– This Is Bare-Knuckle, Geopolitical Street-Fighting:
Let’s start with what may have to be a stand-alone project: the Global D-Oily.
The UK press says the country runs the risk of winter blackouts. The UK government has no plan to ration energy, and PM Truss reportedly just shut down a planned PR campaign to encourage it because she is “ideologically opposed” to such actions. Meanwhile, pubs are reportedly already using candles in places to save money. How romantic: and as you can’t see the prices on the menus properly, it helps you to relax.
The EU just adopted regulation setting 10% voluntary electricity reductions and a mandatory 5% reduction in peak hours. Details to follow, but each state gets to choose how it will do this, and France already suggested it will let each business decide for itself.
The EU and G7 also pressing ahead with price caps on Russian oil exports by a 5 December deadline – or will fall back to a flagged blanket ban on providing insurance and banking services related to such oil trade. So, higher oil prices, as Russia says it won’t sell to any states that impose price caps. The EU is also considering banning Russian metals – which it may not need in its heavy industries that can’t operate without cheap Russian energy.
LNG-carrying vessels are now charging up to $500,000 a day, repeating the madness seen in 2021 container cargo. LNG prices in Europe are going to soar higher. That will impact fertilizer prices, where production is already shutting down; and then food prices. The CEO of Mondelez International on CNBC just said, “Our input costs for the next year are going to be up as much as they are up this year… there will be more food price increases coming in food in my opinion.”
President Biden says he is considering “alternatives to oil”: mithril? Adamantium? Unobtanium? He said he was going to legalise pot straight afterwards by the way. That as Anas Alhajji shares that EV batteries that became water-logged in Florida floods are at risk of corrosion, which could lead to unexpected fires: so when you finally get your EV, after not wondering about where the minerals inside it came from… please keep it dry.
US rage over the OPEC+ production cuts is seeing radical countermoves threatened: the radical ‘NOPEC’ bill to attack OPEC may be attached to the upcoming must-pass National Defence Authorisation Act, so may happen; the White House is refusing to rule out stopping refined energy exports in response; and a bill is to be introduced into Congress to remove US forces and military support from Saudi Arabia. In short, nothing is off the table, and yet again this crisis sees that high prices can mean hoarding, not the neoliberal assumption of ‘high prices cure high prices’.
This is the bare-knuckle geopolitical street-fighting that economists ‘don’t look at’. And who might win? The US, for a panoply of reasons, including that the Saudis are pegged to the dollar, and there is nothing else they could realistically peg to, or a party they could be defended by, without risking a staggering loss of macro-stability, dollar-denominated assets held abroad, and gaining even deeper, longer-lasting pariah status in the West.
Yet a US win would take time, and come at a very high cost to a great many things, including US allies, markets, and the carefully-inculcated image that said markets and US domestic politics/geopolitics don’t have to be studied together by the kind of Wall Street analysts who look at screens and not maps. So, far, far more volatility.
Now, for those with the energy, pun fully intended, back to the original flavor Global Daily.
It’s another payrolls Fridays where it’s either time to stare off into space until that number drops, or to find something more engaging to focus on. Allow me to bridge the gap.
Regular readers know I see an inevitable return to differentiated interest rates by sector within economies as a response to overheated GDP by demand, undercooked GDP by supply, and no traditional combination of fiscal and monetary policy that can address both problems simultaneously.
Earlier this week, one of my colleagues shared a recent research paper from the New York Fed –‘The Financial (In)Stability Real Interest Rate, R**’ (Akinci, Benigno, Del Negro and Queralto)– which argues the US natural real interest rate for the real economy, r*, is not the same as the natural real interest rate for the financial economy, or the “financial stability real interest rate”, r**. In short, “both conceptually and observationally r** differs from the “natural real interest rate” and from the observed real interest rate reflecting a tension in terms of macroeconomic stabilization versus financial stability objectives.”
I was delighted a central bank might recognise the tensions behind the financialised economy and the real economy and, by extension, that one size interest rate does not fit all, least so in geopolitical/geoeconomic crises. Then I read the paper. Let’s just say that the authors and I do not agree on how the world works. In fact, I am not sure anyone but a quant-heavy economist would recognise any of what is described as reality.
