Rabo: There Is War; No Trust; Deranged Speech; And Lack Of Endgame Vision From Both Sides

By Michael Every of Rabobank

Is 'Mayday' One Word or Two?

There is not a lot to laugh about anywhere at the moment. However, a recent very black humor meme that did make me do so was the one I saw a few days ago where:

Putin looks at Defence Minister Shoigu and says, “Tell me how the war is going in one word.”

Shoigu replies, “Good.”

Putin follows up, “Tell me in two words.”

Shoigu says, “Not good.”

It’s ‘funny’ because it’s true. Russia is creating an economic basket-case in a breadbasket and calling it ‘peace’, with global repercussions, yet it is doing the same to itself. A Russian friend tells me he went to his Moscow department store Saturday and took the escalator to the underground level to find the retailer he wanted. The retailer was gone, and the entire level replaced with a vegetable market. I told him to worry when there aren’t any vegetables either.

RUB is trading well vs. EUR due to high energy prices, capital controls, and a collapse in imports - but nobody is trading it or wants to hold it. Russian officials talk about a new financial and currency system and RUB pegged to gold or commodities, as if it isn’t already a commodity currency - but isn’t gold priced in US dollars? Weren’t South African Krugerrands literally gold money the West banned anyway? Moreover, Russian central bank governor Nabiullina says pegging RUB to gold is “not being discussed at all.”

Longer term, consider this point from not-at-all a US flag-waver Milanovic:

“In the next decade or so, the history of economic policy will be enriched by a new, never imagined, experiment: how to accomplish technologically regressive import substitution? This is the problem that Russia will have to face and that is entirely new….

The industrial areas that are normally the backbone of traditional (predigital) development were well developed in the Soviet Union, but have been abandoned, left to deteriorate and, even if existing, are today technologically obsolete. Almost all of what is technologically advanced was produced, or was dependent in part, on Western-made technologies…

Even if Russian regressive import substitution is successful in terms of output, which is very doubtful,…once the Russian market gets reopened and sanctions lifted, all that effort will be shown to have been in vain because the new and created-from-scratch Russian models would be less efficient than Western.”

In other words, the ‘we can do it alone’ policy either fails now, or Russia has to permanently decouple via a step down the industrial technology ladder, which its labor force is not set for. Even worse, the US is allegedly planning to offer Russia’s hi-tech work force special visas to deliberately try to brain-drain it.

Or China fills the technology gap, and the West does to them what it is doing to Russia. For those who say that can’t happen, the Financial Times reports China is worried enough that it can that they just called in all large local and foreign banks to discuss how it might be able to circumvent a SWIFT ban and the seizure of its FX assets, as happened to Russia. The conclusion was that there is no way to avoid it, even if the pain would be enormous for both sides - but arguably far worse for net food and energy importer China.

Frankly, this is hardly what China needs when its manufacturing PMI was 47.4 vs. 47.3 consensus, non-manufacturing 41.9 vs. 46, and the Caixin manufacturing PMI 46 vs. 47.

True, Chinese markets had a stand-out frenetic rally on Friday, in contrast to the gloom in the rest of the world, due to a Politburo promise to roll back regulatory crackdowns. They said the same a few weeks ago: then cracked down. And a few months ago: then cracked down. Indeed, there is a sting in the tail again, as the Wall Street Journal notes: “Regulators are planning to hold off on new rules that limit the time young people spend on mobile apps, according to one of the people, while another person said that Beijing is considering pushing some of its biggest tech companies to offer 1% equity stakes to the state and give the government a direct role in corporate decisions.”(!) That sounds like de facto nationalization on the cheap. If so, expect more ‘CCP apps’ and a lot more time spent on them? After all, what else is one to do when one is in a hard lock-down for the next eight months?

Xi Jinping also gave a speech later on Friday which reiterated the Marxist-Leninist Common Prosperity orthodoxy yet again that, “By its nature, capital purses profits, and if it is not regulated and restrained, it will bring immeasurable harm to economic and social development.” The SCMP covered it thus: ‘Chinese president outlines big role for private capital – as long as it’s on a regulatory leash’. Some say, “OK, invest where the government says and watch the profits roll in.” Except the sectors one backed on that basis have underperformed; and, as I suggested last year, the best return you will get is akin to a government bond yield – low, and in China’s case, falling.

And so to geopolitics.

