By Michael Every of Rabobank
The Terrible Twenties and Wonderful News
We are all looking forward to 2023 after another awful year that makes it three in a row in the Terrible, not Roaring, Twenties. As warned, the 2020s have not held the promise of flappers and speakeasys, but the historical replay of the Russian civil war replayed in modern-day Ukraine; a failed German putsch led by right-wingnuts; growing UK labor unrest; and senior members of the Weimar-esque European parliament being arrested with bags of cash following a corruption probe. Yet at this stage, it looks like 2023 will make it four bad years in a row.
Just wait for the delayed impact of the next big rate hike from the Fed, the BOE, and the ECB this week. What a way to finish off a year in which almost everyone in markets, including central banks, got almost everything wrong.
In 2023, imagine no rate cuts, and maybe even further hikes, even as the economy suffers. Imagine the weather finally turning much colder, as it just has in the UK, and wholesale electricity prices soar to new, insane record levels, as it just did. Imagine governments ramming austerity down everyone’s throat again, “because markets”. Imagine mass strikes as a result – even at the ECB. Imagine unions being railroaded to accept ‘uberfication’, as proposed in the UK, or to take a deal they don’t want, as the railroad unions just had to in the US.
On top, we now have the promise of mass middle-class job layoffs due to technology. Indeed, I come back from two weeks off to discover an AI can now write a perfectly adequate Global Daily! In 2019, I was mocking how badly AIs wrote by quoting a film script for a new John Wick movie in its full glorious comedy; now one can write instructions for removing a peanut-butter sandwich from a VCR in the style of the Old Testament as well as Monty Python, which is where I used to excel.
In short, a swathe of media, communications, PR, and secretarial jobs are about to be automated, taking middle-class incomes with them; and in the creative fields too, where working class participation has already collapsed despite the sector’s professed diversity. As any good sociologist, but no economist, will tell you, radicalising the middle class is how you get from a 1923 failed putsch to a 1933 burning down the Reichstag.
On the other hand, the optimists who tried to sell us on the Roaring Twenties now say 2023 will see central banks slash rates…. despite high and rising core inflation in Europe; and/or that governments will hand over cheques to keep the bread and circus rolling, as many US states already are…. when we know what happens when too much demand meets too little supply; and/or that China is pivoting from Covid Zero, and will opt for more over-production and over-investment stimulus… in which case Western commodity inflation will soar – as will the flow of Chinese goods into global markets already trying to buy fewer of them.
What we need is more supply of more things elsewhere: as @elisabethbraw tweeted yesterday, “The state of the world in a nutshell: German arms makers struggling to make ammunition for Ukraine due to a lack of components from China.” As a result, we are already a decade ahead of the 1920s in the historical trend in the international financial architecture – even if Germany is a deliberate passenger in history this time round.
Taiwanese TSMC’s founder says, “Globalization and free trade are almost dead,” as it shifts production to the US. Fashion brand Mango is the latest to shift production from China; Apple is doing so too. It’s now low-hanging fruit to say what I have done since 2015: that the path were on would lead to global mercantilism. Even Europe has now adopted such policy alongside the US (‘Europe First: Brussels gets ready to dump its free trade ideals’), while the UK is still repeating that Brexit means Brexit, and China never stopped doing it. Oil markets, and indeed commodities in general, are becoming completely politicized, with attempts to impose buyers and sellers cartels, and price caps and floors.
Analysis that can easily be replaced by an AI because it shows very little actual intelligence suggests that such a backdrop means the US dollar is finished rather than about to gain a new lease of life. Forget BIS talk of $65 trillion of off-book dollar derivative liabilities on top of our estimates of $50 trillion of on-book ex-US dollar liabilities against ex-US dollar assets of only $7 trillion. After all, Russia is going to legalize crypto! Moreover, China’s Xi went to Saudi Arabia and shook hands rather than fist-bumped, so oil will soon trade in CNY as well as USD!
These Middle East – Middle Kingdom – Middlebrow arguments are wide of the mark. As pointed out earlier in 2022 in ‘Why Bretton Woods 3 Won’t Work’, oil will remain priced in US dollars. Given the Saudi currency effectively *is* the US dollar there is zero incentive to shift away from it, especially into an illiquid, politicised, now-volatile currency whose assets have plummeted in value recently. What we are likely to see, at best, is *some* portion of Saudi-China trade –where the former runs a huge surplus– priced in dollars, but bilaterally cleared without using dollars, e.g., “We won’t send you the dollars for those widgets, and you don’t bother sending us the dollars for the equivalent amount of oil.”
Dollar weakness we have seen of late is not based on geopolitical shifts, just false hopes of what lies ahead for Europe in particular, as well as happy-clapping from the gang who cried ‘Roaring Twenties!’ – that and Fed swaplines as lifelines in the sea of offshore dollar liabilities.
But if the US focuses on its own middle class again, even if this is via blue-collar production of things, not white-collar production of bad TV and movie scripts, media, and PR, etc., which also means recycling income rather than importing goods —and higher rates for longer— then the dollar will also be going higher, not lower, while net exporting currencies such as the EUR and CNY will be going lower, not higher.
In short, I don’t know what 2023 will hold, but the path towards a return to ‘normal’ of 2% GDP growth and 2% CPI is exceptionally narrow, with very fat tail-risks on either side. Indeed, Philip Marey, using a dynamic Nelson-Siegel approach, has just modelled three Fed scenarios:
- If the world evolves according to the FOMC’s projections, the 10-year yield will eventually be on a downward path that in the long run converges to slightly below 2%. (Though Philip still sees no near-term rate cuts.)
- If inflation turns out higher and more persistent, the 10-year yield could first rise to 5.4% in 2024 and then fall back to 3.7% in the long run. (Which would make a mess of a whole new swathe of market positions.)
- If the economy turns out worse than anticipated by the FOMC and stagnates, the 10-year yield could eventually fall into negative territory. (And if the US is negative, you don’t want to imagine where everyone else will be!)
My own Heath-Robinson/Rube Goldberg methodology says the same: if you got everything wrong in 2022 by thinking things couldn’t really get that terrible then wait until you get a load of 2023; and 2024; and 2025, etc. Sorry, but these really are going to be the Terrible Twenties.
The one upside is the wonderful news today that the US, alongside making a huge breakthrough in AI, has also made a potentially world-changing breakthrough in energy technology. US scientists have reportedly managed to achieve successful nuclear fusion, as opposed to fission, energy generation, which has been a holy grail of unlimited, cheap, green energy since the 1950s. Of course, we have had many false dawns in this area before.
Also, even *if* this is true, and both the climate and energy crisis can be solved, does this mean we solve all other problems simultaneously? Hardly! It just shakes the box in all kinds of new ways.
Would the new technology require new, scarce inputs, in the same way electric vehicles do? Would Russia, suddenly without any geopolitical fossil fuel energy muscle, just disappear quietly with its nuclear arsenal? Would the Saudis and other oil and gas producers, many apparently keen to ‘dump the dollar’, do the same as they face economic ruin? Would the US share its amazing new technology with Europe and China, or retain it for its own advantage? Would there be a military angle, as there was with nuclear fission?
Maybe an AI will say otherwise, and probably most market analysts will argue this news screams “Back to 2%!”, but I am presuming the 2020s will continue to see us grapple with the global metacrisis of what the new world order will look like.