Allow me to dig in while you wait for payrolls, if only to show that this kind of thinking ends up as policy recommendations for the people who set the cost of borrowing. Be afraid. Be very afraid. Or annoyed. Very annoyed. Or amused. Very amused. It’s up to you.
First, the paper develops its concept of r** on the framework developed by Gertler and Karadi (2011) and Gertler and Kiyotaki (2015). Why not Minsky, who wrote the book on this topic decades ago. Why not the Minsky model built by Keen? Instead, they refer to a paper that boldly claims, ”We develop a canonical framework to think about credit market frictions and aggregate economic activity,” which ALSO does not lean on Minsky, while claiming Bernanke as a key source(!) The guy who said “sub-prime is contained,” and that high levels of private debt do not suggest a crisis unless you assume vastly different marginal propensities to consume.
Then things get worse. The authors display they do not understand banks –and this from the New York Fed– when stating “financial intermediaries channel funds from households to firms.” Wrong, as even the BOE admitted years ago.
Then we come to their actual model of how the US economy ‘works’, which is surreal:
“2.1 Households
Each household is composed of a constant fraction (1?f) of workers and a fraction f of bankers. Workers supply labour to the firms and return their wages to the household. Each banker manages a financial intermediary (“bank”) and similarly transfers any net earnings back to the household. Within the family there is perfect consumption insurance.”
Yes, my household is 1 banker, me, and 1 “worker”, my wife – but this is hardly representative.
“2.2 Banks
Banks are owned by the households and operated by the bankers within them. In addition to its own equity capital, a bank can obtain external funds from domestic households.”
I don’t own any banks myself. Do you?
“2.2.1 Agency friction and incentive constraint
We follow Gertler and Kiyotaki (2010) in assuming that banks are “specialists” who are efficient at evaluating and monitoring nonfinancial firms and at enforcing contractual obligations with these borrowers. For this reason firms rely solely on banks to obtain funds and there are no contracting frictions between banks and firms.”
Again, these guys don’t know that is NOT what Wall Street does, or how it doesn’t do it.
“2.2.2 The banker’s problem
The bank pays dividends only when it exits. If the exit shock realizes, the banker exits at the beginning of t+1, and simply waits for its asset holdings to mature and then pays the net proceeds to the household. The objective of the bank is to maximize expected terminal pay-outs to the household.”
Now we are in science-fiction. Banks pay dividends all the time to a narrow slice of households. When they exit, they leave the bill with the central bank, who passes it on to workers either directly, or indirectly via inflation and asset-price inflation. The objective of the bank is to make money and exit without going to jail.
Overall, just as the authors use people who did not see financial instability coming as guides over ones who did, they use ridiculous models of the economy rather than the accurate sectoral balance sheets of Godley.
Then we are on to interest rates:
“2.4 Interest rate determination
We assume that the safe rate, Rt, evolves (mostly) exogenously. The goal is to capture fluctuations in the natural real interest rate, without taking a stance on their causes.”
So the base rate of interest ‘just happens’ outside the model! What are we modelling again? That “stuff happens”?
Their final conclusion is that: “as the banking sector becomes more leveraged, the financial stability interest rate becomes lower. This has implications for monetary policy, in that even relatively low levels of the real interest rate could trigger financial instability.” Well done! But Marx said the same in the 19th century; Keynes in the 1930s; Minsky over 40 years ago; Kindleberger in 1978; Godley two decades ago.
The point today –apart from us now being a few minutes closer to payrolls– is that the real economy is not the financial economy. Even as asset inflation reverses, real world inflation is high. Real world supply-side inflation is going to stay high, because production is being shut off to ensure that outcome. (See the Global D-Oily.)
So, we have to have higher interest rates, even if financial markets won’t like it. And rather than an R* to please markets, we may see R**, R***, R****, and R***** –and some of those rates are going to be effectively zero– as governments and central banks jointly decide who is essential and who isn’t in the face of a supply-side economic war.
That is how political-economy worked for a very long time. The post-80’s experiment of one central bank rate to allocate capital where markets most want it to go is as much as an aberration to long-run norms as free trade is to the mercantilism that preceded it, and will likely succeed it.
Now let’s wait for today’s payrolls print. If it matches the ADP number from earlier this week, markets will be screaming ‘Rs’!
Happy Friday.
* * *
PayPal: Donate in USD
PayPal: Donate in EUR
PayPal: Donate in GBP