Your Second-To-Last Chance To Get It Wrong In 2022

By Michael Every of Rabobank

Second-to-last chance to get it wrong in ’22!

It’s US inflation day. The median market expectation is 0.3% m-o-m and 7.3% y-o-y headline, and 0.3% m-o-m and 6.1% y-o-y core. Nobody knows what we will actually get. Energy prices are still declining, despite massive opacity over what is actually going on, but there are whispers of another hot number in services similar to Europe. Either way, if you need me to tell you this report will have a large market impact then you are in the wrong job. As such, I am going to talk about things related to inflation, not today’s release.

The IMF Global Debt Database released yesterday showed the largest one-year decline in global public and private debt-to-GDP ratios since the 1950s: it fell 10 percentage points (ppts) in 2021, following the largest one-year increase in 2020, when it soared 29ppts of GDP. I would imagine 2022 has seen an even steeper debt decline in those terms. After all, I am no gold-bug, and SBF just –finally!– got arrested in the Bahamas, but this debt decline is not a bug, it is a feature – it’s always been one of the reasons why we have high inflation. As such, anyone seriously thinking we must get back to low inflation and low nominal GDP growth again when debts are so high is not being serious about our real underlying problems.

Indeed, nominal debt continues to escalate at a terrifying pace in both the public and the private sector. With recession looming, and massive energy bailouts to keep households and industry afloat, and urgent infrastructure funding, and major wars and national defence to cover, to say nothing of striking workers who all deserve better pay deals, public and private debt will only go higher from here. The only issue is if the money goes into productive areas, like supply, as a way to bring inflation down slowly, or unproductive ones, like demand and financial bubbles. We also know that debt will increase even if we try self-destructive efforts to embrace austerity.

The solution offered via austerity is to export one’s way out at everyone else’s expense. China is now mirroring Japan in doing that, as Europe and the US embrace protectionism too. Recent China trade numbers showed both its imports and exports collapsing in y-o-y terms: we are all full of others’ stuff, and nobody is going to be able to rely on external demand to bail them out ahead. But if austerity won’t work, that doesn’t leave a lot of good alternative options.

Relatedly, I got some feedback on a recent Global Daily that made one of its long-running points independently and brilliantly. In short, it noted that the low inflation, low rates, high free trade world was over, not because corporations want it to be, but because the smart ones see it has had all the juice squeezed out of it.

You can’t pay Western workers any less, or outsource any more, and not face ‘Marxian’ consequences: there is no sustainable demand there now – debts are too high, and any new bubbles without physical supply are too inflationary. As such, the only logical path is greater regionalisation and onshoring, even though it is also inflationary, as at least that means higher demand, higher domestic supply to moderate it over time, and greater recycling of capital/profits within a sustainable ecosystem. Of course, geopolitics is accelerating this process. However, it is the lack of final demand at the forefront of some minds – and the solution is clearly no longer ‘lower for longer’. That should be worth considering ahead of US CPI today.

More observant readers might also immediately recognise that “mercantilism” and “the 1930s” are about to make an appearance. But note it was not inflation but deflation, deliberately pushed by Germany’s Brüning to break unions, that led to the 1930s. It was not a race to the bottom in currencies but unsustainable debts post-WW1. Behind WW1 was shifting geopolitics, with British imperial power fading as it lost its mercantile strength outside captive markets, as Germany’s and that of the US rose. That should also be worth considering ahead of US CPI today.

Some do, but get the cause and effect wrong. For example, ‘Let’s not repeat the 1930s’ op-eds, which reject any shift from free-trade globalisation as above, which coincidentally are very helpful to asset prices, point to Europe’s successful building of a new, peaceful economic model post-1945 based on that kind of free trade. However, this is yet another false reading of history: after WW2, European countries continued to fight wars for imperial market share outside Europe – it’s just that they lost them all, leaving intra-European trade as their main fall-back option, until globalisation restarted. Think of France and its Indochinese and North African empire and retreat; Britain and its Middle-Eastern and African territories; and the Dutch and Indonesia. Also recall the Central African Franc and West African Franc, tied to the Euro and run by (and, critics say, for) France, remains in place today for a combined population in 14 countries of 193 million. The key point is free trade –with low inflation– was only adopted via military defeat, not intellectual victory: Europe actually wanted to maintain imperial privilege.

The only country that accepted free trade via victory was the US, and it only did so for a subset of countries: trade was only aimed at helping geopolitical friends. On that front, The Economist yesterday published: ‘Aaron Friedberg says the West should abandon efforts to integrate a hostile, revisionist China: Democracies must recreate a strong liberal bloc and resist authoritarian aggression, says the Princeton professor’. This is a very old theme here, and a very unpopular argument in the rest of the world, including in Europe. However, as a very smart friend remarked to me recently, it pays to play both sides when the US always forgets and moves on, but China is far less forgiving: better to hedge ones bets until the very last moment.

But those moments may be arriving: China has just taken the US to the WTO over its export controls on semiconductors – as Bloomberg reports both Japan and the Netherlands are likely to follow the US lead. Moreover, the US has openly rejected WTO criticism of its aluminium tariffs, saying national security (i.e., supply and jobs) transcends WTO rules.

As such, when you look at things from a structural, political-economy, or geopolitical perspective, it is hard not to see major inflation risks for a long time ahead. That doesn’t mean we can’t get a low US CPI print today –we can– or that we wouldn’t see pockets of deflation alongside a recession next year – we could. But what about after that, if you are trading the long end of the yield curve, or taking a buy-and-hold equity position? Are we really going back to low inflation, low growth, low wage growth, low rates, high debts, high asset prices, and high reliance on China for goods and Russia for commodities?

It’s up to you how you want to play that big picture –most just ignore it in my experience– but today’s US CPI number is your second-to-last chance to get something closer to home wrong in 2022: the final one is the Fed meeting later this week. That’s as the Bank of Canada governor just said he’s more worried about not raising interest rates high enough to quell inflation than he is about inflicting additional economic pain – which should be worth considering as well.