war goes on, even though we sent the equipment the Ukrainians need, we are actually going to run strategic risk for the United States and NATO in terms of our own inventories and our ability to recapitalize our own defense enterprise, much less sustain the Ukrainians could increasingly become taxed.
TONY ROTH: from our standpoint, right, that’s really important because that tells us that it gives us an edge right on our invest, our investing framework and it tells us to go invest in the industrial sector, which includes the defense sector.
Now, what about the Russian Air Force? I find it to be one of the things as a layperson obviously that I find to be very unintuitive is the idea that we can actually get these armaments to the Ukrainians, because I would’ve thought that clearly the Russians would be easily able to control the skies, because America’s not willing to provide planes directly because that would be too much of a direct conflict and risk nuclear war. So, they would dominate the skies and, therefore, be able to bomb any armaments coming into the country. Why is that a naïve or simplified conception?
BENJAMIN JENSEN: Well a lot of people thought that. I tended not to think it only because of the historical example and a contemporary illicit business example. Historically, every time we as a country – Vietnam is a perfect example of this, even Afghanistan – have tried to use aerial interdiction to interdict supply runs from a safe haven, whether it’s in that case North Vietnam, Cambodia, Laos, or Pakistan, one thing you find is that when you have big borders it’s a big sky and you can always decompose the material to move amongst commercial traffic. So, that’s why I also say another parallel is our own war on drugs.
TONY ROTH: So interesting.
BENJAMIN JENSEN: It is extreme – there’s just so many routes and such a big sky, so much terrain you – we tend to think that the supply is coming with something waving weapons convoy in the air and it’s easy to spot.
TONY ROTH: Totally.
BENJAMIN JENSEN: But even if it did do that, you’ve got to detect, and you have to have a targeting cycle that moves from detection to interdiction.
TONY ROTH: So, you know, I guess the answer speaks, what you’re describing is it speaks to the challenge of the mission from the perspective of the Russians, not the inadequacy of their Air Force.
BENJAMIN JENSEN: I do think that if it was a small frontage they were trying to interdict, I think they could do better. The other challenge, though, is the Ukrainians have been extremely creative with some of their surface to air missile defense schemes. And the other challenge you run into is that, you know, I don’t know this, but if you just look at even commercial transponder reporting of the amount of aircraft that are flying around Ukraine, it’s really impossible for me to believe that the Ukrainians aren’t getting past the best intelligence in the world every time a Russian pilot even smokes a cigarette, much less takes off in a fighter jet headed toward Ukraine.
So, I think it’s a combination of intelligence support and then also very creative uses of surface to air and sweeps and CAPs, so fighter sweeps and combat air patrols. So let me give you, it’s a technical example of this. If I don’t turn my radar on, it’s very difficult for you to see a surface to air missile system, right? It’s once it turns the radar on and emits that you can start to get detection.
So, the Ukrainians seem to have been very good about oscillating when they turn on or turn off radars and then also passing information from other people’s sensors so that I can turn the radar on quick and then off or I can vector in or move in a surface to air missile strike from like a Stinger, a handheld device.
TONY ROTH: when you put all that together, do you think that there’s a relative sort of balance just from a military standpoint or is one side, is Russia still clearly dominant just given their sheer numbers? Or do you think that the momentum, just from, again, a sheer military capability standpoint is really increasingly shifting to the Ukrainians? And it just seems to me from reading the news that the latter is the case given morale, given the amount of military equipment coming in, etcetera.
BENJAMIN JENSEN: I would say I think it’s most likely to head towards a stalemate and attrition and that’s actually a scary outcome, because then it starts to test the extent to which Ukrainian creativity and will combines with Western political focus and resource flows, because right now you have two competing war models. Ukrainian creativity plus Western resources against Russia’s willingness to suffer and extract attrition.
Right now, they seem to have turned themselves into parity and the question is three months, six months, like what does it tip and what would be our early indicators it’s going to tip? I have to wonder how long all democratic countries will remain as focused on Ukraine as they are. We’re already entering midterm season in the US. We’re going to have different debates. European elections are going to pull them in different directions. And then, how long will they be willing to keep spending billions of dollars to fight a proxy war essentially against Russia? That is an open political question and war is a continuation of politics by other means.
