Macroeconomic & Geopolitical

How Ukraine Mission Creep Will Fuel the Next Inflation Wave

May 2022 – 3 min read

And that’s on top of the other risks from war aims that are turning ever more resolute, expansive, and vague.

Increasingly sharp and focused Fed rhetoric has bond markets convinced America will avoid a damaging period of wage-and-price spirals. But that confidence may fade quickly if U.S. political leaders continue to offer increasingly vague and lofty goals in Ukraine’s war. “Mission creep” not only makes for bad military strategy, it also threatens to unleash lasting inflationary forces long beyond the recent commodity price shock.

With Speaker Nancy Pelosi insisting that America stands with Ukraine “until victory is won” and Defense Secretary Lloyd Austin speaking of a “weakened” Russia that can’t invade again, the world looks headed for a long, grinding, and terribly expensive conflict. If there’s anything that will end 40 years of declining inflation and interest rates, it’s an Eastern Europe quagmire that triggers massive new military spending, a painful rewiring of global commodity flows, and an even more expansive set of global financial sanctions.

A conflict that still looked unlikely in early February and seemed certain to deliver quick Russian victory by early March now looks like a lasting and dangerous feature in European and world politics. If Russia’s initial war aims have shifted geographically from Kyiv to the east and south, Western war aims have dramatically increased from symbolic support for Ukraine’s lost cause to something that can leave Russia permanently damaged.

American and European leaders grow more committed to Ukrainian support with each new report on civilian deaths and Russian atrocities. President Joe Biden seems likely to get Congressional support on a $33 billion request for Ukraine as polls show rare bipartisan advocacy of this administration’s policy. Finland and Sweden are fast-approaching NATO membership as the Bundestag overwhelmingly approves the delivery of heavy arms. As more Western politicians journey to Kyiv to shake hands with Volodymyr Zelensky, their emotional commitment and concrete support will only grow.

This is the exact kind of mission creep that military experts regularly warn against. After Vietnam but before Afghanistan, the late soldier and Secretary of State Colin Powell proffered “rules” for the proper commitment of U.S. troops, including a clear and attainable objective, a full analysis of the risks, and a plausible exit strategy. If these questions have been asked about Ukraine, we have yet to hear conclusive answers.

But if the military consequences of the West’s deepening commitment look unclear, the economic consequences are beginning to come into view. 

First, we now face a generational increase in defense spending. The Biden administration’s budget for next year calls for a 4% increase, and that number will grow substantially if Republicans take control of Congress after mid-term elections this fall. Germany has broken long-standing precedents to ramp up its military budget, and other European nations look likely to follow suit.

Second, the shock from an interruption of Russian exports is only the beginning of input price pressures. Europe, in particular, faces years of amending its trade flows to replace lost supplies of energy and minerals, but also to find new markets for its exports. Egypt, Turkey, and other developing countries will need new sources of food and fertilizer. Supply chains that might have returned to normal as pandemic shocks ease now face new stresses that may last years.

Third, global financial flows are looking at fresh uncertainty as sanctions enforcement ratchets up against countries like China, India, and others that are reluctant to be drawn into the struggle. Rising public outrage in the half of the global economy that has sanctioned Russia will demand stiff penalties for banks or firms that skirt the rules. It’s still far too soon for any significant abandonment of dollar holdings given so few attractive alternatives, but souring relations may reduce the appetite for holding treasuries and, on the margin, drive rates higher.

All too recently anyone bemoaning persistent deflationary pressures from deeper globalization, aging demographics, and advancing technology would recall that the Great Depression only really ended with World War II. Of course, the current conflict remains a far cry from that level of devastation and spending, but escalation looks more likely than peace.

It’s possible, of course, that an eventual cease-fire may fade into a contained, frozen conflict. It’s possible that higher commodity prices bring new supplies faster than expected. It’s even possible that skillful Western diplomacy manages to keep “neutral” countries from expanding their commercial engagement with Russia.

But all of these possibilities would seem more likely if U.S. and European leaders offered a clearer description of their goals in supporting Ukraine and greater confidence that the goal line itself will not move.


Christopher Smart, PhD, CFA

Chief Global Strategist & Head of the Barings Investment Institute

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