By Michael Every of Rabobank
Of Mice and Men, Cheese and Monkeys
In 2020, I returned from my winter break to find markets were saying “Keep Calm and Carry On” about a virus in China with no human-to-human transmission: “World War Z!” was my response. In 2022, I return from my winter break to hopes the virus is becoming endemic due to the far more infectious but far milder Omicron variant. If so, it’s most likely zoonotic transmission was responsible rather than anything mankind has done: that is to say *if* we can return to normal soon, it will be because of mice, not men. Take the win, but be humble it is the subject of experiments, rather than those in white coats doing them, who may prove the source of salvation.
Back in 2020, I also returned to find markets in hysterics about the US assassination of Iranian hardman Soleimani: “Keep Calm and Carry On!” was my response. In 2022, markets are saying “Keep Calm and Carry On!” about US-Russia hardman tensions: yet war is a fat tail risk in my eyes. Talks Monday produced no results, as Russia’s demands to rewrite Europe’s security architecture to give it a sphere of influence were rejected; further Russian equipment is still moving west from its Far East; the Pentagon says it is monitoring the potential roll out of tactical nuclear weapons(!); Moscow blames a failed “color revolution” for the unrest in Kazakhstan rather than internal politics, framing how the Kremlin may respond elsewhere; and The Guardian’s lead story Tuesday had the same picture of what a Russian offensive may achieve as the worst-case scenario we put forward last April (a bifurcation of Ukraine). We will shortly see another key meeting between Russia and NATO members, but Russia says it isn’t “optimistic” about the outcome.
Notably, except to most Europeans, the EU just suffered the ignominy of having its existential security discussed right over its head by a Great Power it ignores except when selling it cars or taking its gas or oligarchs, and the US Superpower it chaffed at even pre-Trump. Europe was like a child during a divorce, with key decisions being made about its future environment while it plays with “strategic autonomy”. But that’s what you get from impotent, austere, pacifist mercantilism based on the assumption that if the only thing you have isn’t a hammer, then nothing around you can ever be a nail; if Germany drives EU foreign policy, and German exporters drive German foreign policy; if Europe morphs from what The National Review once sneered at as “Cheese-eating surrender monkeys” to the even weaker “Cheese-selling surrender monkeys” reliant on external demand for growth; if Berlin opts for cheap Russian over US gas, which is the only thing stopping the EU from facing insane energy prices right now; and if Lithuania is deleted from China’s trade database over a political spat, and German firms threaten to remove supply chains from a fellow EU member rather than China in response.
As a related aside, yesterday saw new German Economy Minister Habeck say “we will need immigration to address labor shortages” – after the recent election, not before it, naturally. This translates as “we need to keep wage inflation down,” despite the ECB not seeing any sustained sign of it, and implies saving more than is spent, producing more than is consumed, and exporting more than is imported….and then letting everyone else borrow more to do so while tut-tutting at their spendthrift ways. Some see it as a wirtschaftswunder; some as a wirtschafts-blunder; some as Käseverkaufende Kapitulationsaffen. We are talking about the clash between leaders who think only of the world of MICE (e.g., meetings, incentives, conventions, and exhibitions), and those who think of men (in uniform).
But it isn’t just the EU showing schoolboy/think tank/economist naïveté. The White House displayed the same in the recent UN Security Council declaration that "A nuclear war cannot be won and must never be fought." Speaking as someone who, as a child, was dragged to Greenham Common CND marches against the US nukes that helped win the Cold War, let me agree that nuclear war should not be fought. However, if you take nuclear weapons off the table as the country with nuclear superiority then you either eliminate the risk of war entirely —which frenetic rearmament around the world says surprisingly isn’t happening— or you hand the initiative on conventional arms to potential enemies on the other side of the world, and more so given supply snarls are so snarled nothing can get from A to B, even in a war. I won’t quote Vegetius again, but if you don’t know what I mean, start asking yourself if you’d rather live with Uncle Sam or Mother Russia.
