The Kids Aren't Alright

By failing to prepare, you're preparing to fail― Benjamin Franklin

On June 1st, 15 years ago, General Motors filed for Chapter 11 bankruptcy protection, marking one of the most significant industrial bankruptcies in history and a pivotal moment for the US automotive industry. The company had been grappling with challenges for years, struggling to compete with foreign producers, notably Toyota.

It was a dead heat. General Motors sold 9.37 million vehicles worldwide in 2007 and lost $38.7 billion. Toyota sold 9.37 million vehicles in 2007 and made $17.1 billion. That was the second-best total in sales in GM's 100-year history and the biggest loss ever for any automaker in the world. For Toyota, that was roughly $1,800 in profit for every vehicle sold. For GM, it was an average loss of $4,100 for every vehicle sold.

General Motors' 2009 bankruptcy stemmed from a blend of longstanding structural issues and the immediate fallout from the global financial crisis of 2007-2008. Over the years, the company grappled with a bloated cost structure, driven mainly by high labor expenses and substantial legacy obligations, including pensions and healthcare commitments to retirees.

GM's product lineup suffered from quality concerns and a lack of innovation compared to its foreign counterparts. Moreover, its reliance on large, fuel-inefficient vehicles left it vulnerable to fluctuating fuel prices and changing consumer preferences favoring more environmentally friendly options.

The company's fate was sealed as credit tightened during the 2008 financial crisis, exacerbated by pressure from the United Auto Worker union, which had negotiated labor contracts entailing high wages, extensive healthcare benefits, and generous pension plans. Resistance to changes within the company further hindered its ability to adapt to evolving market dynamics and consumer preferences.

Ultimately, General Motors was rescued through government bailout programs in December 2008 and 2009, totaling $69.5 billion in aid. Following its public offering in November 2010, its stock performance has remained lackluster compared to competitors like Honda, Toyota, and Volkswagen, rising only about 29% since its IPO.

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Looking ahead to the present, the landscape of electric vehicles (EVs) has shifted, with Chinese car companies emerging as significant competitors to US EV producers. In response, the White House imposed a 100% tariff on electric cars from China, albeit with limited impact given the minimal importation of Chinese EVs into the US market.

The irony is not lost that President Biden, who once criticized Trump's tariffs against China, has now implemented similar measures.

Trump doesn't get the basics. He thinks his tariffs are being paid by China. Any freshmen econ student could tell you that the American people are paying his tariffs.

Since 2020, the world has experienced a series of rampant economic and geopolitical disruptions, a "series of crises." It all began with the pandemic in 2020, followed by lockdowns, stimulus packages, and monetary expansion. The chain of events continued with the war in Ukraine, the energy crisis, and, most recently, escalating tensions in the Middle East after the massacre in Israel on October 7, when Hamas fighters killed thousands of civilians.

Especially since Russia invaded Ukraine, the global economic and political order has begun to shift from a unipolar structure led by the US to a multipolar one. Therefore, it's worth taking a step back to monitor how recent policy changes affect long-term economic developments and trends. The 2020s have been markedly different from the 2010s so far.

While central banks desperately attempted to stimulate inflation in the previous decade, the massive monetary injections into the economy during the pandemic pushed inflation to uncomfortable highs. The ECB and the Fed had no choice but to act and significantly tighten monetary policy. Consequently, interest rates rose, but inflation continued to climb.

The war in Ukraine exacerbated troubles in energy markets as Europe significantly reduced energy imports from Russia and rushed to purchase liquefied natural gas from the market, driving gas prices to extreme highs. The imbalance between supply and demand led to higher inflation before eventually subsiding as the market moved toward a new equilibrium.

Since then, inflation has decreased substantially, although it still remains above the ECB and the Fed's 2% target. Real interest rates have risen sharply but have not pushed the US economy into recession. Nonetheless, the latest data suggests that the US economy is now beginning to slow down. Europe was in recession and is starting to recover, but I believe the pace of recovery depends on the future trajectory of the US economy.

Both central banks have kept interest rates high and steady for several months now, and it's not implausible that they will remain at current levels for the rest of the year. The ECB may only cut rates 2-3 times, while the Fed might cut rates only once, as it was surprised by the resilience of consumer prices in the first quarter.

Despite the rate hikes, risk assets have rebounded from their initial sell-off when central banks began raising interest rates and have reached new all-time highs. The rise of AI has propelled stocks like NVIDIA to extreme heights, with no end in sight to the rally.

Surprisingly, gold has also performed well despite the rise in real interest rates, reaching new all-time highs. On the other hand, government bonds have experienced two disastrous years, and 2024 doesn't appear to be any better. Some analysts interpret the gold rally as indicating that some countries are trying to move away from US treasuries to gold, driven by purchases from eastern central banks, but this thesis is far from certain.

