Macro Trends: Picnicking on the Precipice
I have learnt that economists have the consistency of a stopped clock; the occasions when they are right tend to be overwhelmed by those where they are not.
Sometimes they make the right call but get the timing wrong. That’s the fate of theorists and those preaching underlying value; but being theoretically correct is no substitute for being actually right. Sometimes however, an economist's prognosis is so weak and equivocal that any temporary blip or slight statistical tilt can result in an undeserved victory lap. (1)
Obviously, a year spent working through macro economic equations at Sussex University does not qualify me to be a fully fledged economist. It did however train me in humility and fallibility. So, clown feet to the fore, here I go again, treading into the world of macro economic predictions.
Energy
The Ukrainian War brought into focus the fragility of supply chains but especially energy security. Previously, all conversations around energy concerned the rather lofty goal of eliminating fossil fuels and decarbonisation. Keeping the lights on through security of supply is now the new rock n’ roll for western governments. The Just Stop Oil morons are appearing not only wrong but passé.
The limitations of solar and wind power (intermittency, costly rare metals, storage) needs to be bolstered by a base load provider. I’ve written before about the emerging consensus that nuclear is the way to go. As nuclear has a predictable base load and - uranium aside - is domestically secure, there is an increasing trend towards building new generation IV reactors, increase use of small modular reactors whilst also extending the existing fleet.
Of course, thorium reactors and molten salt processes could (should) be way forward but as with everything concerning nuclear, politics and inertia will get in the way. Reusing nuclear waste also suffers from underinvestment but, with investment, nuclear could go nuclear in a big way in the next few years. (2)
Fossil fuels are not the way of the future but they are the bridge. Prematurely hacking at the supports of this bridge and shutting off financing is a poor policy as new oil fields are becoming harder to find, and harder to exploit. Let’s hope sense prevails as we transition from one energy paradigm to another.
How we pay for energy might however be at an inflection point.
De-dollarisation / Blockchain
The status of the dollar as the world’s reserve currency is under attack. The recent moves of the BRICS nations to explore global payments (especially oil) in currencies other than the dollar is a major development in the last couple of years and was on the agenda of their annual meeting in South Africa recently. (2)
Put simply, if demand for dollars - and inter alia dollar debt - wanes then this will have a major impact on both the system of world trade but particularly the US’s ability to print its way out of trouble. However, there is no agreed alternative medium in sight, for example, none of the BRICS currencies are able to play this role. (3)
The eventual alternative to the dollar will, I’m sure, involve blockchain technology. Potentially the solution could be an exciting amalgamation of both old and new, blockchain technology linked to physical gold. Back to the future indeed!
Could the dollar make a comeback? Let’s look at debt and bond yields.
Debt and Bond Yields
Congress recently raised the debt ceiling and US debt now stands at $33T with no clear path to lower this inexorable rise. Taxes won’t be raised, spending won’t be cut, and so the only solution will be the further issuing of debt to a market increasingly backing away from dollars (see above). Therefore bond yields are rising, forcing the contribution of debt interest to the federal budget to rise concomitantly (currently on a clear and short path to $1T per annum). And those cheap COVID era bonds are having to be refinanced at much higher rates.
The Fed has been trying, weakly, to shrink its balance sheet in 2023. But if demand for USD bonds declines it will have to pivot and start firing up those printing presses again to monetise a growing debt that is both hard to sell and expensive to service. (4)
But QE - as we now know, and should always have known, leads to inflation.
Inflation
The entirely predictable spike in inflation rates over the last couple of years has been lowering over the last few months. This lays bare the real underlying question; what proportion of the increase was due to supply side shocks caused by COVID and what proportion was caused by QE?
So whilst global supply chains have been - to some extent - normalised, what is the residual after effect of printing money? It could be that inflation has been secularised within our system regardless of the price shocks and that higher base levels will be the norm for some time.
And so, to fight inflation, interest rates will remain high, cutting off investment and freezing the housing market. Could this lead to a recession?
Recession?
The primary question over the last year is whether we are heading into a recession and, if we are, will it be a deep recession or a mild one? Most economists thought there would be a recession in the second half of 2023. That seems unlikely but the signals are mixed. Employment numbers remain high, inflation is dropping but above target and COVID hysteria has - mostly - stopped. China opened up this year and supply chains have re-orientated despite the shock of the Ukrainian War and the concomitant sanctions imposed by the West on Russia.
But, inflation remains high, real estate in the US and China is looking precarious (5), western government debt keeps rising along with yields, the banking system has been rocked by the banking collapses, oil prices are rising once more…
I predict a mild recession in 2024. But my longer term view is that unless western governments get to grip with the twin issues of debt and energy, recessions will appear more frequently with lower lows and lower highs.
Coda - Are You Not Entertained? AKA - what do I really think?
I circle around and but finally come out punching. Yes recession next year. Yes, more recessions to come, maybe not huge but more frequent and tracing a downward path unless we sort out energy supply and our governments stop spending money they do not have. I understand Keynesian counter cyclical pump priming but why do our governments always spend more than they have even in good times and either monetise the debt and so cause inflation, or borrow and pass on the liability to future generations?
Well Tim, they do it because they can. What stops them? Fiat currencies have no earthly bounds beyond market tolerance. And that market is broken. We have the current perversity of US analysts right now living in a topsy-turvy world where good news is bad news and bad news is good news. So if employment figures are healthy then markets are depressed because analysts think that tight labour markets mean that the Fed will not lower interest rates. They want BAD news so the Fed will pivot and lower rates and maybe print more money. But QE, as we know, tends to inflate asset prices and so apart from being wrong in so many others ways, also tends towards pushing money to those that have at the expense of those who do not. You don’t have to be a redistributive socialist to be angry about that.
Was it always like this? Did everything depend on central banks and whether funds rates are a half point up or a quarter point down? I suspect not. Maybe, maybe, in the past we produced products of value and investments were made on real value and not cheap money. Maybe.
The answer seems to take away the punch bowel from politicians. Every crisis is met by spending someone else’s money and if that isn’t available, just conjuring it up anyway and causing inflation. But perhaps that’s too easy an answer. Maybe the fault lies in the mirror - our politicians only bribe us with our own money because we let them, want to be convinced they have the answers.
Maybe economics is like salvation; true grace starts from within. And that, my friends, is a much harder journey.
NOTES
1) Which prompts me to relate the old joke about the economist who predicted 15 of the last 2 recessions. Maybe Keynes had it right when asked about what will happen in the long run - “In the long run we are all dead.”
2) I feel a little smug that my (tiny) investments in uranium companies have shown decent growth in 2023. If only all my stock picks were as prescient. More seriously, the 1970’s decision to drop the thorium programme in favour of uranium, seems increasingly dumb. Maybe I’ll explore this further at some future time.
3) The loud discussions in the macro community about de-dollarisation obscures the reality (so far). Whilst central bank reserves of USD have dropped 7% to 59% over the past 7 years, worldwide trade in dollars - according to ING, has hardly moved in that same period. The BRICS conference recently tasked the countries to investigate local and alternative currencies by next year. A related but out of scope issue for rivals to the dollar, is the huge Euro Dollar market which facilitates dollar trades outside the US.
4) Remember the BoE was forced to buy bonds last autumn to prop up the UK pension market.
5) Evergrand crashing and the Chinese real estate market, built on debt and speculation, may cause a large crash of the Chinese market (30% of all activity is real estate related). US real estate may get hit by mortgage rate inertia where people with a low existing mortgage decide it’s not worth moving when the incremental cost of a more expensive mortgage is factored in.