The Ukraine war is a bloody stalemate with tens of thousands of dead on both sides. Russia, already accused of war crimes, is talking about “filtration camps” in areas it controls that ‘weed out’ people seen as too Ukrainian, while sending mainly women and children off to Russia to be ‘Russified’. State TV is pushing a nuclear attack on the UK, or setting off an underwater nuke to wipe out the British Isles with a tsunami. We usually get this kind of talk from Iran and North Korea. Russia’s Foreign Minister Lavrov just claimed Ukraine’s President Zelenskiy can be a Nazi despite being Jewish because “some of the worst anti-Semites are Jews,” and “Hitler had Jewish blood”. We usually get that kind of talk from ISIS.

Today is the May Day holiday in Europe, but next Monday is Russia’s Victory Day. Military analysts had expected Putin to grind out a Tacitus-style win by then. However, with more Western weaponry pouring into Ukraine, along with Nancy Pelosi, that seems unlikely. There are suggestions Putin may now use the military parade to officially declare war and mobilize. (Which does not sit with the tight fiscal policy of a gold standard by the way.)

As the risks of escalation increase, Noam Chomsky just gave an interview in which he declared the only possible exit is a pan-European security structure for all to join, or Helsinki 2.0 - and the one statesman who he says could make that deal happen is “Donald J. Trump”. Cue paroxysms from those who prevented that path from being taken --if it ever really could have-- from 2017-2020 because of the need to paint Trump’s 2016 win as due to Putin via Russiagate rather than being the legacy of awful neoliberal policies, only some of which he changed, i.e., trade politics.

(Russiagate, being disassembled by Special Counsel Durham, was something the head of the new Disinformation Governance Board under the Department of Homeland Security said was ‘true’, while Hunter Biden’s laptop was ‘false’. Here, she channels Mary Poppins to explain why her role is important for a crowd who thinks ‘Hamilton’ is anti-Trump rather than a Trumpian economic policy. In 2020, she sung a different tune to Congress when saying, “I totally understand your aversion to the idea that government would fight back against disinformation. In fact, you know, the use of that term has been basically the foundation to some very draconian fake news laws in places like Russia… I do not believe that government should be in that business either.”)

However, Chomsky is likely wrong in that this particular Helsinki 2.0 ship looks to have sailed, as Finland moves to join NATO, for example - one of the few ships that actually can sail, as global supply logjams build up again.

There is war; no trust; increasingly deranged speech; and lack of end-game vision from both sides. Even if Russia did sign up to a new Helsinki, somehow, it would just alienate China,… unless the new Helsinki is a global free-for-all. In which case, why bother?

Relatedly, as the US and UK are reported to have met to discuss future tactics over Taiwan, as of today lower-ranked Chinese PLA officers will have more scope to supervise senior ranks: experts say this is aimed at better securing the PLA’s loyalty to Xi Jinping. And why should this be needed, one wonders? To add to tensions, this week may see the public launch of the latest US Indo-Pacific strategy, aimed squarely at China.

Against that backdrop, this week will show that major central banks think the economy can be summed up in one word - “Inflation”.

After all, Europe is limping towards cutting off Russian oil by end-2022, perhaps. Moreover, Bloomberg notes that food prices are going to soar as fertilizer use plummets:

“For the first time ever, farmers the world over --all at the same time-- are testing the limits of how little chemical fertilizer they can apply without devastating their yields come harvest time. Early predictions are bleak.

In Brazil, the world’s biggest soybean producer, a 20% cut in potash use could bring a 14% drop in yields, according to industry consultancy MB Agro. In Costa Rica, a coffee cooperative representing 1,200 small producers sees output falling as much as 15% next year if the farmers miss even one- third of normal application. In West Africa, falling fertilizer use will shrink this year’s rice and corn harvest by a third, according to the International Fertilizer Development Centre, a food security non-profit group…

For the billions of people around the world who don’t work in agriculture, the global shortage of affordable fertilizer likely reads like a distant problem. In truth, it will leave no household unscathed. In even the least-disruptive scenario, soaring prices for synthetic nutrients will result in lower crop yields and higher grocery-store prices for everything from milk to beef to packaged foods for months or even years to come across the developed world. And in developing economies already facing high levels of food insecurity? Lower fertilizer use risks engendering malnutrition, political unrest and, ultimately, the otherwise avoidable loss of human life.”

So, perhaps central banks need two words, not one – but they are going to be “rate hikes”.

First up tomorrow will be the RBA, with a looming election and a teetering housing market. The market thinks 15bp to take rates to 0.25% is most likely; even that is seeing ‘For Sale’ signs hit lawns. Of course, both big parties in the election favor of pushing up house prices even further – or at least that’s what the impact of their related policies would be. This is Oz after all.

Then we get the Fed, where 50bp is a done deal. The issue will be over how hawkish or dovish the wording and Q&A from Powell is. Then we get the BOE and another 25bp hike to 1%.

Tell me in one word how markets are going to react. Then tell me in two words.