Given the growing divide between the West and the East, one must conclude that the era of worldwide globalism and relatively free trade is drifting toward protectionism. The US strives to shield itself from Chinese goods and incentivize businesses to relocate production back to American soil by offering subsidies.

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The US Inflation Reduction Act has also caused problems for the Eurozone economy, leading businesses to abandon plans for new facilities on the European continent in favor of projects within the US. Additionally, the ban on Russian energy has put European producers, especially energy-intensive businesses, at a competitive disadvantage.

Despite these challenges, the European Union has aligned more closely with the US and is strongly following its lead in geopolitical matters. Like the US, the EU also plans to protect itself from "unfair business practices" from China, particularly in the green industries.

While the US has only recently begun intensifying efforts to transition towards a greener economy under the Biden administration, the European Union has long been at the forefront of this movement. Both view the 'green transition' as a strategy to stimulate economic growth.

Consequently, both countries plan to invest in building up domestic green industries to create jobs, foster growth, and reduce dependence on China. Chinese businesses have made significant inroads in recent years, with more than half of the world's installed wind turbines now produced in China. Through aggressive pricing policies, China has eroded the market share of European producers, leading many to relocate their production facilities to the US.

However, the green transition faces challenges due to current interest rate levels. Even at lower rates, low-carbon energy, and green technologies heavily rely on government subsidies. With interest rates as they are, these initiatives become even less profitable while the cost of subsidizing them increases.

If implementing the green transition necessitates lower interest rates, governments may exert pressure on central banks and question their independence if rates are not voluntarily reduced. Nevertheless, there is a growing possibility of a recession occurring this year, which could alleviate some of these pressures.

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Currently, the market remains preoccupied with inflation fears, interpreting the sideways trend of recent months as potentially signaling a bottoming out while paying scant attention to the evident slowdown in growth in the United States. Some Federal Reserve officials are further fueling speculation by suggesting that the possibility of additional rate hikes should not be entirely ruled out.

However, this assertion is somewhat of a double-edged sword. If the Fed tries to convince the market that it underestimates the duration of rates remaining at current levels due to stronger-for-longer growth, the yield curve may steepen as long-term rates rise, as has recently occurred. Increasing long-term rates are exerting downward pressure on stocks, inhibiting further growth. The longer this situation persists, the more it weighs on the economy and risk assets, potentially leading to a decline.

Conversely, if the current growth slowdown persists, it could undermine what is purported to be an 'income-driven recovery,' particularly if businesses encounter increasingly price-sensitive consumers and struggle to pass on rising input costs. The latest release of the Federal Reserve's Beige Book indicates such a trend. In such a scenario, an initial rate cut may uplift stocks, but if the slowdown continues, subsequent rate cuts by central banks may drag stocks lower.

Therefore, while the short-term outlook may be somewhat uncertain and heavily dependent on whether the market focuses more on elevated inflation numbers or a potential growth slowdown, both scenarios ultimately point in the same direction for potential long-term developments.

There is an argument that central banks will not return interest rates to the zero bound in the next recession. While I agree that they may not do so immediately, I believe there is a high probability that they will need to do so later. This is because many companies still benefit from borrowing at lower rates before interest rates rose. However, if they borrowed at, for example, 1% in the past, but rates are only cut to 2%, they would still experience a doubling in interest expenses if they need to refinance.

I think central banks may not have a choice if they want to avoid pushing approximately 20% of all businesses, estimated to be 'zombie companies,' to the brink of bankruptcy. Although this would be beneficial in the long run, I doubt they are willing to inflict such short-term pain on the economy.

If this scenario proves correct, the short-term strong disinflationary forces may eventually give way to another push for inflation, driven by another expansion of the money supply. However, due to lag effects, I assume that it’s possible that effect won’t show up until 2026, after a period where CPI in the West falls below the 2% target first.

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However, suppose governments revert to the same policies employed during the pandemic, relying on easy monetary policy and potentially reintroducing quantitative easing to combat the slowdown. In that case, it will merely serve as a temporary, intermediate phase. While the situation in the US remains unclear due to the upcoming elections, the EU will undoubtedly view this as an opportunity to drive the green transition further. The fear of reigniting inflation that this may bring is likely to be dismissed by economists, drawing comparisons to Japan's experience and downplaying potential risks.

In my view, the situation will differ significantly from Japan's scenario. Combined with the monetary response here, it's probable that the EU will respond with increased coordination or centralization, potentially implementing joint bonds regularly. Given the ECB's recent emphasis on 'green monetary policy,' there's no reason to believe this debt won't be monetized.

As this money competes with the private sector for natural, tangible resources, it will increase the general price level. The question then arises whether the US will follow suit and if the Fed will act concurrently. Failure to do so could lead to a significant surge in the dollar.

