Date: 5/12/2022
Author: Mr. X
Economic doomsaying is the most tiresome form of analysis. It’s obnoxious because, eventually, you are going to be right. Nothing lasts forever.
Chronic pessimism is a way of asserting control over the uncontrollable. If you constantly expect the worst, you can take a grim satisfaction when things work out the way you predicted. If they don’t work out that way, well, you are still benefitting.
For my entire life, I’ve seen hysterical campaigns directed at both left and right that the dollar is going to “collapse” and this will change everything. This is usually accompanied by a call to buy gold and silver from the person giving the warning.
This isn’t entirely wrong. At some point, the dollar will lose its status as the world’s reserve currency. Powers such as Russia and China are trying to engineer that outcome. Cryptocurrency, according to some boosters, could also make the dollar redundant.
But not anytime soon.
As I wrote earlier this week, the dollar is in a remarkably strong position compared to all its rivals. Crypto, China, and even the Euro and Pound have all suffered against the greenback. The ruble has actually held up well, but there’s reason to distrust that it can last. While high energy prices are providing key support for the Russian currency, the Russian economy will massively contract this year and capital controls can only be maintained for so long.
The Biden Administration has been blaming President Vladimir Putin for inflation, which is an obvious dodge. Inflation would have been occurring even if Russia had not invaded Ukraine, or if Russia had made a more limited incursion into the two separatist breakaway republics and avoided severe sanctions. Yet both President Joe Biden and President Putin are correct when they say the war is creating a systemic crisis, though each blames the other.
President Putin’s fundamental misreading of Western politics may be largely responsible for his disastrous decision to invade. He overestimated Western political divisions, ignoring the reality that even at a time of ideological polarization, Republican and Democratic leaders both favor a more interventionist foreign policy.
A Republican takeover of Congress may mandate even more aid for Ukraine, despite some populists like Tucker Carlson, Rep. Marjorie Taylor Greene, and Senator Rand Paul speaking against it. These critiques of American foreign policy get wide publicity in Russian media, but it’s dangerous to believe your own propaganda.
Still, Western leaders may be making some mistakes too. Funding a proxy war with over $40 billion is not a good idea when you are trying to fight inflation. It’s not a good idea for the Continent to cut itself off from Russian energy supplies. Rather than descending into madness as some Western media would have us believe, President Putin likely thought that Europeans would put their own domestic economies ahead of Ukraine. He was too cold-blooded and rational. He underestimated the moral outrage his actions would cause. He overestimated the strength of anti-interventionist movements in the West following the American defeat in Afghanistan. More than anything, he didn’t understand the ability of Western media to turn Ukrainian resistance into the most prominent cause in the world.
European nations, and to a lesser extent the United States, are willing to take economic damage for geopolitical ends. In a Guns of August type scenario, statesmen are unable to clearly communicate to each other what they are trying to achieve and what they are willing to tolerate. That’s why this situation is so dangerous.
That geopolitical volatility is what’s going to make this economic turmoil far more serious. Federal Reserve Chairman Jerome Powell, who was just given another term by the Senate, said in March that the central bank underestimated inflation. It should have moved more quickly to increase interest rates. Many of us were saying that for some time. However, in Chairman Powell’s defense, he couldn’t have predicted President Putin’s invasion. Even if the Fed had waited too long, it might have been able to achieve a “soft landing” for the economy without the invasion. I doubt he can now.
The Fed’s challenge is to prevent the economy from overheating by raising interest rates while not crushing growth by raising them too much or too fast. Since the end of the Cold War, especially during the reign of Fed Chairman Alan Greenspan, we’ve seen this as a balancing act, with success or failure determined by the judgment of domestic policymakers.
Even the 2007-2008 financial crisis was a self-inflicted wound. Washington allowed, and indeed encouraged, loans to people that borrowers couldn’t pay back. This created a class of toxic assets that threatened to collapse the entire financial system. As a result, the federal government had to bail out the banks, creating a widespread distrust of the financial system. This helped fuel the development of cryptocurrency.
It’s somewhat tragic then that the first domino that could lead to a large-scale financial crisis is the asset valuation crisis emerging in crypto. As Dr. Kent Moors pointed out in July 2021, the key weakness in crypto markets are the stablecoins used for crypto transactions.
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The collapse of Luna (now almost worthless) and the related algorithmic stablecoin (UST) wiped $200 billion from the market in a day. If Tether, another stablecoin, doesn’t have sufficient reserves, the sector could disintegrate. Treasury Secretary Janet Yellen is already calling for more regulation, with the stablecoin crisis serving as justification.
At the same time the liquidity of many investors has suddenly vanished, there are problems with the housing market. Owning a home is the main way many Americans build long-term wealth. NPR reports that that some economists think housing is wildly overvalued right now. A fall in prices could be great for Americans looking to buy a new home, but a catastrophe for those who are falling back on property values now that their 401(k) and crypto holdings are shredded.
Finally, and most importantly, inflation is outpacing wage increases despite the Federal Reserve’s rate hikes. Inflation increased 8.3% in April, slightly less than March but larger than expected. Unlike other situations in the recent past, this won’t be something the Federal Reserve will simply be able to manage. It’s being driven by underlying conditions outside the central bank’s control, as Jerome Powell himself recently said.
