Page 83 - bne Magazine August 2022

bne August 2022
Opinion 83
Exhibit 3. German 1-year forward baseload electricity since 2008 (Euros per megawatt hour)
• High electricity prices (above) and gas prices (at quadruple the US prices) due to the war in Ukraine are contributing to Germany’s loss of competitiveness, which cannot fuel its export machine. Indeed, for the first time in over 30 years, Germany had a trade deficit. The German economic model is based on cheap Russian energy. Germany willingly threw away the option of nuclear diversification, shutting its nuclear plants.
• A total disruption of Russian hydrocarbon supplies to Europe is now a very real scenario, and would make matters worse.
• Inventory shortages and supply-side disruptions in the fertiliser and food sectors risk creating famine, further price spirals and political unrest. Inventories of key commodities like wheat are extremely low.
• Despite Quantitative Tightening (QT) in the US already having caused so much pain, real interest rates in the US and Europe remain high, and in the case of Europe, the trend is frightening.
Exhibit 4: Eurozone inflation vs. short-term interest rates from 1997 to 2022
• The European Central Bank is in a “damned if you do, damned if you don’t” dilemma. It desperately needs to raise interest rates. However, raising interest rates would put strain on the periphery (e.g. Italy) and further dampen GDP growth.
• On top of all this, we have the consequences and uncertainties from the coronavirus (COVID-19) pandemic and the Ukraine War. Epidemiologists are again raising concerns about the newest variants, while Putin just keeps escalating.
• The above list is far from exhaustive. There are many other vulnerabilities. Certain European banks have equity-to- asset ratios below 3%. Demonstrations are going on by deposit holders in China who cannot withdraw deposits since April. Meanwhile, Evergrande’s default on over $300bn of debt continues to work its way through the system.
Much is already breaking. The economy is rapidly decelerating. In the US, Q1 2022 came in at -1.6% growth; the Atlanta Fed estimates Q2 growth at -2.1%. (Two negative growth quarters make a recession). Danger signals, such as inversion of yield curves and reverse repos at new records, are flashing.
“The number of emerging market countries experiencing a crisis is increasing by the month. High US interest rates are sucking moneys out of emerging markets into the US”
The trillion dollar question is when the US Fed will pivot from Quantitative Tightening (QT) to Quantitative Easing (QE). It is the high levels of debt that could make the next crash the most dramatic of this century.
Powell seems to think that there is a feedback loop, whereby high interest rates are enough to drive down inflation.
But what if other things (increased money supply, supply bottlenecks, inflation expectations, etc) keep inflation from responding? The economy may crash before inflation comes down.
Think of a dry forest with an accumulation of flammable undergrowth. There may never be a forest fire; but one tiny spark has the potential to cause a conflagration.
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