It's worth noting that both US presidential candidates, Biden and Trump, have pledged to 'bring production back to America.' However, a strong dollar makes this goal much more challenging to achieve than a weaker one, pointing to increasing political pressure on the Fed to weaken the dollar.

While I suspect bond prices will undergo some form of mean reversion and briefly recover from their current lows within 1-1.5 years, the long-term trajectory for bonds still suggests lower values. If inflation picks up again, increasing investors' expectations, demand for long-end bond issuances will decline, as it currently does. However, given the relative nature of the game, it's likely the dollar will still appreciate against most other fiat currencies, except perhaps the Japanese yen or the Swiss franc, which cannot loosen monetary policy to the same extent as the Fed.

There's also a geopolitical component at play here. Regardless of one's stance on ongoing conflicts, it's undeniable that tensions between the US and the EU on one side and China and Russia on the other suggest an increasing likelihood of more proxy conflicts and reduced political diplomacy to resolve them, resulting in diminished trade relationships.

Decreased trade between these entities will necessitate seeking alternative suppliers, driving up demand and prices. Without monetary expansion, this would lead to lower prices in other areas, such as labor, and an increased incentive for innovative investments to reduce resource consumption, albeit over a transition period. As these phases are typically not painless, it's not unreasonable to assume that politicians will opt for the easier route of monetary expansion.

Geopolitical turmoil, expansionary monetary policies, and increasing inflation expectations—sounds like a recipe for gold's success, doesn't it? The 1970s and the recent uptick in Gold/JPY suggest so. However, it depends on whether central banks are willing to apply the brakes as forcefully as they did recently.

Other tangible assets should also benefit, particularly raw materials essential for achieving the green transition and the countries possessing these resources. Given the expected 50% increase in global energy demand by 2050 and chronic underinvestment in the sector, these countries are likely to profit, too, as the world's energy demand cannot be met without oil and gas.

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Each of these policies creates winners and losers. Winners will include those close to governments, such as public workers and big businesses. Investors could also benefit if they interpret developments correctly and invest accordingly. Overall, it's arguable that most winners will be among the wealthier rather than the poorer.

Those with minimal or no assets will bear the brunt of negative consequences, mainly due to high inflation and subsequent erosion of purchasing power. Small businesses will suffer the most from the increasing burden of protectionism and government interventionism. In summary, those with little influence and no ties to governments will likely bear the brunt of such a scenario.

It's not that efforts to create a better and cleaner planet with reduced resource usage should be abandoned. However, it's naive to assume that such goals can be achieved solely through top-down governance and financing via the printing press. In fact, an increased reliance on printing money often fuels a race to consume resources faster.

As governments and central banks increasingly attempt to micromanage economic trajectories, entrepreneurs and businesses veer away from their primary purpose of anticipating consumers’ future needs and desires. Instead, they focus more on predicting government policies and positioning themselves through lobbying to benefit from them.

This scenario hinges heavily on the assumption that politicians will steadfastly pursue their stated objectives. This assumption seems more plausible in the euro area given Christine Lagarde's call for a "complete overhaul of the entire economic and financial system" and the ECB's plans to penalize banks for a "protracted failure to address the impact of climate change."

Designing a utopian world through intellectual circles has long been an ambition, often stemming from good intentions. However, it inevitably leads to the question of how to deal with dissenters who refuse to follow the prescribed path. Historically, force was the standard response, but contemporary politics favor subtler methods like 'nudging,' a concept social scientists advocate.

Nudge is a book by Nobel prize-winning economist Dick Thaler and law professor Cass Sunstein, wherein they describe a system of “libertarian paternalism” for State-directed “choice architectures” to improve public policy outcomes by influencing our behavior through clever framing techniques.

To be clear, I’m not applying the word “paternalism” to their work. That’s their word. Because that’s what they think good government is, a father-knows-best apparatus where we unruly teenagers should be pushed and prodded into making better life choices.

In an increasingly complex world, the likelihood of such endeavors succeeding diminishes, especially considering the numerous historical instances of failed attempts. Moreover, history is replete with unexpected twists, suggesting outcomes may diverge significantly from what's laid out here.

As the saying goes, the road to hell is paved with good intentions. Examining politicians' statements reveals that the 'pretense of knowledge' among policymakers and central bankers today is higher than ever. Given these uncertainties, it's prudent to remain vigilant and prepared.

Chances thrown, nothing's free
Longing for, used to be
Still it's hard, hard to see
Fragile lives, shattered dreams (go!)

The Offspring - The Kids Aren't All Right

Have a great weekend!

Fabian Wintersberger

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All my posts and opinions are purely personal and do not represent the views of any individuals, institutions, or organizations I may be or have been affiliated with, whether professionally or personally. They do not constitute investment advice, and my perspective may change over time in response to evolving facts. It is strongly recommended to seek independent advice and conduct your own research before making investment decisions.