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By: Frank Knopers
The Western world is on the verge of an economic depression, caused by economic warfare and the powerlessness of central banks. That's what Credit Suisse credit analyst Zoltan Pozsar writes in a New analysis. He explains that the current high inflation is not the result of pent-up demand after the corona crisis, but of economic warfare. This is causing high energy prices and disruptions in international logistics chains, problems that central banks cannot solve with interest rate hikes or bond-buying programs. What does that mean for the global economy?
According to Pozsar, prosperity in Western countries relies to a large extent on cheap labor from China and cheap energy from Russia. These factors ensured that inflation remained relatively low, while our assets in the form of shares and real estate continued to increase in value. As a result, the Western world became richer and richer and central banks could easily keep inflation under control. But due to the war in Ukraine and the sanctions against Russia, energy prices have risen sharply, resulting in high inflation. There is little central banks can do about this, because they cannot influence the cause of this inflation. The cause is a disruption in the supply of energy as a result of political decisions.
According to Pozsar, the only thing central banks can do is to slow down economic growth in such a way that supply and demand come back into balance. That would mean that central banks would have to pursue policies that lead to a drop in demand, falling stock prices and lower house prices. A risky strategy, given the economic uncertainties that already exist as a result of the war and Western sanctions.
There is therefore a good chance that central banks will lose control of this adjustment process and that they will single-handedly cause an economic depression with aggressive interest rate hikes. The risk now is that the Federal Reserve, led by Jerome Powell, will have to raise interest rates to five to six percent and keep interest rates at that level for a long time in order to create enough substantial demand dropouts to bring supply and demand back into balance.
"Central banks are done fighting deflation in an environment of rising asset prices. They are now fighting high inflation by lowering the prices of assets. Central banks need to adapt from a world with too much stuff and insufficient demand to a world with scarcity of stuff and too much demand."
Pozsar warns that war and increasing geopolitical turmoil always have a price-pushing effect. This is reflected not only in high energy prices, but also indirectly as a result of protectionism and deglobalisation. As a result, international trade becomes less efficient and prices for consumers rise. If economic warfare is the real cause of high inflation, then central banks in Western countries have little influence on it. The market will then not get information from press conferences of central banks, but from the actions and statements of the most important heads of government. Interpreting their speeches will become more important than weighing the words of the Lagardes and Powells of this world.
With the disappearance of cheap energy from Russia and increasing tensions between the United States and China, the Western world is risking the prosperity that has so long seemed self-evident. If the situation deteriorates further, we will move from a world with globalisation and economies of scale to a world with de-globalisation and higher prices. If, as a result of economic warfare and sanctions policies by the West, China and Russia become more aligned and join their economic forces, the economic position of the Western world will deteriorate. It could provide the impetus for a Bretton Woods III system, which Pozsar wrote about earlier.
Inflation across Europe and in the United States has not been as high as it is today in decades. This affects not only consumers, but also companies in the wallet. More and more households are at risk of energy poverty as a result of high energy prices. High inflation is normally only seen at the end of an upward economic cycle, but now inflation could remain structural. With all the consequences that this entails for our prosperity and purchasing power. Of this, Pozzar says:
"It's a matter of what perspective you look at. Is inflation cyclical (due to a messy reopening of the economy after the corona crisis) or structural (due to a messy transition to a multipolar world order), in which two major economic powers challenge the hegemony of the US dollar. If the former is the case, then we have already seen the peak of inflation. If the latter is the case, then this inflation is just the beginning. Causing high inflation could even be an instrument of war, because Lenin once said that weakening the currency is the best way to destabilize a capitalist system."
The credit analyst concludes that in this day and age, it is much more important for investors to understand and anticipate the interplay of politics and geopolitics than to align investment policy with central bank actions. That sounds like a good time to add precious metals to the investment portfolio, as the Gold price usually rises in times of geopolitical and social upheaval. Even in a deflationary depression, gold is a safe haven, because in that scenario the price of the precious metal usually falls less than the prices of other asset classes such as stocks and real estate.
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