By Michael Every of Rabobank
Despite know-nothing, buy-anything market expectations that peace talks would prompt a rapid end to this war --because markets-- we are no nearer that happening. Russia is still insisting Ukraine surrender or be flattened: so far, it won’t do and is being. Russian media calls Ukraine Nazi… as Russians wear the same color shirt with ‘Z’s emblazoned on them, wave flags and pump fists in unison, shouting “Za Russiu! Za Presidenta! Za Putina!” (“For Russia! For the president! For Putin!”) They think they are fighting WW2. Which is ironic given The Economist points out Russia is being Stalinized. Ukrainians remain as defiant as they were in WW2 too.
The Russian people are now the poorest in Europe per capita (lower in dollar terms than Moldova): yet Putin says Western sanctions were going to be imposed anyway, and they will adapt. And adapt they are. As a mirror to the Western seizure of Russian yachts and mansions in Europe, foreign business assets of departing firms in Russia --which now include Goldman Sachs and JP Morgan - and when you’ve lost the “vampire squid”...-- will be auctioned off to Russian bidders, and if none emerge the state takes control. This looks like an equally corrupt reversal of the disastrous privatisations of the early 1990s. At the same time, 500 leased Western jets in use in Russia, which can no longer get insurance or service, are likely to be seized too, with compensation offered in roubles: don’t expect Russia to ever get Western replacements. Russia is also proposing a ban of foreign ships at its ports as Russian ships cannot call at Western ports. As we argued in ‘In Deep Ship’, this shows how geopolitical supply chains and ocean carriers now are.
Crucially, Russia and Belarus have imposed a fertilizer ban. Even given the many different kinds of fertilizer and different prices in different geographies, this will have yet more inflationary consequences for global food prices. Putin knows this; he knows the industry is prepared to buy fertilizer regardless of what he does to Ukraine; and he blocked it anyway, even warning food prices would go up as a result.
Understand this: Russian agri commodities are being used an economic weapon rather than a neutral exception to that war, as the West tried to achieve. (Albeit failing because so many Russian agri businesses have a sanctioned oligarch someone in their structure.) This is no surprise. Indeed, debating the point with a brilliant colleague focused on the food and agri markets, I was told Putin would rationally want the billions of dollars fertilizer sales could bring in. I replied this war is now about the fact that Putin rationally does not want billions of DOLLARS, because he cannot use them; and he will use commodities as a weapon to win a new sphere of influence and trading structure.
Tellingly, Putin says he has agreements with “friendly countries” to get fertilizer: so, sign up to Putinism and get cheap commodities; uphold the sovereignty of nations and get expensive commodities. This is exactly what we have previously modeled - and it ends in global bifurcation and countertrade (as Beijing warns it will react furiously if the US sanctions it for dealing with Russia). After all, logically:
- The West can retreat out of fears of hunger for up to 1bn people - and a new illiberal world order emerges with huge consequences for agri trade; or
- The West can fight Putinism and hunger - by shifting agri policies and trade patterns; or
- The West can only fight Putinism - and we see that hunger, which will create global chaos.
Indeed, regardless of whether you want to fight Putin and hunger, or just fight Putin, or fight reality to say “BAU, please!”, rapid change is coming. While the plural of Tweets is not “truth” or “analysis”, one from an individual who works in the global fertilizer industry was succinct: ”Newsflash: Globalisation as we know it is dead. Great power politics will determine commerce, not the commodity traders.” After all, if Russian oligarchs can be humbled by raw geopolitics, why won’t far poorer commodity traders be? Even perennial Pollyanna Bloomberg yesterday ran an article (“Another MMT Idea That More And More Governments May Embrace”) quoting an academic and an analyst arguing what we have done for years, that:
“…while EMs may not enjoy monetary sovereignty, they can engage in long-term policies to pursue monetary sovereignty. In other words, they can create the conditions where they need to hold less foreign hard currency…. this starts with --to the greatest extent possible-- establishing self-sufficiency in areas like food and energy.
