Disasterpieces
After a bad year in 2020, I thought that things could not get worse in 2021, and again, I was dead wrong. At the beginning of Q2 in 2022, I have to admit that everything may worsen from year to year in this decade.
Rising inflation worldwide was caused by massive fiscal expansion in 2020 and (gradually) 2021. The war in Ukraine has resulted in additional uncertainty on world markets, leading to even more distortions in the supply/demand price system.
I have to admit that I have stopped digging too much into the current news about the war. It is unbearable for me to see more pictures of destroyed tanks, houses, hurt, and dead people. I feel that, for me, as an individual, it is too hard to filter the information correctly, and that is why I stopped looking at that pictures and videos. The saying that the first casualty of war is the truth is true, especially in times of unfiltered news on social media.
I really do not want to say anything about the war itself. I wish that the killing stops as soon as possible, although I have no idea how it can be achieved.
However, I worry that many (especially economists) are calling for more strict and harder sanctions to bring the Russian Bear down to its knees. Lately, the Washington Post published an article on when sanctions led to success in the 21st Century.
When I read the article, sanctions mostly worked against small countries, and sanctions hardly worked against big countries. The successful ones against former Yugoslavia (1921), India (1965-1967), and South Korea (1975-1976) were exceptions. Additionally, the world has changed, and a rise in global trade and less dependency on the West may be one cause why sanctions have not been very successful, take the sanctions against Iran as an example.
However, many believe that the plan would work if the sanctions were hard enough. Although it is acknowledged that Europe also suffers from them, the argument is that this is worth it. It is for peace; it is for freedom.
Many German economists say that the costs of stopping energy imports from Russia are manageable. However, the German industry sees that differently, for example, the CEO of BASF, Michael Vassiliadis.
Now, the president of the German Bundesnetzagentur (Federal Network Agency for Electricity, Gas, Telecommunications, Post and Railway), Klaus Müller, has warned that a lack of gas might lead to disastrous consequences. I think that it is telling how those people with skin in the game have a contrarian view as all the economists who see a manageable situation.
Halts of production might lead to more unemployment or new programs of Kurzarbeit for a period of unknown length. However, both outcomes imply less income for households, and government transfer payments to support them are putting more fuel on the inflation fire because demand is kept artificially high in times of shrinking supply.
Interestingly, according to the German newspaper FOCUS (which referenced the Swiss Weltwoche), a stop to gas imports would have consequences for Ukraine too:
Can Europe stop importing Russian Gas? Within the discussion, an important detail is missing, as the ‘Weltwoche’ shows: one of the main beneficiaries of Russian gas is Ukraine. The government of Volodymyr Zelensky is making billions in revenue by sending Russian gas to Europe through Ukrainian territory. [own translation]
The article says that more gas has been running through those pipelines since the war started than before. Thus, Ukraine would be affected by a European stop of gas imports too.
While every average citizen I spoke to recently expressed some deep concerns about the current situation, I am still puzzled by the reactions of some European politicians. For example, see the advice from the European commissioner of competition, Margarethe Vestager, a politician from the liberal ALDE group:
Many people suffer from rapid price increases, from energy to commodities, and it seems that no politician cares about that. Just hand out a little free money, and they will be silent.
The performance of the EU is disgraceful, in my opinion. Basically, the EU does the two things it always does when there is a crisis. It does something because one must do something, and in the background, it tries to gain more power. Never let a good crisis go to waste!
On the one hand, the EU commission wants to possibly implement the toughest sanctions on Russia (although some member states are slowing the process down) and forget about the costs to the European economy. It neglects that the planless acting mainly caused the dependency on Russian gas to achieve the Green Transition.
Now the commission plans to cap the import of potash (which is needed for fertilizer production). When we are on the edge of a global food crisis, I consider this a strange move.
I fear that all this might split up the member states again. The reaction to Orban’s election win in Hungary was very telling. Even if you see Orban as a nationalistic populist, one may conclude that parties from the far right and left are gaining votes in times of high uncertainty and rapidly rising prices. If the EU now wants to sanction Hungary, it merely supports Orban’s tale of we versus them (the same might be true for Russia).
Another example is France: A few weeks ago, it seemed that there was no doubt of a win for Macron in this year’s presidential elections. Now, far-right Le Pen and Macron are head to head in the second round Poll of Polls (another poll already sees Le Pen in the lead in Round 2)
On the other hand, the EU wants to increase its power and control over the European citizen. For example, Sebastian Mack, Policy Fellow for European Financial Markets at the Jacques Delors Center, calls for a central asset register within the EU, allegedly to freeze assets from oligarchs more easily.