On the Russian side, we just don’t have good information. It seems increasingly, I mean you’ve had seven oligarchs commit suicide, put it in scare quotes, since the start of this war, most of them in the energy and gas industry. So, it seems like Putin not only has control of his elites, he’s also systematically eliminating those that he maybe thought he couldn’t control.
The latest one, if you haven’t seen the article, the guy oligarch went to a shaman for a hangover. I can’t make this stuff up. And the shaman gave him a hangover cure that accidentally had toad poison. I mean this stuff is surreal.
Will his inner circle stay cohesive or will the West, broadly defined, stay cohesive? Just in terms of game theory models, the more people you’re trying to keep together, the harder it is to maintain cohesion, right?
TONY ROTH: So, we’re now in the second part of this dialogue by necessity. I mean by all accounts this has been a disaster for Putin? We’ll talk more about some of the geopolitical aspects of this in a moment. But what do you think Putin’s objective is at the moment? He’s not going to force out the government of Ukraine. He may be able to knock off Zelensky, you never know. But that doesn’t seem likely. So, he’s got his land bridge more or less. What is his objective at this point from a military standpoint?
BENJAMIN JENSEN: I think that is the open question. He has his land corridor. So now is it just consolidating? Is it tactical consolidation along the front and then stop the special military operation as it’s called? That would seem to be the most prudent course of action, right?
Thucydides reminds us that war is about fear, honor, and interest. So, never underestimate the fragility and delusional pull of the human ego. So, Putin in his case, it’s almost his own ego and sense of what Russia is as an empire that he’s trying to create. And so, at this point, almost consistent with prospect theory, right, that you become more risk acceptant as you’re trying to regain something you’ve lost, it isn’t necessarily going to be rational. In that case, he’s going to be orienting his strategy, which will translate into military objectives, to continuing an attritional struggle until something breaks. Maybe he gets lucky and assassinates Zelensky. Maybe the West gets distracted. Maybe China gets aggressive and pulls some of the attention that way.
He can keep up pressure and wait for an opening and bet that he has more patience than we have cohesion and focus. So, I think that’s really the two kind of polar ends of this. He might not have made up his own mind yet, right? He doesn’t have to.
TONY ROTH: Right. So, in order for him to have that time, the luxury of time, the – he needs to be able to continue to essentially control the narrative within Russia through the perpetuation of I’m just going to say it candidly, you know, lies to the Russian people. I mean the disconnect from reality to reportage is really pretty depressing.
So, do you think that relative to pick a time at the start of the war his grip on the domestic political situation is as strong as ever or do you think that as body bags come back home or as mothers increasingly question where is my son or as inevitably Western perspectives find their way into the country or there’s certainly a, an out-flight of Russian talent a brain drain, going out of the country. So, as all of those forces swirl within Russia, are those just sort of minor eddies on the margin or and he’s got full grasp on the situation? Or does he have only a limited time before ultimately the domestic situation? And also, of course, the GDP situation. They’re in a deep recession and that’s going to last for a long time. What’s your assessment of all that?
BENJAMIN JENSEN: So, I tend to think that he is more insulated from popular protests, meaning he has proven he is willing to exert surveillance and coercion disproportionate to the will of his own citizens to challenge him. And I think there’s a certain disillusionment in society.
One of the reasons Russian propaganda is so successful, and frankly it’s been successful in even corridors in our own country in the United States, is that it plays off skepticism, right? So, what it does is it basically convinces you that everything is a lie. So, why not listen to what I’m saying? It just enhances this inherent skepticism and fear.
And they even have concepts for this they developed under the Soviet Union, right? Reflexive control, active measures. We forget that some of the ridiculous debates in our country like the CIA invented HIV or crack, are functions of KGB propaganda. Like they’ve actually gone and found the article in the 1980s that a KGB operative put into an Indian newspaper to circulate some of this stuff.
So, I mean it is a very powerful tool. And the scary part is in a connected world where we can all share, we almost crowd source our own willingness to be lied to by buying into the skepticism and the moral equivalency and the what about-ism. So, it’s prominent in our country and it’s only going to get worse in the next couple months, in the next two years. And in an authoritarian society, it means that they know they’re being lied to, and they don’t care, because everyone’s lying to them anyway.