The most obvious problem is energy. The European Union is considering some exceptions for Central European countries in order to get an embargo on Russian oil. However, Hungary has vowed to veto any embargo. Brussels may not like it, but Prime Minister Viktor Orban won a larger than expected victory in a recent election. Critically, the invasion of Ukraine strengthened his campaign, contrary to the expectations (and probably hopes) of some Western analysts who thought his ties to Vladimir Putin would drag him down.
Already, energy prices are rising in expectation of an embargo. If any kind of embargo is put through, it will deal a severe blow to already struggling European economies. Even some exceptions won’t spare the Continental economy.
In the United States, President Biden has canceled oil and gas lease sales at three critical locations. At the same time, Congress is preparing to vote on legislation that would somehow ban “excessive” or “exploitative” gas prices. When governments are discussing price controls, it’s a clear sign that they are acting out of frustration, not out of accordance with sound policies.
Rising gas prices, and especially diesel prices, are going to push up transportation costs around the United States. This is on top of wheat prices increasing because of the war in Ukraine, a bird flu that could threaten the supply of poultry and eggs, a fertilizer shortage (partially caused by the war), and a baby formula shortage.
China’s economic recovery is also stalling because of a recent COVID-19 outbreak in Shanghai. The government’s supposed commitment to a “zero COVID” policy, something the World Health Organization says is unsustainable, may be cover for something else going on. The Chinese government has been more forceful recently in subordinating commercial elites like Jack Ma to the Communist Party. This could be part of a power struggle, with Xi Jinping looking to subdue potential challenges from China’s commercial hub.
If there really is a political crisis, the obvious move for the government is to create a foreign policy crisis to unite the country. Chinese officials have been rhetorically backing Russia on social media, but if anything, they are playing down their supposed no limits alliance with Moscow. The leaders may be less militant than the people.
Debate about the war is more open that Westerners think; the Chinese people aren’t just being fed a monolithic propaganda line. According to a recent poll, most Chinese believe their interest lies in supporting Russia rather than the United States, with support for Moscow correlating with higher economic and education levels. America’s increasingly frank talk about arming Taiwan also invites a confrontation.
These tensions are going to exacerbate supply chains, production hubs, and transportation arrangements that have already been strained by COVID-19. The virus itself is probably going to be with us forever, with new strains emerging and vaccines and treatments playing catch-up. Worse, as political leaders are confronted with new economic crises, the best move for them will be to look for foreign enemies. That will further the decline by creating new conflicts and barriers to trade.
When the Fed could seemingly master the economy by fidgeting with interest rates, we were in an age of globalization. The assumption in Washington D.C. was that trading with China would gradually liberalize it. Instead, it, together with Russia, is the basis for a multipolar world order. Powers like Brazil, India, Pakistan, and South Africa may also want out of the American financial order.
That order must ultimately be upheld by power, both economic and military. At least part of the war in Ukraine is about weakening Russia economically and deterring China from directly challenging the United States. Yet all this comes at a cost. Whatever one’s feelings about the war in Ukraine, the tens of billions of dollars that are being spent on weapons that will be destroyed one way or the other. They are not being spent on infrastructure, clean energy, or other programs that could have boosted American productivity. That money is just gone.
We’re getting all the drawbacks of government spending without the benefits.
It’s possible that the invasion of Ukraine breaks Moscow as a significant anti-American power. I don’t see that outcome as likely, nor that Vladimir Putin’s successor will be more restrained than he. We will pay for this in the short-term even in the best case.
The age of self-contained economic blocs and empires is returning unless American power can prevent it. That will come at terrible cost. We’re losing the supply chains built in an age of globalization. The complications of this are raising the chances of future conflicts and even more supply problems. If we see food shortages, the migration crisis from Ukraine will pale in comparison to what follows from the developing world. All this will fuel populist movements from both left and right within the West, creating more economic and possibly geopolitical turmoil.
It’s the mother of all negative feedback loops.
The Fed’s challenge isn’t so much containing runaway growth but preventing stagflation. The economy is fundamentally weak. It’s not simply a matter of changing policy. Essential goods – energy, food, raw materials – are becoming harder to obtain. The dollar itself is strong, indeed, it’s getting stronger. However, that’s because it’s become the best of a series of bad options.
Let’s not be too fatalistic. It’s not inevitable we go into a recession. Nothing is. Yet even one major misstep would push us onto that path. And that mistake doesn’t have to come from the United States.
The fact that Jerome Powell admitted in March that the Fed widely underestimated inflation is a very bad sign. The dollar won’t collapse (compared to most other currencies anyway), but that doesn’t mean the American economy won’t face a severe economic downturn. It really could be different this time. The doomsayers could be right.
That doesn’t mean you still can’t profit from the chaos. Informing you about ways to do that is what we’re here for.
Mr. X is an investment analyst working in the Washington DC area who specializes in the intersection of business and public policy. After fifteen years working in politics, he writes on a classified basis for RogueInvesting.com to bring you news on what those with power are debating, planning, and doing.