Even more astonishing is a thread shared on Twitter by Swedish analyst Martin Enlund about an EU panel on Machine Learning. Within the panel, all nine participants agreed that the EU is way behind China and the US regarding AI. The conclusion (the only entrepreneur on the panel disagreed): We are going to build on the success of GDPR and aim to be the REGULATORY LEADER of machine learning. I am sorry, but one has to conclude that these people have no clue what they are doing.
While the EU is occupied with becoming the regulatory leader of machine learning, European businesses are struggling with supply chain bottlenecks. According to an opinion poll from the German IFO Institute, 80 % of German manufacturers talk of shortages of intermediate products in manufacturing.
Of course, it could be a coincidence that the supply-chain situation gets more severe. At the same time, we already see a push-up in price inflation because of the war in Ukraine and the sanctions against Russia because China is sending its people into lockdowns again.
It reminds me of a dystopian novel when you watch the pictures of Shanghai these days. Nobody can leave without permission, and all essential businesses are closed. And as I wrote above, it is not only people but also supply chains that are locked down.
From Bloomberg: Congestion at ports in China and elsewhere around the world is gridlocking about 10% of the global container-ship fleet, according to shipping line Ocean Network Express.
Because of the lockdown in Shenzhen, Shanghai, and other cities, queues have emerged at the ports again, ready to drive up freight prices in the coming months.
So, lockdowns in China make the problems for Europe (and the US) more severe, especially for Europe, because they bear much higher costs for sanctioning Russia than the Americans. I do not know if Xi’s only goal is zero covid here. Probably he wanted to cause more economic damage to the West by implementing lockdowns, but it is up to geopolitical experts to evaluate that.
Who could have seen this coming? Everyone who has paid attention. In November, I wrote about rising gas and fertilizer prices and warned that we would be confronted with high food prices in 2022.
The fact that the fertilizer for this year is already bought does not change anything. As prices climb further, the situation will become more severe in 2023. Africa, in particular, will be struck by rising food prices. Because of strong subsidies for European farmers, local farmers struggle to be competitive, and thus too little food is produced locally to feed the population.
There is a reason why I called this week’s piece Disasterpieces. The current situation on the globe is similar to the feeling when you hear that song by Slipknot. Currently, I see many problems coming up in Europe, and the politicians think that everything will just go away.
In my text, The Great Leap Forward, I also wrote about the measures governments will take to fight the rise in prices, namely price controls and price ceilings. Simultaneously, I argued, they will start to hand out more free money to the people. Sadly, this will not make the situation better but worse.
This brings me to the last Disasterpiece in this text: The performance of the European Central Bank. Observers of financial markets still think that the ECB will turn very hawkish and will be serious about fighting inflation.
Spoiler: It will not.
Two weeks ago, I wrote about Isabel Schnabel’s various kinds of inflation and her proposal to rethink the measurement of inflation by moving the goalposts. Since then, Klaas Knot added the term slowflation to the equation. He used the term when he said that the ECB does not see any signs of a coming recession. I assume that he was referring to a gradual slowdown (but I could be wrong).
On Wednesday, Reuters published some statements by ECB’s Fabio Panetta. Panetta said that the ECB expects prices to stay higher for longer but pointed out that it would be very costly if it brings down inflation. According to him, the ECB sees inflation expectations still anchored at 2 %.
Market participants consider it a hawkish turn that the ECB will end tapering in Q3 of this year. Additionally, Pierre Wunsch (from the Belgian central bank) stated that he would like to see interest rates back at zero at the end of the year, which supports the hawkish expectations of the market.
However, it is telling what Wunsch also said: But I have to say that, even within the ECB, there has been no discussion about raising rates.
No. Discussion. About. Raising. Rates.
If the ECB were really ready to fight inflation, it would have had to act much sooner. But it has not. It watched prices going higher and higher and tried to convince everyone that it was all transitory.
They could have acted at the end of last year but did not. Regarding the ECB, hawkish just means less dovish. The ECB can bring prices down, but it is frightened to prick all the bubbles it has created. It intervenes verbally and hopes that the market does the rest.
While central bankers talk about how serious they are when they talk about fighting inflation, Eurozone PPI YoY climbed to 30 %. That is about three times higher than the previous high from 1982, which is not a Hump.
If one wants to bring down inflation, one has to bring down demand, but that is dangerous given the high debt levels of governments, households, and businesses. The additional geopolitical problems and supply chain disruptions make it even less likely to have a soft landing for the economy. If rates rise, debt levels become a problem, and inflation might get more severe if rates stay artificially low.
Suppose the European people protest against the sanctions at some point in the future because costs become unbearable for them. In that case, the political sphere in Europe could change drastically, probably not for the better.
Have a calm weekend, everyone!
Fabian Wintersberger
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