So, this could just as likely trigger an in-group/out-group dynamic where I might hate my leader, but I hate you more being from outside my country. Just as much as mothers might cry about their kids fighting, they also might start hating Ukrainians more for killing them.
So, I think it’s very difficult to predict how chaotic that domestic situation could get or if it just is complacent. I think he’s proven capable of controlling elites for now. But we’ll see.
TONY ROTH: Well, if you analogize it to the Soviet Union, what brought down that regime? I mean was it, was the opening only possible because somehow a moderate in Gorbachev came into power and provided that opening and it wasn’t organic through the society and that’s obviously not going to happen here?
BENJAMIN JENSEN: Maybe. It could be a combination of a moderate demographic. That was kind of their Boomer awakening. They didn’t have a summer of love. They had a summer of can I just buy jeans and listen to rock and leave me alone that happened later.
I think from an economic standpoint the unsung hero of the end of the Soviet Union is cheap Saudi oil. So, part of it is they lost their ability to sustain revenue through the machine because of some of the oil price dynamics from the late ‘70s into the early ‘80s, which also not just were a function of the market but also political efforts to open that up. It’s an overdetermined explanation because there’s so many variables you can’t separate them to measure them.
Now the challenge is even if he can hold the political equilibrium and keep throwing forces at Ukraine, to what end? Like what does the objective become and how long can he sustain that? How long? And I think nobody knows.
Right now, the scary thing is – I think I saw a chart. I was talking to the Ukrainian parliamentarian, so it could’ve been biased. He’s made $58 billion in hydrocarbon sales since the start of the Ukrainian conflict. So, he’s still brought in more money than he’s spent on the war.
TONY ROTH: And a lot of that $58 billion was incremental to what he would’ve brought in had the war not occurred due to the price of oil. So what could he do with this money? In other words, how internally complete is the Russian economy and industrial complex? Because if he can’t buy computer chips and he can’t buy advanced technology, can he actually create the armaments he needs to be competitive with these Western Howitzers and so on and so – drones, etcetera?
BENJAMIN JENSEN: Okay. So, Russia can’t import the microchips, but can Kazakhstan, can Brazil?
So, what he ends up doing is have to pay a corruption premium to have someone else smuggle the resources he needs. So, he might pay a little more and have a time lag in terms of the supply chain. But I think he’s going to get the material components he needs. And at some point, China could just decide to openly back him. Thankfully, that hasn’t happened yet.
You know, so I think there’s ways around that. I think the harder part of this is going to be for the Ukrainians is as his own economy shrinks and theirs shrink, they’re reliant upon someone else supplying weapons. But thinking about this in terms of purchasing power parity, right, how much cheaper are the factory workers now who are cranking out Russian munitions? Well, labor costs just dropped quite a bit for them, right? So, it almost like while our labor costs are going up to restock and push weapons to Ukraine, his might actually be going down. And where his costs are going up, not that war is sheerly a function of cost calculations, but I think it’s a good objective way to start looking at it, he will have the ability through other actors to get those component parts.
So, again, all of this trends towards an indeterminate horizon that could be prone to stalemate. He can press this war for a lot longer if he wants to. And he can’t claim strategic victory. I mean it’s the ultimate failure now that Finland and Sweden will join NATO. But he can continue to put the pressure on.
TONY ROTH: And you don’t see ultimately Turkey blocking Finland and Sweden from joining NATO?
BENJAMIN JENSEN: Maybe. But I mean I think that’s a quiet transaction that can be worked out. Whether we believe the headlines and it’s really about PKK activists or it’s really about equipment, money, something. Don’t forget, Erdogan is not in a good domestic situation, either economically or politically. So, he just might be playing a very smart hand in a longer game of poker.
TONY ROTH: So, when you put all this together, what you’re describing ultimately is a likely base case scenario of a slow burn, an ongoing conflict that ultimately the sanctions will not be effective in bringing Putin to his knees. And ultimately the question that we have to ask ourselves is in that scenario is there any reason that the Western European countries would I’m going to use the word prematurely desist from consumption of Russian hydrocarbons and particularly gas, right? Oil’s easy, the Middle Eastern oil that was going to Asia is going to come into Europe. The Russian oil’s going to go to Asia. So that’s going to sort of reach its own equilibrium. But it’s the gas that’s critical. So, in this situation that you’re describing as an outcome, it doesn’t seem that there’s any reason that as long as the Russians don’t use nuclear weapons or chemical weapons that the Western countries can’t wean themself off of gas over a period of years.
