Underlying the chaos and conflict of our times — be it war or cataclysmic natural disasters linked to climate change – is the dependence on fossil fuels. Climate change is the consequence of overuse of fossil fuels over centuries. And, the urge to control regions rich in these fossil fuels has been one of the primary drivers of war.
These wars have periodically driven economies the world over into a tailspin of inflation and growth paralysis. What we are going through today is not dissimilar to earlier episodes of war, disruption and inflation, over the last 80-100 years; territorial control over resource rich regions has been a driving force all along.
The fact is that large quantities of fossil fuels are concentrated in tiny geographical pockets. Hence, the urge to control over regions rich in reserves of coal, oil, and natural gas forms the sum and substance of foreign policy worldwide.
Countries neighbouring these prized regions, as well as others, play all sorts of games to grab them — deploying religion, language, alliances to that end. Conflicts also suddenly start when there is a temporary change in the balance of power, breaking the earlier, often fragile, equations of peace.
Historical overview
Control over fossil fuels has historically been a reason for some of the biggest wars. The centenary of the occupation of the Ruhr (1923-1925) falls next year. The Ruhr region spreads around the Rhine River, which borders France and Germany. French and Belgian troops occupied the minerally and industrially rich Ruhr region, as Germany had stopped sending coal to France as part of the reparation deal struck during World War I. This occupation led to the crash of the German currency and the economy, which eventually led to the start of World War II.
Almost 45 years after the end of World War II, ownership of fossil fuel (petroleum) became the focus of another global conflict when Saddam Hussein invaded neighbouring Kuwait.
A win over Kuwait would have made Iraq world’s leading energy power, dominating both the Arab and the Persian Gulf regions, home to the bulk of the planet’s oil reserves. The US and its allies could not have accepted this dramatic shift in balance of power, if Iraq were to win.
Fast forward to the present day conflict involving Russia and Ukraine. The Donbas region has rich coal reserves. The other parts including the Dnieper-Donetsk region, and the Black Sea of Azov are a rich source of natural gas, an important input for manufacturing fertilisers.
The Russian invasion of Crimea in 2014 was related to control over oil and natural gas reserves in the Black Sea region. Quite like the Ruhr region which had a considerable German population but was occupied by the French and Belgians, this time around the Donbas, Dnieper, Donetsk and the Luhansk regions has a large Russian speaking population — with both Russia and Ukraine claiming rights over these territories. These prolonged conflicts have led to highly volatile energy prices, hurting the world economy. Take for instance, the Yom-Kippur war of 1973 and the subsequent Saudi embargo, leading to worldwide stagflation. During 1974, to fight the raging inflation that skyrocketed to 11 per cent, the then Fed chairman, Arthur Burns raised the funds rate to 12 per cent, before reducing it to about 5 per cent in 1975. But that did not help as there was a second oil crisis in 1979 with the start of the Iran-Iraq war.
Combating inflation
To tame inflation, Paul Volcker, who was in charge of the Fed at that time, pursued a consistent hawkish policy. Between 1979 and 1981, the Fed increased policy rates from 13.6 per cent to 20 per cent. It took about a decade to tame inflation, which touched 14.5 per cent in the US during the early part of 1980s. However, such monetary tightening came with a cost — namely, recession (famously touted as Volcker’s recession), with the US unemployment rate climbing to 10 per cent. There was collateral damage as well. Countries like Argentina, Brazil, and Mexico which borrowed heavily in dollars to sustain infrastructure investment, defaulted as an appreciating dollar increased the cost of borrowing.
The present events are eerily similar. Many countries in Asia (Pakistan and Sri Lanka), Europe (UK) and in Latin America (Argentina) are suffering because of an appreciating dollar, an outcome of a hawkish monetary policy undertaken by Fed Chairman Jerome Powell.
The 2022 inflation is not as bad as what the US witnessed during the late 1970s; but it remains the worst inflation in decades. Aggressive monetary tightening, with the Fed increasing the policy rate by 300 basis points since March 2022, has led to an increase in the yield on one-year US treasury securities, from 1.86 per cent in March 1 2022 to 4.12 per cent on September 9, 2022.
More such bouts of monetary tightening may follow, and that may spell bad news for emerging and developing economies. The good news, however, is that central banks around the world are not averse to raising rates on par with inflation, thereby snuffing out inflation expectations that could feed into a wage-price spiral. However, the rate hikes the world over are likely to peak sooner than later, as fears of a recession loom large.
Inflation volatility is the outcome of our excessive dependence on fossil fuels, and as result there are conflicts, dictatorships, and climate change. An uncertain economic environment instigates fear and induces high defence spending that could otherwise be spent on social welfare measures and to arrest a degrading environment. A decisive shift towards renewable energy could alter this destructive chain of events.
Unlike fossil fuels, sources of green energy — sunlight, water, wind — are much less localised. That could eliminate the reason for many territorial conflicts.
Banik is with School of Management, Mahindra University; Cozzi is with Institute of Economics, University of St. Gallen