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Musings Report 2022-26 6-25-22 Weaponizing Recession
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Weaponizing Recession
Before we start, I want to emphasize that I don't create content to win a popularity contest or persuade anyone to agree with me.
I create content to present what I think could be consequential dynamics going forward, dynamics that are generally below or above the conventional radar, unrecognized or under-appreciated..
This often places me (in many readers' view) squarely in La-La Land. This is the nature of speculations that veer from the accepted wisdom / conventions of the moment.
Okay, let's get started.
As I mentioned in The Difference Between a Forecast and a Guess, there are forecasts issued to reassure the public, and there are forecasts which are kept confidential to avoid spooking the herd or revealing operative agendas that only work if they are kept confidential.
Central banks issue forecasts that are clearly designed to reassure the herd that all is well. Though the forecasts stick to the financial realm, whatever influences interest rates and money supply influences currencies, and currencies influence economies and geopolitics.
Every nation has "global interests." Governments naturally do whatever they can to boost dynamics favorable to the state and nation, and obstruct or hinder dynamics injurious to the state or nation.
Most nations have relatively few levers they can pull to influence global finance, trade, growth, currencies or the geopolitical balance of power.
One such lever is the interest the state pays on its sovereign bonds.
If a central bank/state increases the interest it pays on its bonds, that attracts capital seeking higher return (presuming the bond is perceived as safe from default).
This inflow of capital strengthens demand for its currency, because the bonds are denominated in the state's currency.
As the currency strengthens vis a vis other currencies, it buys more goods and services. Imports become cheaper and the nation's exports become more costly to those using other currencies.
Another lever is to reduce the exports of commodities, especially essential commodities like energy and grains. If this reduction reduces the global supply, the price leaps.
If allies get the exports and enemies don't, this punishes enemies and rewards allies.
A third lever is to cut off imports. A consumer nation can boycott imports from specific exporters, or make do with domestic supplies, or only buy from allies.
A fourth lever is to meet with allies and reach an agreement about finance and commodities to stave off imbalances that threaten the stability of the alliance.
An example of this is the 1985 Plaza Accord that weakened the U.S. dollar at the expense of the Japanese yen and European currencies. The strong dollar was crushing U.S. exports and generating destabilizing trade deficits in the U.S.
Each of these levers has geopolitical consequences.
Financial actions such as raising interest rates are presented as purely financial, but their geopolitical consequences are not lost on the nation's political / military leadership.
Boosting or trimming exports of commodities can be presented as financial, even when the real purpose is geopolitical.
In other words, events which are presented as solely financial can be "nudged" to serve geopolitical aims.
Consider how the low price of oil in the late 1980s contributed to the collapse of the Soviet Union.
In the mid-to-late 1980s, the price of oil fell and stayed relatively low for years. (EIA data)
In 1986, oil fell under $10/barrel. Adjusted for inflation, this was lower than prices paid in the late 1950s.
Although this ample oil supply was fundamentally a result of super-major oil fields discovered in the 1960s and 1970s coming online, it had a geopolitical consequence few fully appreciate: it pushed the Soviet Union over the fiscal cliff into collapse.
Oil and natural gas exports were the primary source of the Soviets' hard cash it needed to buy goods and commodities from other nations.
Once the oil revenues dried up, the Soviet Union was no longer financially viable.
Was this lengthy "glut" of oil just good luck for the U.S., or was a policy agreement reached with Saudi Arabia and other oil exporters that "nudged" the price lower also a factor?
What do you reckon--pure luck or luck "nudged" to achieve a geopolitical goal? Given the high stakes and the vulnerability of the USSR to low oil prices, is it plausible that the period of low oil prices was entirely happenstance?
Let's shift gears and consider currencies, which are the financial foundation of national security and stability.
In the 35 years since the Plaza Accord, the U.S. has endeavored to keep the dollar relatively weak for a number of reasons: to limit U.S. trade deficits, and avoid putting undue pressure on emerging countries with debts denominated in USD and nations that import commodities priced in USD, which is virtually all commodities..
This weak-dollar policy has changed, with profound implications. The soaring USD is adding a currency "surcharge" on top of rising prices for commodities such as oil and grain.
Take Japan as an example: the yen has weakened 20% against the USD. This means every commodity priced in USD is 20% higher in price for those using yen.
Add the increase in cost due to global scarcities and that's a double-whammy hit of inflation.
These sharp increases in inflation / price of essentials are recessionary, as demand craters. People simply don't have enough earnings to pay higher costs for essentials and maintain their discretionary spending on goods and services.
Recall that price is set on the margins. If supply of oil falls 5 million barrels per day (BPD), price rises. But if demand falls 10 million BPD, the price of oil plummets.
As the price of oil falls, oil exporters receive much less money, and so they compensate by pumping more oil. This serves to further depress prices.
While exporters claim to be restricting supply as price declines, everyone is pumping as much as they can because they have no other source of income. They don't have a choice once they burn through their cash reserves.
Those who believe Russia will sail through Western sanctions with few consequences aren't looking at oil infrastructure parts and equipment. These come from the West. Once they're no longer available, oil production falls as wells, pumps, pipelines, etc., go off line due to lack of parts.
A sharp global recession would crush demand for oil. Discretionary spending dries up very quickly once people run out of cash and credit.
The strong dollar is pushing emerging nations into insolvency, as they can no longer afford to buy fertilizers, grains and oil. Once a nation's currency collapses, its demand for imports collapses, too.
Who would benefit from a rising US dollar and a global recession, and who would be hurt?
