From Credit Suisse, August 24:
War means industry.
Wars cannot be fought with supply chains that crisscross a globalized world, where production happens on faraway, little islands in the South China Sea, from where chips can be transported only if airspaces and straits remain open...
Global supply chains work only in peacetime, but not when the world is at war, be it a hot war or an economic war. The low inflation world had three pillars: cheap immigrant labor keeping nominal wage growth “stagnant” in the U.S., cheap Chinese goods raising real wages amid stagnant nominal wages, and cheap Russian natural gas fueling German industry and Europe more broadly. Implicit in this “trinity” were two giant geo-strategic and geo-economic blocks: Niall Ferguson called the first one “Chimerica”. I will call the other one “Eurussia”.
Both unions were a “heavenly match”: the EU paid euros for cheap Russian gas, the U.S. paid U.S. dollars for cheap Chinese imports, and Russia and China dutifully recycled their earnings into G7 claims. All sides were entangled commercially as well as financially, and as the old wisdom goes, if we trade, everyone benefits and so we won’t fight. But like in any marriage, that’s true only if there is harmony. Harmony is built on trust, and occasional disagreements can only be resolved peacefully provided there is trust. But when trust is gone, everything is gone, which is the scary conclusion from Dale Copeland’s book: Economic Interdependence and War
Reviewing 200 years of history, including the Napoleonic and Crimean wars, the book explains that “when great powers have positive expectations of the future trade environment, they want to remain at peace in order to secure the economic benefits that enhance long-term economic power. When, however, these expectations turn negative, leaders are likely to fear a loss of access to raw materials and markets, giving them an incentive to initiate crises to protect their commercial interests”. This “theory of trade expectations” holds lessons for understanding not only today’s conflict between the U.S. on the one hand, and Russia and China on the other, but also the outlook for inflation. Put simply...
...if there is trust, trade works. If trust is gone, it doesn’t. Today, trust is gone: Chimerica does not work anymore and Eurussia does not work either. Instead, we have a special relationship between Russia and China, the core economies of the BRICS block and the “king” and the “queen” on the Eurasian chessboard – a new “heavenly match”, forged from the divorce of Chimerica and Eurussia..
How did we lose trust? The “cartoon” version goes like this: China got very rich making cheap stuff, and then wanted to build 5G networks globally and make cutting-edge chips with cutting-edge lithography machines, but the U.S. said “no way”. As a result, Chimerica is going through a messy divorce. The two sides don’t talk anymore:
“Pentagon chief’s calls to China go unanswered amid Taiwan crisis” (see here).
Russia got very rich selling cheap gas to Europe, and Germany got very rich selling expensive stuff produced with cheap gas. Current accounts swelled for both. Business was so good that Russia and Germany planned a vow renewal with Nord Stream 2. But the ceremony was called off abruptly and turned into divorce, as one side did something the other couldn’t tolerate. Events unfolded quickly and involved NATO, Ukraine, and the balance of power in continental Europe, and the result is another messy divorce, in which the two sides don’t talk anymore:
“Olaf Scholz says partnership with Putin’s Russia is ‘inconceivable’” (see here).
Finally, the U.S. got very rich by doing QE. But the license for QE came from the “lowflation” regime enabled by cheap exports coming from Russia and China. Naturally, the top of the global economic food chain – the U.S. – doesn’t want the lowflation regime to end, but if Chimerica and Eurussia are over as unions, the lowflation regime will have to end, period. As we noted in our prior dispatch, the special relationship between China and Russia (”Chussia”) is a powerful one: a marriage of commodities and industry, uniting the largest commodity producer (Russia) and the factory of the world (China), potentially in control of Eurasia...
....MUCH MORE (10 page PDF)
