By Michael Every of Rabobank
“Truss-itory” Inflation and Soviet Planning
With US markets closed yesterday for Labor Day all the action was in Europe – and given that Nord Stream 1 had been shuttered and the European Commission had floated war economy style regulations, and Russia then made clear that unless sanctions on it are dropped, no gas will *ever* flow through Nord Stream 1 again, it was no wonder Eurostoxx were down and EUR dipped below 0.99 for the first time in 20 years, as the Dollar wrecking ball momentum continued. (Forcing China to slash banks’ FX reserve requirement ratios from 8% to 6%, which won’t do anything to stop the ongoing slide in CNY for long, sitting at 6.9340 at time of writing this morning in Asia.)
Benchmark Dutch TTF gas was up hugely at first before closing ‘only’ 17% higher on open recognition that while much bad news is now priced in, Europe is really in the economic war I have been warning of.
As pointed out on Twitter, Russia’s move is so blatant there is no way Europe can fudge an agreement with it the way some might have over ‘technical issues’ with the pipeline. (As was Russian President Putin also approving a new foreign policy doctrine backing a “Russian world” covering all Russian speakers, including some in the EU, while building up relations with all the countries the USSR was friendly with to boot.) This is a gun to the EU’s head. So was OPEC+ agreeing on a token 100,000 barrel a day cut to production. So was Iran saying no to the nuclear deal unless the IAEA backs off from investigating the serious breaches of the last nuclear deal it didn’t stick to.
Assuming Europe cannot retreat, that means a severe recession with very high inflation, and if anything were to happen to gas flows via Ukraine, which could easily occur, Europe would need to make swinging cuts to demand in order to avoid unplanned ‘gas outs’. German Economy Minister Habeck just said: “Expect the worst.” As mentioned yesterday, existential choices now need to be made, because there may not enough energy to go round. The choices are obviously unappetising.
First, Germany is to delay mothballing some nuclear reactors – so common sense at gunpoint.
Yet Europe and the UK will not ration energy by price because it means the staggering bills already being seen, and then stagflation, incession, or ‘inpression’ (an inflationary depression). They will instead subsidize businesses and households even if that means wholesale energy prices march even higher. Germany’s latest EUR65bn energy bailout will do just that; so will Sweden’s and the Netherlands’ measures, and France’s and Spain’s: and Brussels is talking about an EU-wide energy price cap. Only part of these subsidies will flow from windfall taxes (which also remove the industry capital needed to invest in new energy supply). New UK PM Truss, just selected with an underwhelming 57% mandate of a tiny Tory electorate, has also floated Covid-furlough sized spending to cap business and household energy bills; and huge tax cuts; and a 2.5% trend GDP growth rate target. Good luck with the latter.
Borrowing or printing money to pay for imported energy (in dollars), while running rising twin deficits is a great way to destroy one’s currency – which means ‘Truss-itory’ inflation, not transitory. So, we must then ration by diktat: but how?
By sector: households or industry? Households freeze and vote. But industry employs households – or doesn’t. (As California tells its drivers who bought EVs to go green that they can’t now charge them because of grid power shortages.)
By industrial energy intensity and shut the ‘sinners’ down? But that ignores the value-chain impact on GDP and employment (i.e., no x, then no y, and if no y, so no z, etc.)
By industry in terms of external realpolitik, i.e., the sectors that produce defence-related goods come first?
By industry in terms of internal realpolitik? i.e., the sectors that employ the most people come first?
By industry for equity? i.,e., all sectors take the same cuts so there can be no favouritism, even if this is totally inefficient?
These are the kind of questions Soviet planned economies asked daily – and got wrong because they had no pricing mechanisms, interest rates, fully-fungible money, external trade, or business/consumer feedback mechanisms like the media or elections. And they all wanted to arm themselves to the teeth for the struggle against US imperialism of course.
This is not a joke.. This is not a blast from the past. This is not an abstract exercise. This is a thought process undoubtedly already underway at the highest levels of some governments, or which I hope to goodness already is. As I have alluded to before, I also hope someone from the army engineers is nearby to help steer the discussion away from the silliness of traditional economics and GDP by demand and towards a national security focused GDP by supply.
Indeed, we also need to invest in the supply side, not just cut it back. Without that, we remain trapped in this purgatory. Will the private sector do it? If they could, they would have, but they didn’t. Now they have windfall taxes too. That is why the European Commission is getting ready to tell them to do so. Presumably with state capital and printed money. Or the state can just do it directly.
But what to invest in? One has to use the same thought process as for rationing, but in reverse. Do we want output for households or industry? Both need energy now. Do we plan energy from ‘sinful’ or ‘sin free’ sources? (As California tells its drivers who bought EVs to go green that they can’t now charge them because of grid power shortages.) But do we look at the crossovers? (i.e., you need sulphuric acid to extract ‘green’ metals like lithium; and you need fossil fuels to produce sulphuric acid; and you need fossil fuels to produce many renewables to some degree…. but the army engineering corps know all this.) Do we look at the downstream value-chain impact on GDP and employment? Do we look at the goods needed for external realpolitik? Do we look at lobbyists and internal realpolitik? Do we just aim for equity?
The Soviet planners had to juggle such output decisions daily – and usually got them wrong because they had no pricing mechanisms, interest rates, fully-fungible money, external trade, or business/consumer feedback mechanisms like the media or elections. And they all wanted to arm themselves to the teeth for the struggle against US imperialism of course.
If you have enjoyed a nice market career forecasting GDP by demand and making macro forecasts within traditional parameters on the back of it, I’m happy for you: what are you planning to do now that skillset becomes that of a Soviet apparatchik after 1991? Get with the plan, and get with the planning – and with the US imperialism!
Yes, we all know how badly governments plan. To which I say: have you met the private sector? And what do we do when the things we need most don’t make money, or won’t do so for decades? Yes, I know that doesn’t stop Silicon Valley – but they have the promise of being monopolists one day, or just selling out early to a greater fool or an existing monopolist.
The central bank all of this is in focus for today, or rather is all a big blur for, is the RBA. The market expectation is that they will hike another 50bps again to take their overnight cash rate to 2.35%; and they still have another three meetings this year. Just weeks ago, the Reserve Bank was trying to peddle the view that the rates peak would be around 3%. The market rightly now sees 4% is far more sensible. Painful as that will be, Australia (where I was just called a “provocateur”, which is a badge I will wear with pride!) is still vastly better off than the UK or Europe. They have summer coming up when we have winter, for one. And they have stuff, even if they also have no planning.