BENJAMIN JENSEN: Maybe. But that’s a really hard economic question, right? So, there’s two cost functions at play. One, just as you adequately laid out was how does the industrial supply lines of the gas, transit, produce, consumer realign itself? And that’s going to take months, if not years, in terms of the contracts and then also in terms of the infrastructure.
The second piece of it, though, is when do green sources become economically viable at scale to make a sufficient substitution for clean gas or just gas that’s cleaner than oil? That is really difficult. That’s why you see really smart investors like Bill Gates pouring so much money into alternative nuclear, because they just don’t buy that the cost functions for green energy work out. And part of that’s a storage issue. That’s why you have people like Elon Musk. Tesla isn’t just about Tesla. It’s about getting the price for the lithium battery down enough that you can have cars and that’s why Solar City, I can have a Tesla roof with a Tesla battery that actually that can now power my own closed loop system. So, I think you have really innovative people thinking about this and even in the best case they still see it’s a decade-plus away.
TONY ROTH: So, I want to understand what you’re saying here, Dr. Jensen. This is a really important point to us. Right now, when we look at the cost curve of wind, for example, it’s come down very, very consistently over the last decade, same with solar. Different rates, but the cost curves are very, very low right now. In fact, it’s cheaper to build a solar farm and an energy farm over their useful life for the cost of the energy they provide relative to a gas fired plant, but it takes a much longer time to build those, and they don’t provide a – energy in a reliable way, the way that gas does. So, you need to have a battery complex in order to store the energy so it’s available. Is that what you’re saying?
BENJAMIN JENSEN: That’s absolutely what I’m saying. And the other piece of it is higher voltage transmission lines. So, the entire way energy grids are designed are based upon different projections of energy needs. And this is where, you know, even the most free-market person has to wonder of a role of government as kind of market maker of how do you create that kind of harmony of interests that allow you to rebuild grid infrastructure while taking advantage of those declining cost curves in solar and wind?
And it’s not just about the cost of the energy now. It’s about your ability to predict the cost of it over time and ensure a stable flow. That’s why the storage thing is such a big deal with renewables and how I can put those together.
And, frankly, this is going to be important for Ukraine too, because this war will end and the Ukrainian economy, I mean some of the numbers getting thrown around are something like over $200 billion now in infrastructure loss. You have massive amount of reconstruction that’s going to happen.
So, the smart thing to do would also be as you rebuild a country like Ukraine or help is start experimenting with some of these new grid and infrastructure type investments, as well as weaning Europe off of it. I just think it’s going to take a lot longer to wean Europe off Russian gas than a lot of estimates. Even the Europeans are kind of admitting this. They’re setting aside hundreds of billions of dollars to do it.
TONY ROTH: Right. But the underlying premise that we’ve established I think is that in a slow burn situation, I mean Russia’s already committed atrocities in their, you know, sort of – what’s the term to describe, you know, you sort of wipe everything out in front of you?
BENJAMIN JENSEN: Yeah. Annihilation.
TONY ROTH: Annihilation strategy, okay. And that has not caused them to back away from the consumption of gas. So, again, absent going nuclear, literally not just metaphorically, it seems as though the gas will continue to flow to Eastern Europe. As you pointed out, they’ll get around the ruble issue, you know, having to settle in rubles.
And that’s important because that means from an economic standpoint, back to our original framing, we would expect, and this is probably the summary and takeaway of the conversation that’s so critical. We would expect from a supply chain standpoint to not see the level of disruption to the cost of gas globally that would push us into a recession. And we’ve already talked about crude and why there’s more fungibility there and probably not going to see $150 crude, at least not just due to this particular conflict.
So, that’s important because that suggests to us in a GDP that’s growing at nominally 9% or so, but with inflation coming down, peaking at 8% let’s call it, but coming down measurably going forward, probably ending the year around 4.5% let’s call it conservatively, that there’s plenty of room for economic growth in this economy on a real basis.