Rather than orienting an economy around exporting as much as possible in order to build up stockpiles of foreign cash, build up more self-sufficiency, so that the foreign cash becomes less necessary in the first place… Russia’s invasion of Ukraine as well as surging commodity prices may accelerate this type of thinking… Putin’s aggression will make [commodities] even harder to come by. The resulting shortages will have to be managed with some combination of delivery delays, rationing, and price increases… Spending money on rearmament and supply chain security will boost incomes and employment and may support technological innovation.”
A few hours later, Serbia joined the list of countries halting agri exports, in the case of corn; and Sweden and Denmark said they would now spend 2% of GDP on defense; and the UK announced 150 Royal Navy warships and civilian vessels will be built --at home-- over the next 30 years.
Meanwhile, even before the war had really begun to hit economies we already had high inflation. Yesterday saw US CPI at 7.9% y/y, a 40-year peak, and with far worse to come as it broadens out from the ‘only used cars’ base some claimed for it last year. We also saw Italian PPI at 41%(!) y/y --which Turkey had to see a currency collapse to achieve-- while German PPI is running at the highest since 1949. No, this is not “transitory”. It is now structural on the supply side at least.
So, on top of all the physical calamities being inflicted, central banks think now is the time to act. As our ECB team put it in ‘Cautiously hawkish steps’:
- The APP taper has been accelerated to €40bn in April, €30bn in May and €20bn in June.
- The ECB signalled that purchases could end in Q3 already but remains fully data-driven.
- Policy rates will be hiked “some time” after the end of net purchases, rather than “shortly”
- Moreover, the ECB signals that the hiking cycle will be gradual.
In short, despite the fog of war, the ECB took more decisive actions than expected. It’s cautiously hawkish recalibration of asset purchases shows it will not lose sight of inflation - which is hard to do when it is 41%. The bank’s inflation forecast has been revised up significantly, but the ECB seems to underestimate the potential adverse impact on growth - which is easy to do for central banks who do not understand geopolitics, it seems. Overall, these adjustments somewhat reduce the risk that an economic downturn hits before the ECB can exit its asset purchases and implement a first rate hike. Or, in my own words, they are making their mistakes in advance.
If you want an example of what that meant for markets, the Italian 10-year bond yield jumped 29bp from the intra-day low to the close of 1.90%. And, again, this is before the insanity seen in commodities markets even starts to hit home in full. Expect far more far more violent volatility in all asset classes going forwards.
Relatedly, Bloomberg says “Hedge Funds Walk Away From LME After $3.9bn Trades Torn Up”, where a fund manager is quoted as saying it is too risky to trade. Nickel trading, like the Moscow stock market, is still not open on the Hong-Kong owned LME; the Exchange anticipates it will set a maximum limit-up and limit-down for all outright contracts when trading resumes; Bloomberg says Xiang Guangda, the Chinese tycoon facing a multi-billion dollar loss on his short nickel position, is determined to stick with it, which is described as "a characteristic display of self-confidence”; and @CliffordAsness of Principal AQR Capital Management tweets: “And the cheaters win. @LME_news please note, I’m accusing you of reversing trades to save your favoured cronies and robbing your non-crony customers. Everyone who trades should know what you did. You got lawyers, I’m ready. Bring it slime balls.”
There is a direct link to Putinism here. The price surge in nickel was due to him invading Ukraine; and the concept of open global trade in commodities based on politically neutral supply and demand, and transparent prices, rules, and regulations is deeply undermined --as with fertilizer-- in this case, to prevent massive losses by what some see as a politically powerful client.
That is perhaps the end of Western liberal global capitalism as we knew it: and the birth of a zero-sum geopolitical bareknuckle “markets go where we want them to” global state capitalism.
And, yes, dear readers, the West paved the way here with its own past actions. The folks who will look past this chaos to US household wealth rising $5,279bn in Q4 (tell that to the people who can’t fill up their car, buy food, or pay rent!) introduced globalization, QE, ‘Fed puts’, the ‘Too Big to Jail’ 2008 response, and even historical efforts to ‘corral’ key commodity prices geopolitically when needed.
But that was always sold as the exception. It is now risks becoming the global rule - and with the West on the wrong side of it.