We posted the front page of the 10-page PDF but something Izabella Kaminska wrote at The Blind Spot about war and financing same reminded me of something Zoltan Pozsar posited.
From Credit Suisse, August 24, 2022:
Page 7:
....I get it why the U.S. wants to invert time. But we can’t win by slowing progress.
We’ll also have to progress by building, and that’s where industrial policy comes in:
as an investor, you care about the inflationary consequences of Russia and China
challenging the U.S. hegemon. Where inflation goes, policy rates go, or if not,
financial repression is an issue. Either way, you care, especially if you are a
bond house or if you depend on fixed income. These are the scary times when
the “euthanasia of the rentier” is a risk. To ensure that the West wins the
economic war – to overcome the risks posed by “our commodities, your problem”;
“chips from our backyard, your problem”; and “our straits, your problem” –
the West will have to pour trillions into four types of projects starting “yesterday”:
(1) re-arm (to defend the world order)
(2) re-shore (to get around blockades)
(3) re-stock and invest (commodities)
(4) re-wire the grid (energy transition)
Similar to how Basel III was the “tab” associated with the Great Financial Crisis,
the above list is the tab for the currently unfolding “Great Crisis of Globalization”.
The four items on the list are self-explanatory. We read about them every day:
Regarding re-arming, Germany plans to spend $100 billion on arms (see here),
the West plans to spend some $750 billion to re-build Ukraine (see here), and
the G7 aims to raise $600 billion to counter China’s Belt and Road (see here)
– yes, the game of chess in Eurasia is also about the Belt and Road Initiative...
Regarding re-shoring, Secretary Raimondo’s focus on chips for the military and
the three new fabs funded by the $52 billion CHIPS Act is just the beginning.
The EU is also busy funding fabs to regain “industrial sovereignty” (see here).
Supply chain issues due to zero-Covid policies will bring home more industries.
Friend-shoring won’t work, as stuff from friends will have to sail through straits,
and what’s the point of friend-shoring if straits can be subject to blockades?
Regarding re-stocking, news of the EU’s natural gas and electricity shortages
need no belaboring: the EU needs to re-stock to keep industry alive and to heat.
The U.S. will also have to re-stock: the SPR will be “empty” by November.
India has instructed all its industrial states to build inventories of coal sufficient
to cover residential and industrial needs for the next three years (see here).
Europe and China are suffering historic droughts at the moment, and this year’s
wheat harvest in Ukraine is missing. Food and energy shortages are looming...
...and commodity inventories will take off like FX reserves after the 1997 crisis,
and will involve not just food and energy but also some industrial commodities.
Regarding re-wiring the grid, governments’ commitment remains unwavering,
even after the war in Ukraine. Energy transition was the only big item on the
to-do-list before the war and was a formidable economic challenge to begin with.
After the war, the list got longer and so the challenge became even more formidable.
I think that the above four themes (re-arm, re-shore, re-stock, and re-wire
the electric grid) will be the defining aims of industrial policy over the next five years.
How much the G7 will spend on these items is an open question, but given that
the global order is at stake, they will likely not be penny pinching. If Tim Geithner
were in charge, he’d put “a lot of money in the window” to show who’s in charge.
And hopefully it will be like that...
...and if so, any investor will have to be mindful that the above to-do-list is:
(1) commodity intensive
(2) capital intensive
(3) interest rate insensitive
(4) uninvestable for the East
Commodity intensity means that inflation will be a nagging problem as the West
executes on the above list. Re-arming, re-shoring, re-stocking, and re-wiring
need a lot of commodities – it’s a demand shock. It’s a demand shock in a
macro environment in which the commodities sector is woefully underinvested –
a legacy of a decade of ESG policies. Underinvestment means supply constraints,
and geopolitics means even more supply constraints: resource nationalism
– see Russia’s stance or Mexico’s recent decision to nationalize lithium mines –
means that the supply you think is there to meet the surge in demand isn’t there:
prices can thus surge. Executing on the to-do-list can easily drive another
commodity super cycle, like the one we had after China joined the WTO in 2000.
But that super cycle happened in the context of a peaceful, unipolar world order
in which great powers had positive expectations of the future trade environment
(see the “theory of trade expectations” above). But that’s not the case anymore.
Capital intensity means that governments and also the private sector will have
to borrow long-term to execute the to-dos. Re-arming and re-stocking are the
domains of the government, and re-shoring and re-wiring the grid will involve
public-private partnerships. Private firms will have to issue debt and raise equity
to build things: ships, F-35s, factories, commodity warehouses, and wind turbines.
Insensitivity to interest rates means that the to-do-list will have to be executed
regardless of whether the Fed hikes rates to 3.5% or 7%. Hell or high water,
executing on the to-do-list is imperative. Industrial sovereignty depends on it.
On the other hand, private equity is sensitive to interest rates, and industrial policy
done right, with overwhelming force, will eventually “crowd out” private equity.
Finance is about multi-decade cycles. Private equity rode the “lowflation” cycle
and the cycle of globalization that, post-GFC, enabled decades of money printing.....
....MUCH MORE
As Ms. Kaminska says, one way or another wars are paid for.
