But when trust is gone,
everything is gone, which is the scary conclusion from Dale Copeland’s book:
Economic
Interdependence and War
Reviewing
200 years of history, including the Napoleonic and Crimean wars, the book
explains that “when great powers have positive expectations of the
future trade environment, they want to remain at peace in order to secure the
economic benefits that enhance long-term economic power. When, however, these
expectations turn negative, leaders are likely to fear a loss of access to raw
materials and markets, giving them an incentive to initiate crises to protect their
commercial interests”. This “theory of trade expectations” holds lessons
for understanding not only today’s conflict between the U.S. on the one hand,
and Russia and China on the other, but also the outlook for inflation. Put
simply…
…if there
is trust, trade works. If trust is gone, it doesn’t. Today, trust is gone:
Chimerica does not work anymore and Eurussia does not work either. Instead, we
have a special relationship between
Russia and China, the core economies of the BRICS block and the “king” and the
“queen” on the Eurasian chessboard –
a new “heavenly match”, forged from the divorce of Chimerica and Eurussia…
(….)
Energy transition was the only big item on the
to-do-list before the war and was a formidable economic challenge to begin
with. After the war, the list got longer and so the challenge became even more
formidable.
I think that the above four themes (re-arm, re-shore,
re-stock, and re-wire the electric grid) will be the defining aims of
industrial policy over the next five years. How much the G7 will spend on these
items is an open question, but given that the global order is at stake, they
will likely not be penny pinching. If Tim Geithner were in charge, he’d put “a
lot of money in the window” to show who’s in charge.
And hopefully it will be like that…
…and if so, any investor will have to be mindful that
the above to-do-list is:
(1) commodity intensive
(2) capital intensive
(3) interest rate insensitive
(4) uninvestable for the East
Commodity intensity means that inflation will be a
nagging problem as the West executes on the above list. Re-arming, re-shoring,
re-stocking, and re-wiring need a lot of commodities – it’s a demand shock.
It’s a demand shock in a macro environment in which the commodities sector is
woefully underinvested – a legacy of a decade of ESG policies. Underinvestment
means supply constraints, and geopolitics means even more supply constraints:
resource nationalism – see Russia’s stance or Mexico’s recent decision to nationalize lithium mines – means that the
supply you think is there to meet the surge in demand isn’t there: prices can
thus surge. Executing on the to-do-list can easily drive another
commodity super cycle, like the one we had after China joined the WTO in 2000.
But that super cycle happened in the context of a peaceful, unipolar world
order in which great powers had positive expectations of the future trade
environment (see the “theory of trade expectations” above). But that’s not the
case anymore.
Capital intensity means that
governments and also the private sector will have to borrow long-term to
execute the to-dos. Re-arming and re-stocking are the domains of the
government, and re-shoring and re-wiring the grid will involve public-private
partnerships. Private firms will have to issue debt and raise equity to build
things: ships, F-35s, factories, commodity warehouses, and wind turbines.
Insensitivity
to interest rates means that the to-do-list will have to be executed regardless
of whether the Fed hikes rates to 3.5% or 7%. Hell or high water, executing on
the to-do-list is imperative. Industrial sovereignty depends on it. On the
other hand, private equity is sensitive to interest rates, and industrial
policy done right, with overwhelming force, will eventually “crowd out” private
equity. Finance is about multi-decade cycles. Private equity rode the “lowflation” cycle and the
cycle of globalization that, post-GFC, enabled decades of money printing.
That cycle
is over…
…it broke
like FX pegs broke in 1997 and like private money broke in 2008.
Finally,
uninvestability means that for certain large countries in the global East, it
makes absolutely and categorically no logical sense to roll their investments
in G7 debt claims. Not just because of what happened to Russia’s FX reserves,
but also because rolling a $1 trillion portfolio of U.S. Treasury securities
means that you will fund the West’s effort to re-arm, re-shore, re-stock, and
re-wire…
…against
the East.
And we are
back to where we started on the cover page: Dale Copeland’s theory of trade
expectations is the right frame to think about world from here, and sadly
things make no sense to continue like they used to, be either from a real
(trade/production) perspective or a financial (FX reserves) perspective…
…which is
why Bretton Woods III is destined to happen. It’s already happening, and we
will explore the Bretton Woods III topic in detail in our upcoming dispatch:
War
and Currency Statecraft.
ZOLTAN POZSAR (WAR AND INDUSTRIAL POLICY, 24-08-2022)
https://plus2.credit-suisse.com/shorturlpdf.html?v=5amR-YP34-V&t=-1e4y7st99l5d0a0be21hgr5ht
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