Yes, with both US and Australian store shelves looking like 1980’s Soviet or 2020’s British ones (are they both doing Brexit now too?), the West isn’t ready for a war. But that’s the whole point for the other side. (“I say, old chap! This war thing. Can we rearrange it to later next year? It’s awfully inconvenient at the moment, you know. Supply chains and all that, you see.”) Yes, Moscow has a moderate GDP at best with a terrible demographic trajectory, and Russian oligarchs enjoy living in London and New York. Yet oligarchs don’t make foreign policy, Putin does – and he doesn’t like their capital flight, and is taking a far bigger picture view…or just likes expensively playing soldier.
Does a US that won’t fight in Europe and a Europe that can’t fight anywhere scare a Russia that can? Equally, does the threat of US financial sanctions deter Putin when they have not stopped anyone to date and would splinter the global economy, as China would surely not comply, and Europe couldn’t? These also seem a ‘nuclear weapon’ the US is unlikely to use. As such, the likely costs for Moscow are perhaps lower than the potential gains from acting on its comparative advantage —military, food, and energy— to ensure a permanent sphere of influence. In short:
- If the West blinks --and the US Secretary of State is literally Blinken-- it dismantles the global security architecture and emboldens “revisionist powers” everywhere.
- If Moscow blinks, the status quo limps along to the next pushback from one of the “revisionists”, and we see if the EU and White House learn any lessons in the meantime.
- If nobody blinks, your 2022 forecasts are already wrong. We are back to the geopolitics of the 1930’s on WW2’s starting line, and WW1’s too if this spills over into Bosnia with Russian help. (Note the deepening US military presence in Albania.)
Yes, recent wars have only happened to poor people far away who can’t fight back, but the fat tail risks of poor people not so far way being hit are of massive volatility in FX, stocks, bond yields, energy, wheat, aluminium, and potash, which means food prices most everywhere. Crucially, these are *not* too awful to materialize, just as Covid wasn’t. Yet if we are determined to avoid them regardless, then strategic studies experts argue the only logical routes are giving Russia (and others) what they want, which is destabilising, or pushing back aggressively, which is destabilising. On which cheery note, today also sees US inflation, which might have ended 2021 over 7% y/y. Who saw that coming?
Not the economy, as the NFIB survey just showed 22% of US small firms saying inflation is their main problem, up from 1% this time last year.
Not the Fed, where Powell now says inflation will stay high until mid-2022. Wasn’t it mid-2021 this time last year? Is this ‘modelling’ based on an understanding of supply chains, as shipping backlogs at LA/LB port hit record highs, and China shuts down again due to Omicron? Philip Marey’s take is here, with a teaser being: “Powell did his best to come across as an inflation hawk, as did his colleagues in the FOMC in recent days in various speeches and interviews. They squeaked like good little hawks, although looking at the data this is completely incredible.”
Not Wall Street, whose markets don’t fear bombs but are now terrified of looming Fed rate hikes. “Powell Makes Case for Fed Curbing Inflation While Doing No Harm” says Bloomberg soothingly, quoting a man who got every key forecast wrong last year who is asking to keep his job while saying he will implement a policy that always ends badly for both the wealthy people offering it to him and the poor he pretends to also represent, albeit in different ways: “Russia Makes Case for Curbing Ukraine While Doing No Harm” in the same vein.
So, how many hikes this year? 2, 4, 5, 6? Pick a silly number from any one of the usual silly forecasters we have to listen to. And throw that many darts at your own bare feet to see the effect. The Fed will be wrong, as usual. The only question is how bad the damage is as a result.
Joining things up, could war in Europe mean the Fed delays rate hikes and market risk is ironically on again on this one metric alone? Traditionally, yes, on rates: especially if it is an expensive war against people who can actually fight back. However, when you consider the amount of fiscal spending that would have to flow, and what the price of energy and food would be, and the massive supply-chain disruption involved, the argument would probably still favor rate hikes.
So, war and inflation and rate hikes, even if no Covid? At least it means if we *only* get ruinous rate hikes, it’s an improvement! Who says I can’t ever see the upside of things?
Oppenheimer, co-creator of the nuclear bomb, on seeing it first detonated reportedly quoted from the Baghavad Gita: “Now I am become Death, the destroyer of worlds.” His brother, with him at the time, says he actually heard him say, “Well, I guess it worked.” I very much hope somebody is going to be saying the latter about the contradictory mishmash of policies we are opting for, from monetary to fiscal to energy to health to defense.
But it takes real optimism given we are mostly led by mice, not men.