BENJAMIN JENSEN: I think in the United States there is. The other intangible is the cascading effects economically from the Russian conflict aren’t just in hydrocarbon pricing. It’s also going to be in very important industrial materials, so aluminum, palladium, some others. And I think the most underappreciated one is really going to be the world is about to enter a food crisis that could produce second and third effects the likes of which I mean it’s hard to imagine.
We forget that the Arab Spring coincided not just with a thirst for freedom but food price inflation. And I know we love to talk about CPI ex-energy and food, which is always silly to me because they’re the two things that everybody needs. I think the food aspect could really cause some disturbances that it’s hard to predict how far they’ll go.
So, while I don’t think it’ll impact US GDP necessarily, but it’s going to create real discontent in the labor markets because if you’re at the lower end, you’re struggling to pay for gas and just like you started, buy groceries, and you’re seeing trend towards unionization that’ll accelerate because of this. So, I think there’s some weird inefficiencies on the horizon.
TONY ROTH: Well, and you make a really important point, which is that the reason that we focus as economists and investors on what we call core inflation and not headline inflation, so it’s all price movements minus energy and food, is because energy and food are very volatile and there could be a big storm. It could be a refiner gets knocked offline due to a hurricane. It could be all kinds of different reasons that are typically very transitory, impermanent that cause greater volatility in headline inflation. So, we focus on the core. This is a very different situation …
BENJAMIN JENSEN: Yes.
TONY ROTH: Potentially. The persistence of the upper pressure on energy prices and potentially food prices may be much greater than anything we’ve seen in the past, which should cause us to be much more worried about headline inflation and set aside these historic notions of core inflation. So, I think that’s a really important point.
This has been an amazing conversation. Let me ask you just one last question, which is know is on a lot of people’s minds and it’s impossible to answer. But we talked about nuclear a few times in this conversation. Do you see any real chance that is Putin going to try to use nuclear in order to draw in other countries because he becomes desperate?
BENJAMIN JENSEN: I don’t think so, but I think my confidence in that prediction will decline the longer the war lasts. And let me just explain what I mean by that. We’re about to release a piece at CSIS called The Coming Storm that’s based upon a series of war games we did with partners in Europe, congressional staffers, and military professionals that really looked at this question of horizontal escalation and vertical escalation. Horizontal, geographic, does the conflict spread outside the Ukrainian borders? Vertical, do you, being to use different instruments, go from conventional to chemical to nuclear, and then how much, a little bit, a lot?
One of the things that series of war games, and then we did a lot of survey experiments in them, so analyzing attitudes towards risk, we found is that the longer the conflict lasts the more risk acceptant actors become. And so that’s why I’m kind of framing it this way. I don’t think there’s any rational incentive to use even a tactical nuclear device. The kind of industry term is dial-a-yield, so much smaller than Hiroshima or Nagasaki, but still a shock value effect to see a mushroom cloud on TV.
I do think though the longer the conflict lasts, given those political uncertainties we talked about and uncertain battlefield gains, the unthinkable becomes thinkable. So, in the next month, no. If this is still going in a year, maybe.
TONY ROTH: So, in other words, we have to be very, very careful because the more it looks as though Putin would need to retreat with his tail between his legs as it were he’s not going to allow that to happen without resorting to something like this. So, we have to make sure that he has a measure of face-saving in this process. We have to be very smart about how, you know, we arm the Ukrainians and how this thing goes.
BENJAMIN JENSEN: Yeah. Fear, honor, and interest. I really find it hard to believe that Putin is going to all of a sudden find some benevolent side. So, when you push a thug into a corner is when they get the most dangerous.
TONY ROTH: Your knowledge here has just been tremendous and it’s such an important conversation. But I think we covered what we wanted to, and I hope that, you know, for the listeners they’ve really gotten that point that as you move towards a stalemate there’s a really good base case type of scenario here where we don’t get the kind of disruption to energy that causes a recession in the US. Maybe Europe, maybe Europe, but not the US is what we’re seeing right now. Not based on this. Of course, lots of other factors at play.
Thank you so much, Dr. Jensen –
BENJAMIN JENSEN: Thank you.
TONY ROTH: – for being with us today. And thank you to the audience. And I encourage everyone to go to wilmingtontrust.com to provide feedback and read and listen to all of our content. Goodbye, everybody.
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