Sanctions policy is backfiring now
Unintended consequences seem to emerge more and more, when the West resumes and even strengthens the sanction policy on Russia. This is the case both in America and in Europe.
Critical investors’ warnings in America: China – Russia partnership
In America, the critical investors are worried about the foreign policy of the US government in proceeding with the other big powers in the world—Russia and China. Logically, you wouldn’t want Russia and China to team up but to split them apart, which is just basic strategy.
Nonetheless, the US government is bungling this basic geopolitical strategy. Instead, they are causing Russia and China to get together in an alliance against the United States. If Russia and China come together, you have a credible challenger to the US empire. That’s a historical development that changes the whole geopolitical game and that is what we are seeing right before our eyes, having enormous implications for investors’ portfolios.
China will be the bigger challenger to the US soon. So, from the US viewpoint, it would make much more geopolitical sense to ally with Russia to knock China down a peg or two. This is simply pointing out the basic strategy and power dynamics at play and how the US government is fumbling it. In any case, splitting Russia off from China is improbable to happen now. That means we will see Russia and China team up to form a credible geopolitical, economic and financial partnership to the detriment of the US.
The US government is bungling the geopolitical strategy on several levels. It will foster the partnership of Russia and China, which can act as a counterweight to the US. They are creating an alternative monetary and economic system outside of the dollar that billions of people worldwide could use. It’s a nightmare scenario for US strategists unfolding right now. That will have enormous implications for the stock market, the US dollar, the euro and monetary alternatives such as gold, silver and Bitcoin (or digital money). Financial markets have not yet priced in the implications of the US flawed geopolitical strategy. In other words, there is an enormous information asymmetry in the market.
Toxic US Treasury bonds
With near-zero interest rates, investing in US Treasury bonds is a recipe for financial suicide.
Bond yields are so low, they guarantee that you will lose money after accounting for inflation.
Among numerous big American investors, billionaire hedge fund manager Ray Dalio recently argued that, if you invested in US bonds it would take 500 years to get your money back. JP Morgan CEO Jamie Dimon says he wouldn’t touch US government bonds with a 10-foot pole.
The US government has gone overboard with the sanctions. They can wield this financial weapon, because the US dollar is the world’s reserve currency. Sanctions are like an “easy button” to cause economic pain to coerce another country into behaving a certain way. It’s an expedient option but not one that has been thought out well.
Russia is not a tiny, feeble country that can’t punch back. Russia is the world’s largest or second largest exporter of numerous natural necessary resources (like gas, oil, aluminum, nickel, coal, uranium, lumber, wheat, fertilizer and palladium). Aside from China, Russia produces more gold than any other country, accounting for more than 10% of global production. These are just a handful of examples. There are many strategic commodities that Russia dominates. In short, Russia is not just an oil and gas powerhouse but a commodity powerhouse. Europe cannot survive without Russian commodities.
Taking Russian commodities off of global markets would cause an across-the-board price shock that would decimate financial markets, banks, and practically every industry. That’s one reason why the US government’s Russia sanctions are shortsighted. Another reason is that it only makes sense to use sanctions to the extent it doesn’t incentivize the other big powers in the world to create alternative financial institutions. But that is precisely what is happening, and it’s undermining the US dollar’s role as the world’s reserve currency.
Double-digit inflation is now guaranteed and it will be long-lasting
Although Kiev would surrender to Russia and signed the armistice it will not mark the end of the sanctions war but will be an excuse for its actual intensification and indefinite prolongation.
When that becomes the reality, however, inflationary hell will break out all over the world. It now appears that commodities markets have been so drastically roiled by the action to date that Washington’s war on the global trading and payments system is now open-ended and can theoretically go on for years. Double-digit inflation is now guaranteed and it will be long-lasting.
The global outlook for corn supplies has plunged since Russia’s invasion of Ukraine began in late February. The war-torn country supplies a fifth of the world’s corn and could experience a 50% decline in output this year. Corn futures haven’t exceeded $8 a bushel since September 2012, following a devastating drought that damaged crops across the US Midwest. Now supply risks return but for different reasons. A combination of factors has sent corn futures in Chicago to the highest level in a decade as investors fret over dwindling supplies. This shall be a representing example of price hikes of large number of food products worldwide.
The US consumer is starting to fail, near-guaranteeing a recession
Consumer spending powers the economy, making up 68% of GDP here in the US and like it or not, much of that consumer spending is funded by debt – credit cards, mortgages, auto loans, etc. But rising interest rates are now starting to make the cost of that debt more expensive. That trend, combined with increases in the cost of living caused by today’s spiking inflation, is pinching folks’ ability to borrow and spend. More and more signs exist now that the consumer is starting to tap out and should that happen, the risk of recession grows substantially. European consumer is experiencing similar views in the EU and in UK.
US debt saturation: off the cliff we go
When the system can’t borrow more and distribute the insolvency, it implodes.
The basic idea of debt saturation is that we can continue to borrow and spend as long as one of two conditions hold: 1) real (inflation-adjusted) income is rising, so there’s more income to service additional debt, or 2) the cost of borrowing declines so the same income can support more debt.
After 13 long years of declining interest rates and stagnant incomes for the bottom 90% of Americans, we’ve finally reached debt saturation: after dropping to near-zero, interest rates are now rising, pushing the cost of debt service higher, while wages are losing purchasing power (a.k.a. inflation), so there’s less disposable income left to service debt. The game plan for the past 13 years was to fund “growth” today by borrowing vast sums from future incomes.