The US would benefit from a higher USD because that lowers the cost of all imports. Everyone using weaker currencies would pay more for imported commodities.
As demand for oil falls, price plummets. That helps consumer nations and hurts oil exporters.
As the USD rises, it drags every currency pegged to the USD higher with it, making their exports more expensive. That would pressure China's exports, forcing China to adjust its currency peg, reducing the purchasing power of everyone using yuan/RMB.
A few analysts (Art Berman for example) who have generally been accurate in their forecasts foresee oil at $45/barrel in a deep recession.
Many think this is impossible, but price is set on the margin, and if demand falls faster than supply, prices drop.
Another factor few fully appreciate is that speculation is a key driver of higher oil prices. Physical oil supports an enormous mountain of financial instruments that influence the price of oil: futures, derivatives, etc.
Speculation dries up when the price falls, and this accelerates the decline.
With sanctions pressuring its oil infrastructure and prices falling sharply, Russia's primary source of income would also fall sharply.
A rising dollar and a global crash in demand for discretionary goods would increase China's costs of importing essentials and dampen its exports.
There are asymmetries between the U.S. and Russia and China. The U.S. economy is not as dependent on one export as Russia, and the U.S. economy ($23 trillion) is far larger and more diversified than Russia's ($1.8 trillion pre-sanctions).
The dollar/RMB peg only works one way: the USD is not pegged to the RMB, it's the other way around.
Is the looming global recession merely "bad luck" or could an unavoidable global recession be "nudged" to serve geopolitical aims?
If I were a senior Pentagon planner, I would look very favorably on global demand collapsing in a deep recession.
The strong dollar would cushion the U.S. from the worst of the global recession while impairing the finances of Russia and China.
From one point of view, a global recession is inevitable as inflation has forced central banks to take away the zero-interest rate punchbowl and limit money-creation.
Rather than look at the downside of global recession, why not look at the potential geopolitical upside and "nudge" the recession with a strong dollar to crush demand for oil?
I am confident of three things: 1) price is set on the margins 2) currencies are the foundation of every economy, everything else is secondary and 3) the financial forecasts issued to calm the herd do not reflect the operative geopolitical goals.
The forces that have been unleashed (higher interest rates, scarcities, strong dollar) will take time to work through the global economy. The USD may drop and oil may rise over the next few months, but where will global demand and oil price be in a year?
Many people expect the dollar to weaken and the Federal Reserve to lower interest rates back to zero once the recession becomes undeniable.
I am not so sure. A case can be made that interest rates have completed a 40-year cycle of decline and are now in a secular cycle higher.
A case can also be made that the weak-dollar policy has ended and the dollar will move higher, accelerating the financial and geopolitical consequences described above.
Many people see Russia and China establishing an alternative global currency that enables them to completely abandon the dollar.
Such things take a long time to scale up to reach "network effect" benefits, provide ample liquidity, demonstrate the transparency required to establish trust and thus price stability, etc.
The USD will likely remain influential for a few more years.
Interest rates and currencies don't control everything, but they can be "nudged" to take geopolitical advantage of conditions.
The next few years may be more interesting than many expect.
Highlights of the Blog
The Global Power Shift Isn't West to East--It's Not That Simple 6/24/22
Our No-Win "Kobayashi Maru" Economy 6/22/22
The Difference Between a Forecast and a Guess 6/20/22
Tectonic Shift of Mercantilism Revalued (with Gordon Long, 42 min)
Best Thing That Happened To Me This Week
First lychee of the season. These trees tend to cycle between big and small harvests. Last year we were blessed with 400 pounds of fruit, this year we'll be lucky to get 20 pounds: same trees, same care, slightly different weather. Our neighbors also had skimpy harvests this year. It goes with the terroir.
Our heirloom tomatoes are ripening, it's salad time. (Also in the basket are guajillo peppers, which add a nice sweet crunch to salads.)
From Left Field
NOTE TO NEW READERS: This list is not comprised of articles I agree with or that I judge to be correct or of the highest quality. It is representative of the content I find interesting as reflections of the current zeitgeist. The list is intended to be perused with an open, critical, occasionally amused mind.
Analysis: Why us? Italy seeks way out of low-wage economy trap -- file under 'demographics is destiny'...
The Digital Republic by Jamie Susskind book review – why the west was no match for the tech giants -- what we've been calling The Network State....
Greens unlikely to survive the coming winter -- burn coal or freeze, what to do?...
Pictures of imperfection (energy and finance)
The Peak of World Oil Production and the Road to the Olduvai Gorge -- inconvenient....
Where Colorado River no longer meets the sea, a pulse of water brings new life -- water use is now a zero-sum game in the Western U.S.: somebody wins, somebody else loses....
Pollen and Heat: A Looming Challenge for Global Agriculture
Cryptocurrencies: A Necessary Scam? Matt Stoller makes some good points here...
The Unthinkable Is Happening in India Right Now
The Ugly, the Bad, the Good'ish (Chris H.) -- insightful housing supply charts....
The Criminal Order Beneath The 'Chaos' Of San Francisco's Tenderloin -- is this where the public wants this to go?
What’s Cholesterol Got to Do With It?
HOW TO MAKE A MINT: THE CRYPTOGRAPHY OF ANONYMOUS ELECTRONIC CASH (via Chad D.) (National Security Agency Office of Information Security Research and Technology, Cryptology Division, 18 June 1996) -- for all of us who thought bitcoin was birthed in 2009...
"When it becomes serious you have to lie." Jean-Claude Juncker
Thanks for reading--
charles |
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