Justified as they are, the sanctions imposed on Russia — one of the world’s largest exporters of metals and hydrocarbons — are wreaking havoc on already-strained commodities markets, with potentially dire consequences for the global economy. To avoid unnecessary damage, officials should be prepared to meet this extraordinary challenge with a no less extraordinary response: Emergency support from the U.S. Federal Reserve.
In recent weeks, uncertainty about how the war and sanctions will affect supply has led prices of everything from oil to nickel to gyrate wildly, in some cases more than doubling in a matter of days. The volatility has, in turn, prompted lenders and clearinghouses to demand more collateral to back market participants’ rapidly expanding positions, in some cases boosting cash demands tenfold. Combined with supply-chain snarls, which have increased the volume of commodities in transport, this has placed extreme stress on the finances of some of the world’s largest trading firms, such as Glencore, Trafigura and Vitol — stress that recently forced the London Metal Exchange to shut down nickel trading to avert a cascade of defaults.
The repercussions could be far-reaching. Trading firms play a central role in ensuring that supplies reach end users. If they can’t borrow the money needed to maintain their positions, production of goods ranging from gasoline to electric cars could suffer, further aggravating price spirals and logistical issues. Food shortages, rationing and power outages are not beyond the realm of possibility.
Central banks were created to address such market failures. By providing emergency loans against good collateral, or by standing ready to purchase assets directly, they temporarily replace private financing until the crisis passes. That’s what both the Fed and the European Central Bank did at the onset of the coronavirus pandemic, with the Fed extending its support all the way to the markets for municipal bonds and corporate debt. Typically, the mere promise of support is all that’s needed to get markets functioning again.
So far, though, central bankers have been reluctant to backstop the commodities market. The ECB rebuffed a call from the European Federation of Energy Traders to provide emergency funding for exchanges and clearing members, on the grounds that its statutes don’t allow such support. But what about the Fed? Section 13(3) of the Federal Reserve Act grants it the power to enter credit markets above and beyond its standing authority to lend to banks. It can, and should, stand ready to use that power to head off a commodities disaster.
