To investors,
Zoltan Pozsar of Credit Suisse dropped a must-read piece last week entitled “War and Industrial Policy.” He starts off describing how global supply chains can only work efficiently during peacetime. Zoltan explains the three pillars of the recent low inflation world:
Cheap immigrant labor keeping nominal wage growth “stagnant” in the US
Cheap Chinese goods raising real wages amid stagnant nominal wages
Cheap Russian natural gas fueling German industry and Europe more broadly
Notice how he starts each of these pillars with the word “cheap.” We’ll come back to that in a little.
Zoltan quickly moves to coin a new term to describe an important part of the economic strength over the last few decades. He states “implicit in this “trinity” were two giant geo-strategic and geo-economic blocks: Niall Ferguson called the first one “Chimerica”. I will call the other one “Eurussia.” This is an important distinction because the two alliances were separate, but similar. Zoltan describes how they work by writing:
“Both unions were a “heavenly match”: the EU paid euros for cheap Russian gas, the U.S. paid U.S. dollars for cheap Chinese imports, and Russia and China dutifully recycled their earnings into G7 claims. All sides were entangled commercially as well as financially, and as the old wisdom goes, if we trade, everyone benefits and so we won’t fight. But like in any marriage, that’s true only if there is harmony. Harmony is built on trust, and occasional disagreements can only be resolved peacefully provided there is trust. But when trust is gone, everything is gone, which is the scary conclusion from Dale Copeland’s book: Economic Interdependence and War”
The general idea is that peace between nations is built on trust. That trust can be based on the greed of future profits (economic trade) or the fear of future ruin (military strength). Sometimes it is one of these, but sometimes it is both.
When nations lose trust with each other, it creates an environment where they are likely to engage in conflict to accomplish their goals. This could be driven by the pursuit of raw materials, cheaper labor, strategic military positioning, or a host of other potential reasons.
Zoltan’s analysis of the end for the two global alliances is simple, yet eye-opening:
“China got very rich making cheap stuff, and then wanted to build 5G networks globally and make cutting -edge chips with cutting -edge lithography machines, but the U.S. said “no way”. As a result, Chimerica is going through a messy divorce. The two sides don’t talk anymore: “Pentagon chief’s calls to China go unanswered amid Taiwan crisis” (see here).
Russia got very rich selling cheap gas to Europe, and Germany got very rich selling expensive stuff produced with cheap gas. Current accounts swelled for both. Business was so good that Russia and Germany planned a vow renewal with Nord Stream 2. But the ceremony was called off abruptly and turned into divorce, as one side did something the other couldn’t tolerate. Events unfolded quickly and involved NATO, Ukraine, and the balance of power in continental Europe, and the result is another messy divorce, in which the two sides don’t talk anymore: “Olaf Scholz says partnership with Putin’s Russia is ‘inconceivable’” (see here).
Finally, the U.S. got very rich by doing QE. But the license for QE came from the “lowflation” regime enabled by cheap exports coming from Russia and China. Naturally, the top of the global economic food chain – the U.S. – doesn’t want the lowflation regime to end, but if Chimerica and Eurussia are over as unions, the lowflation regime will have to end, period.”
Translated into layman terms…the world is undergoing a seismic shift and the future will not look like the past. So what exactly would this new world look like? It is hard to tell, but Zoltan explicitly calls out the initial formation of US-sanctioned countries beginning to work together.
“If I step back, I see a fierce, geo-strategic game of chess in progress on the Eurasian landmass. Forget the BRICS…and try to focus instead on Turkey, Russia, Iran, China, and North Korea playing “TRICKs ” on the Eurasian landmass – an alliance of economies sanctioned by the U.S. getting ever closer economically and militarily. This Eurasian “alliance of the sanctioned” is forcing the friends of the U.S. to play pragmatically.”
Sounds less than ideal, right? Definitely. But what happens if this unlikely alliance continues to pick up steam? That is even less ideal. Zoltan explains how we could go from a low-inflation environment to a high-inflation crisis quickly.
“If Pax Americana enabled globalization and globalization underwrote lowflation, the TRICKs trying to poke holes in the Pax means that inflation is a big risk. To understand the path of inflation from here, we will have to read more history and think about trust, trade, and Dale Copeland’s theory of trade expectations: if trust drove globalization, and globalization drove “The Great Moderation”, distrust will drive de -globalization, and de -globalization “The Great Reflation ”
The ramifications of a multi-polar world, along with a move away from a low inflation world, are complex and hard to identify. It is easier to identify change underway, than successfully predict the end state of the change.
It is essential to understand that the world is changing. There is a geopolitical chess game being played. Average citizens, both in the United States and around the world, are caught in the crosshairs. Inflation is rising. Commodity prices are rising. The cost of living is rising. More and more people feel like they can’t get ahead.
The unfortunate part of the story is that your options are limited. You can ensure you are educated on what is happening. You can read history about transition periods. And you can try to position yourself financially to be as resilient as possible. Outside of those simple steps, the only other thing is to hope for the best.
The United States of America is undergoing a test. It is a test of our ethos. It is a test of capitalism. It is a test of our diplomacy skills. And it is a test of our military strength. The average citizen won’t be able to do much on those fronts. But the average citizen can take up the economic weapon of entrepreneurship. They can build businesses. Serve their local communities. Create GDP growth. Drive economic value.
Prepare for the worst, but be willing to solve problems you see. That is the whole game right now. Wish I had better news. But the story is not over. We have the ability to improve the future. It will take people with the courage to build though. Hopefully that will be each of you :)
Hope you have a great day. I’ll talk to everyone tomorrow.
-Pomp
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