Global Instability
Mon Jul 18 2022
Coming out of the economic drags that is COVID, countries are waking up to the new reality of inflation and the concomitant government rate hikes to fight inflation. Asset bubbles are popping in Real Estate, Stocks, Bitcoin, as investors run for the exit before everyone else. Russia has taken the opportunity to invade Ukraine and China’s political machine has created the zero-covid dystopia. Investors who are risk-off are getting burned by inflation. Investors who are risk-on get sucked into the crashing markets with no end in sight.
The Fed
The role of the Federal Reserve is to keep inflation down and employment high. Despite global uncertainty, US labor market is still very tight. Layoffs are appearing at some tech companies, but so far nothing alarming. In order to clamp down on inflation, rates have to continue to go up so that demand goes down. We’re seeing commodity prices drop for Crude so supply-side inflationary pressure will ease in the near future.
Some are worried that the Fed might cause a recession. It is likely that we are already in a recession but companies are still hiring even though real GDP is negative. The Fed is not worried about recessions because it knows how to get out of a recession (with QE). But the Fed has no experience fighting hyperinflation. They must combat inflation with little regard for recessions until inflation is brought in line and then deploy QE to fight inflation.
If the money supply expansion is on base supply and not a stimulus check then another inflation is unlikely to occur. Stimulus checks cause inflation because they increase the money on hand for those who spend it on CPI-related items without increasing the supply of those items. Base money supply increase impacts assets such as stocks and real-estate and therefore does not impact CPI and does not create inflation.
Sources of Instability
Currently, the war in Ukraine limits the world’s oil and wheat production. Countries are slowing switching to substitutes such as nuclear for energy needs. US is burning through strategic oil reserves and should increase production of oil domestically as longer term solution. Substitutes will alleviate supply-side inflationary forces even if the war in Ukraine does not subside.
The world is as intertwined as ever. Trade between US and China were near all-time historical highs in 2021 despite supply chain challenges due to COVID. Russia’s brazen land-war in Ukraine saw only tepid economic responses from Germany despite the clear political will to impose strong sanctions. Comparative advantage from economic trade is too powerful of a force to sever. And to sever it is to cut yourself off from the progress of the world, with North Korea as a reminder of the pariah status it imposes.
Russia’s cold calculation that the West cannot live without Russian oil so far has been spot on. Russian oil simply takes a more circuitous route through India so the European countries can have plausible deniability (to the benefit of India). Never has the world been so dependent on each other economically, militarily (mutually assured destruction), and culturally.
Financial Systems
The global financial system has one goal, which is to make money. Making money requires stable political and economic systems. The central banks of the world aim to provide a stable economic growth with low inflation so more money can be made. Every financial system aims for greater long-term stability.
Black swan events such as COVID and Putin are destabilizers. As the world adapts to them, the destabilizing forces are absorbed and are no longer effective. The world learns to live with COVID. The world learns to live with a war-torn Ukraine. No one knows how long the Fed will raise rates to counter inflation and no one knows how long the war in Ukraine will go on. But soon, both scenarios will be normalized and compensated for so that economic stability will return and globalization will continue its inexorable march towards greater integration.