“TV viewers in Russia see only the Kremlin’s version of events in Ukraine,” complained the BBC loudly, earlier this month. While it’s difficult to disagree with that assessment, the same could be said about disinformation spouted by Europe’s or North America’s politicians and dutifully parroted by the mainstream media—not just on the Ukraine topic, but on subjects much closer to home.
Consider President Biden’s June 3 speech, in which he suggested that “families are carrying less debt” and “their average savings are up” since he took office, adding that “more Americans feel financially comfortable.” Of course, he also took the opportunity to refer to America’s inflation as “the Putin price hike”.
Now, let’s take a closer look at the topics the president touched on. Do American families carry less debt? The green line of the Federal Reserve’s chart shows the opposite. Are their average savings up? The red line on the same chart exposes that as a blatant lie.
For fun, let’s also examine the notion of “the Putin price hike”. The chart on the left (data courtesy of the government’s statisticians, red and blue captions added by the author) demonstrates the ominous rise in U.S. consumer price inflation before and after Russia’s invasion of Ukraine.
The question that comes to my mind: is President Biden suffering from dementia, as many have suggested, or is he merely uninformed? Another possibility is that he is an outright sociopath, intent on manipulating and distorting facts whenever it suits his personal agenda. Prudence dictates that I should let you, the reader, come up with the answer. But I’ll say this: if Biden is a sociopath, his affliction is close to the norm in today’s political universe.
Now, having dispensed with the short-comings of our political leaders, let’s for a moment dwell on the media, who are completely aware of the lies and present them as truth. I firmly believe that the abandonment of the mainstream media as a source of information has only just begun. A large part of the population is looking toward independent news sources, which include both idealists intent on providing balanced information and opportunists concocting off-the-wall conspiracy theories. The result, of course, is deepening social division. And as the economic repercussions of decades of misguided policies unfold, things will only get worse.
In my updates over the past year, I’ve repeatedly commented on the two possible outcomes to the current predicament:
- Central banks stick to their promise to contain inflation, aggressively raising rates and ending various market support operations, with the result that the economy will substantially weaken; or
- The weakening economy causes central banks to change course and revert to easing, in which case inflation will become more entrenched.
What’s important to recognize is that both outcomes will cause social dislocation. A deteriorating economy will only aggravate the pain already caused by shortages and price pressures, further weakening consumers’ balance sheet and driving them deeper into debt. Riots are already the norm in numerous emerging economies; it’s easy to foresee similar chaos in parts of Europe and North America.
As I asked in my last update, “The question for the next twelve months: how will people cope with sharply higher food and utility bills, climbing credit card debt, sky-rocketing car loan costs and fuel prices, and higher mortgage payments—all while inflation-adjusted wages are declining?” One possibility is that governments will ramp up fiscal spending and initiate support packages much as they did during the height of the Covid-lockdowns. Unfortunately, that would not only undermine the central banks’ anti-inflation efforts, it would also create a financing challenge. We all know that national finance departments can issue bonds, but their newly issued debt has to be bought by someone. In the past decade, central banks have stepped in, buying bonds in the hundreds of billions. The question now is whether their new anti-inflation platform precludes such support operations.
To complicate things further, central banks and finance ministries aren’t the only factor in our economic and socio-political future. Geopolitics are complicating the situation, as are renewed flare-ups in the pandemic, not to mention entirely unexpected events that could rapidly derail the bit of balance we have left—a climate emergency or a serious cyber-attack, for example.
Financial markets will continue to reflect these realities. The guiding principle of the post 2008 era—that the Fed, thanks to low inflation, can and will do everything to protect the “wealth effect”—has been invalidated, at least for now. Yes, the stock market has bounced back from its recent 20% swoon, but the rebound has so far been unimpressive. A drop to the recent lows and below would not surprise.
But before I move to my review of the markets, let me say a few words about the European Union, most of whose member states are in far worse shape than the United States.
Europe’s Self-Destructive Agenda
So far this year, Europe’s key stock indices have outperformed Wall Street. That is largely due to the sharp decline in the Euro which, under normal circumstances, should help exports. The only problem in the current context: the continent’s manufacturing capacity is severely hamstrung by high commodity prices and shortages. I expect Europe to underperform most of North America and Asia—economically, as well as in financial markets terms.
Yet, major differences will exist between the EU’s member states. That is because the European Union’s harsh rhetoric is by no means shared. Some nations, like Germany, appear supportive of the full sanctions package against Russia and military aid for Ukraine—effectively marching to America’s tune. Others, a lot less so. Take a look at France’s current posture: it’s spending far less on support payments to Ukraine and, due to its established nuclear energy infrastructure, is taking far less of an inflation hit.
All of this will have political consequences. Just as Russia’s invasion of Ukraine has briefly united the continents’ nations, the unequal fall-out that different parts of Europe will have to face, will lead to deep splits.
In the end, what Washington has long feared—an EU that no longer wants to follow the U.S. dominated post-war world order—may well be what Washington will get, largely because of the crippling, U.S.- composed sanctions regime the Europeans decided to mimic. My prediction: within two years, individual European nations will insist on vastly different social and economic platforms, fine-tuning their policies to their own needs. In short, the notion of EU unity is already unravelling, which means that the U.S. hegemony will soon resume its downward trajectory—not because Russia has done anything justifiable or particularly clever, but because the sanctions model has been ill-conceived.
All in all, we are facing an unprecedented confluence of game-changing developments. Importantly, the crises we face are not the result of a pandemic or a military confrontation in Ukraine. Both have been meaningful catalysts, but the cause of the massive dislocations we face is that policies on virtually every front have been allowed to go in an unsustainable direction. Consuming today at tomorrow’s expense, over a period of decades, has grave consequences. We are now entering the tomorrow.
If this is the U.S., imagine Europe
Worse, how the coming adjustment will play out is unknowable. All we can do is reassess the situation as it evolves and make adjustments, and that necessitates flexibility. From an investment viewpoint, it makes sense to maintain a high degree of liquidity, which is why we hold a significant percentage of total assets in cash and gold. Gold has had the added advantage of reducing portfolio volatility and has held up well during the recent period of rising interest rates and dollar strength.
Given our belief that inflation will stay at high levels for considerable time, we see no reason to abandon our position.
Our allocation to equities (roughly 45%) hasn’t changed much, but the components keep undergoing adjustments. In the current inflationary environment we continue to overweight the materials sector (energy, mining, food and fertilizers), as well as companies that have demonstrable pricing power and can generate impressive, sustainable cash flow.
Our 10% bet on bonds has, so far, been a mixed blessing. The portion allocated to Treasury Inflation- Protected Securities (TIPS) has marginally risen, while the 5% invested in ETFs targeting 3-5 year maturities has declined by the same margin.
Our overall mandate remains unchanged. We’ll continue to be prepared for multiple outcomes, and will make adjustments where necessary.
Best wishes,
Peter Cavelti