Black And White Gold + BRICS And Mortars = Inflation

By Michael Every of Rabobank

Black gold, white gold = inflation

Trigger warning: today’s Daily again references big picture issues and literal triggers, rather than the up-and-down xbp or y% of assets a, b, or c.

Except in one regard: markets were juiced yesterday by a major US energy firm announcing it would start share buy-backs on a huge scale. That is despite the backdrop of rising refinery crack spreads and worries about the future upwards trajectory of energy prices. Regardless, financialisation again takes priority over productive investment and production – although the US firm involved points to the regulatory backdrop steering towards a green transition as part of reason for its choice.

On which, the Guardian(!) yesterday “Revealed:” –though it’s no revelation to some– “How US transition to electric cars threatens environmental havoc.” In short, the required lithium is three times current global production, with appalling environmental side-effects and destruction of water tables; and that’s just for the US, not the growing global market.

The Guardian argues the only sustainable solution is to build more walkable US cities with public transport and bicycle options. Which rules out the American Way; and that of Canada and Mexico; Latin America; obviously the Middle East; most of Asia; Australia; even fluffy New Zealand; and Africa too, as it develops. Indeed, we would need an unfeasibly expensive economic geography-economic model redesign to make everywhere work like Amsterdam, nice as that would be. Logically, therefore production of either black gold, oil, and/or white gold, lithium, is going to be needed on a vast, and environmentally damaging scale ahead.

Yet the market is celebrating a return to financialization and share buybacks that produces nothing but inequality and, for the real economy, volatility.

BRICS and mortars = inflation

That backdrop also has enormous geopolitical and geoeconomic implications. Given where many key commodities reside, we recently saw the proposed launch of a pan-LatAm currency, the ‘Sur’, to be used for international trade settlement to replace the US dollar. Russia’s Foreign Minister Lavrov is suggesting 2023 might also see the launch of a new BRICS currency tied to gold at the summit to be held in South Africa at a later date.

Some think that if new bricks in an anti-US wall mean the US dollar is doomed; and gold is picking up of late, with China stepping up its purchases (even if total holdings are still miniscule compared to dollars), which some think makes that case.

However, this new paradigm doesn’t recall how gold worked when it was around – and I mean the true gold standard prevailing before WW1, not the ‘let’s pretend we are on  gold’ that was evident after WW1 and after WW2, both of which broke down.

In the ‘gold old days’, it was used for international trade settlement, and local paper money could be redeemed for it. Banks still made fiat loans. Governments often still spent far more than they taxed.

If the economy overheated, imports flooded in, and gold flooded out. Devaluation of the paper currency vs. gold followed, so imports got more expensive and exports cheaper. The same thing happened if other countries raised the deposit rates they paid on gold above those elsewhere. To prevent painful devaluations, gold deposit rates needed to rise to entice foreign gold back into the country, and/or public spending had to be slashed, or taxes raised, to cool things down.

Overlooking the fact that inflation therefore swung wildly from high rates to deep deflation, because gold was the target, not stable prices, this arrangement was no different from the neoliberalism of the IMF and Wall Street. Brave, anti-imperialist, anti-Western BRICS governments thinking a new, more humanistic path can be paved with gold –with public transport, bicycle lanes, and walkable cities– are deluding themselves. It’s a policy straitjacket.

Globally, it is also a black or white zero-sum game that will see the US weaponize itself, and the dollar, further.

The concept is the BRICS keep their local currencies but switch to a gold-backed currency for trade settlements: freedom! Except you can’t run trade deficits on gold without having an ‘IMF’ policy response forced on you. So, logically:

• The BRICS would have to force the West they export to move onto gold too, and watch them suffer devaluation, deprivation, and desperation for once – how bullish for markets!; or

• The BRICS would accept dollars as settlement, then sell them in the market for the new gold-backed currency – to whom? No BRICS would want dollars, and the West would not use gold; or

• The BRICS would have to decouple from trading with the West and sell all their output to each other… while balancing intra-bloc trade to avoid anyone becoming a Germany to anyone else’s Greece. That’s despite them being commodity exporters, with the exception of China.

Furthermore, this is all going to happen while the West watches impotently on, not seeing an existential threat emerging, even to the wolves of Wall Street. The bloodthirsty world-dominating US imperialists some intellectual BRICS fans decry are also structurally incapable of doing anything at all to snuff out evident threats to their franchise from the disenfranchised. True, the latest heralding of energy-sector share buybacks and the usual inanities at Davos suggest that could be the case. Yet, as always, I urge you to look elsewhere, and at the military.

Western Leopard 2 tanks will now trundle towards Ukraine, although in uncertain, but certainly low numbers. More importantly, the New York Times tweets: “To keep Ukraine’s howitzers firing, the Pentagon will increase its production of 155-mm shells six-fold, to 90,000 rounds per month – raising ammunition production in the US to the highest levels since the Korean War.” Moreover, the Washington Post has an editorial about the $858bn Pentagon budget, and how it adopts wartime purchasing practices. In particular, a provision allows the US military to sign “emergency” multiyear, non-competitive agreements to produce munitions, missiles, rockets, and mortars, aimed at cost-saving via bulk buying, two things the Pentagon has failed badly at for years.

The Post also notes the budget proposal does far more than that: “It lays the foundation for a vastly revitalised defence industrial base – and does so with one eye on the People’s Republic of China.” 25 new mass-assembly lines will soon roll out weapons quantities “far in excess of what is required to replenish Ukraine.” 700 HIMARS systems are ordered vs. the 20 sent to aid Kyiv, and 3,600 of two kinds of anti-ship missile, more appropriate for the South China than the Black Sea.

Concurrently, there is also a lobbying effort underway for the US to start to rebuild its merchant marine, as well as reversing planned cuts to the US Navy.     

Strategically, Vegetius would argue this is the right thing for the US to do, and the Pentagon specifically echoes him in stating, “Production is deterrence.”

More US production of mortars is also a response to the BRICS, and sits alongside the CHIPS Act and Inflation Reduction Act that together bring tech production back home.

However, this boost in production is also inflationary before it eventually moderates via a domestic supply-side response.

I repeat that until now the Ukraine war, and the wider new Cold War, have been fought with INVENTORY run-downs; now they will have to shift to PRODUCTION, reordering economies in the process.

This surge in Pentagon demand against supply constraints in the US defence-industrial sector is going to have a similar effect to that of Covid stimulus (which a recent Fed paper suggests added 2.6 percentage points to headline CPI).

That suggests a risk that the Fed might have to do more on rates than some think it will after its upcoming pause (which the market just got excited about hearing the BOC use too). Indeed, as just shown, an interest rate response was a past method of draining gold from rival countries, and it’s true for the Fed today too; and if means less financialisation and more production, all the better. (Which may be why Wall Street really won’t talk about this.) Plus, the Fed has swap lines it can use, or not, within the hegemonic Eurodollar system.

Also, even if the Fed ignores the Pentagon —highly unlikely– and opts for more financialization, the drop in production –and geopolitical drop in the dollar– would also prove inflationary. Again, that would shock some in markets.

Okay, that’s enough references to big picture issues and literal triggers: please go focus on the up-and-down xbp or y% of assets a, b, or c.