These fantasies have now run aground on the unforgiving shoals of reality. There’s no way to expand debt if income is losing ground and the cost of borrowing is soaring. There is no trick left to keep expanding debt: rates are rising, not falling, and wages are losing ground to the soaring costs of rent, adjustable mortgages, healthcare, childcare, food, energy, junk fees, property taxes, etc. As for the phantom wealth of bubbles: as rates rise and the Federal Reserve trims its stimulus, all the bubbles will pop. When the system can’t borrow more and distribute the insolvency, it implodes and so off the cliff we go.
Fed’s decision dilemma
We are heading into a truly turbulent situation. What the Federal Reserve does next, could create chaos in the stock market and decimate the value of the US dollar. The US is fast approaching an inflection point and the Fed will be forced to make a fateful decision that will inevitably destroy trillions of dollars in wealth. The Fed has two choices:
1) keep printing trillions and let inflation skyrocket
2) tighten monetary policy and watch the markets crash.
In other words, it can sacrifice the stock market or the dollar.
Stopping the money printing would go a long way to cleansing the economy of its massive distortions. It would be painful in the short term but it would enable the economy to rebuild on a better foundation. However, that is politically unacceptable.
When faced with the choice, politicians usually choose the most expedient option. Therefore, they are likely to choose the easy option – keep printing money and pretend inflation is under control for as long as possible. Further, unless Congress makes some politically impossible decisions to cut spending, the US government will have endless multitrillion-dollar deficits that ever-increasing money printing will have to finance.
The Congressional Budget Office estimates the total deficit between 2021 and 2031 will be close to $20 trillion but that will almost certainly understate the actual numbers. Who is going to finance this, conservatively, $20 trillion shortfall? The only entity capable is the Fed’s printing presses.
But there’s another compelling reason the US government won’t tone down the printing presses. That is because inflation reduces the real debt burden. It allows you to borrow in dollars and repay in dimes.
Inflation is a boon to debtors and there is no bigger debtor in the history of the world than the US government, with its more than $30 trillion debt.
Last staple to the coffin of the EU
the EU is set to declare a full embargo on Russian oil next week, after this weekend’s French election. This will send price of oil above $185 as well as shoot gas price up to sky according to JPMorgan. Why wait until after the election to launch the embargo?
Europe’s bureaucrats are correctly terrified that the coming oil price spike to push the vote in Le Pen’s favor, which is why Europe will wait until after the election (when Macron will supposedly be the next president of France, as Belgium hopes) to announce it publicly.
Despite the clear intentions of Western governments to cripple Russian energy production, loadings of Russian oil have so far been surprisingly resilient, so that Russia’s current account balance is at all-time highs and the USD/rouble ratio has returned to pre-war level (1USD=79-82 roubles).
if Europe follows through on its warning to expand sanctions to all Russian oil, what happens to the price? According to JPMorgan, nothing good. As JPM’s commodity strategist Natasha Kaneva writes, she has reviewed various scenarios should Europe expand its sanctions to include Russian oil and warns that “any immediate embargo measure taken by the European Commission will have a severe impact on the global oil market with risks to price entirely to the upside in the short-term.”
The bank has examined three potential tools the EU could use to sanction Russian oil, from the most aggressive, a full embargo on imports from Russia, to the more conservative, taxes or price caps on Russia oil imports. In any scenario, to avoid the extreme price spikes, the market needs time to adjust.
As JPMorgan states, a full and immediate embargo is likely to hurt European consumers more than Russian producers in the near term. More importantly, a full, immediate ban would likely drive Brent crude oil prices to $185/bbl as more than 4 mbd of Russian oil supplies would be displaced with neither room nor time to re-route them to China, India or other potential substitute buyers.
In any of these scenarios, it is obvious that Russia will turn to friendlier buyers for its exports of crude oil and oil products.China and India have both already ramped up purchases of Russian oil in the past two months and Turkey has also continued to ramp up purchases of Russian oil toward pre-COVID levels in spite of the conflict in Ukraine. Together, these three countries can likely import an additional 1 mbd beyond what they are importing today.
In UK “Fuel Poverty” will crush households into debt abyss
Living standards in Britain continue a death spiral as a large number of customers will go into debt due to soaring power bills, according to Bloomberg. European electric utility executives told MPs on the business, energy, and industrial strategy select committee in parliament that emerging signs show an alarming number of customers have trouble paying their power bills.
In Britain, living costs skyrocket as wages fail to outpace inflation amid rising energy costs. According to the Resolution Foundation, the average family will be paying 1,100 pounds more over the next 12 months to satisfy their energy needs. This will break the bank for lower-income households that will go into debt. To mitigate some of the stress on families, the government pledged a nine-billion-pound rescue package for consumers.
High inflation has pushed the UK Misery Index, an economic indicator to gauge how the average person is doing, to three-decade highs. Energy prices could continue to rise if Europe bans all Russian oil. JPM warned Tuesday that crude could hit $185 a barrel if that happened.
A kinetic war started by Russia quickly evolved into an all-out financial war with the seizure of assets and possession Russia’s FX reserves. Russia in turn seized western jet aircraft worth billions of dollars and the West began seizing Russian Oligarch’s property and yachts in hopes that they would rise up and overthrow Putin. Russia’s decision to use national currency in all international trade represents a new cycle of high stakes. In fact, at high levels in Brussels and Washington elites believe that Putin’s days are numbered but the reality may turn out to be rather different. Anyway, the effect of seizing Russia’s FX reserves will have far ranging consequences.