WorldoutofWhack

Posted on March 28, 2022 by Gail Tverberg

Most people have a preconceived notion that there will be a clear winner and loser from any war. In their view, the world economy will go on, much as before, after the war is “won” by one side or the other. In my view, we are basically dealing with a no-win situation. No matter what the outcome, the world economy will be worse off after the fighting stops.

The problem the world economy is up against is the depletion of many kinds of resources simultaneously. This depletion is made worse by rising population, meaning that the resources available need to provide an adequate living for an increasing number of world inhabitants. Because of depletion, the world economy is reaching a point where it can no longer grow in the way it has in the past. Inflation, food shortages and rolling blackouts are likely to become increasing problems in many parts of the world. Eventually, the population is likely to fall.

We are living in a world that is beginning to behave like the players scrambling for seats in a game of musical chairs. In each round of a musical chairs game, one chair is removed from the circle. The players in the game must walk around the outside of the circle. When the music stops, all the players scramble for the remaining chairs. Someone gets left out.

In this post, I will try to explain some of the issues.

[1] In a world with inadequate resources relative to population, conflicts are likely to become increasingly common.

The Russia-Ukraine conflict is one example of a resource-associated conflict. The allies underlying the NATO organization have chosen to escalate the Russia-Ukraine conflict, in part, because the existence of the conflict helps to hide resource shortages and accompanying high prices that are already taking place. No matter how the war is stopped, the underlying resource shortage issue will continue to exist. Therefore, the conflict cannot end well.

If sanctions lead to less trade with Russia, (or even worse, less trade with Russia and China), the world economy will have an even greater problem with inadequate resources after the war is over. In fact, many parts of the current economic system are in danger of failing, primarily because depletion is leading to too little energy and other resources per capita. For example, the US dollar may lose its reserve currency status, the world debt bubble may pop, and globalization may take a major step backward.

[2] There is a huge resource depletion issue that authorities in many countries have known about for a very long time. The issue is so frightening that authorities have chosen not to explain it to the general population.

Mainstream media (MSM) practically never mentions that there is a major issue with resource depletion. Instead, MSM tells a narrative about “transitioning to a lower carbon economy,” without mentioning that this transition is out of necessity: The world is up against extraction limits for many kinds of resources. Besides oil, coal and natural gas, resources with limits include many other minerals, such as copper, lithium, and nickel. Other resources, including fresh water and minerals used for fertilizer are also only available in limited supply. MSM fails to tell us that there is no evidence that a transition to a low carbon economy can actually be made.

[3] The big depletion issue is affordability of end products made with high priced resources. The cost of extraction rises, but the ability of the world’s citizens to pay for end products made using these high-cost resources doesn’t rise. Commodity prices do not rise enough to cover the rising cost of extraction. When this affordability limit is hit, it is the resource extracting countries, such as Russia, that find themselves in a terrible situation with respect to the financial well-being of their populations.

The big issue that hits because of depletion is a price conflict. Businesses extracting resources need high prices so that they can reinvest in new mines, in ever more costly locations, but consumers cannot afford these high prices.

In a sense, the higher cost is because of “inefficiency.” As a result of depletion, it takes more hours of labor, more machine time, and a greater use of energy products to extract the same quantity of a given resource that was previously extracted elsewhere. Growing efficiency tends to help wages, but growing inefficiency tends to work the opposite way: Wages don’t rise, certainly not as rapidly as prices of end products.

As a result, commodity exporters, such as Russia, are caught in a bind: They cannot raise prices enough to make new investments profitable. The problem is that the world’s consumers cannot afford the resulting high prices of essentials such as food, electricity and transportation. Russia reports very high reserve amounts, especially for natural gas and coal. It is doubtful, however, that these reserves can actually be extracted. Over the long term, selling prices cannot be maintained at a sufficiently high level to cover the huge cost of extracting, transporting and refining these resources.

The success of a country’s economy can, in some sense, be measured by the country’s per capita GDP. Russia’s GDP per capita has tended to lag far behind that of the US (Figure 2).

Russia’s inflation-adjusted GDP per capita fell after the collapse of the central government of the Soviet Union in 1991. It was able to grow again, once oil prices began to rise in the early 2000s. Since 2013, Russia’s GDP per capita growth has again fallen behind that of the US, as increases in oil and other commodity prices again lagged the rising cost of production. Given these difficulties with depletion, Russia is becoming increasingly unwilling to ignore poor treatment it receives from Ukraine.

There may be another factor, as well, leading especially to the escalation of the conflict. The US seems to covet Russia’s resources. Some powers behind the throne seem to believe that Western forces supporting Ukraine can quickly win in this conflict. If such an early win occurs, the aim is for Western forces to step in and inexpensively ramp up Russian resource extraction, allowing the world a new source of cheap-to-produce fossil fuels and other minerals.

In this context, Russia launched an attack on Ukraine on February 24, 2022. Ukraine has presented Russia with problems for many years. One issue has been transit fees for natural gas passing through the country; is Ukraine taking too much gas out? Another problem area has been the rise of the far-right Azov regiment. Russia has also expressed concern that NATO has been training soldiers within Ukraine, even though Ukraine is not a member of NATO. Russia doesn’t want military, trained by NATO, at its doorstep.

[4] World economic growth very much depends on growing energy consumption.

There are two ways of measuring world GDP. The standard one is with the production of each country measured in inflation-adjusted US$, with the changing relative value to the US$ considered. The other approach uses “Purchasing Power Parity” GDP. The latter is supposedly not affected by the changing level of the dollar, relative to other currencies. Inflation-Adjusted Purchasing Power Parity GDP is only available for 1990 and subsequent years. Figure 3 shows the high correlation between energy consumption and PPP GDP during the period from 1990 through 2020.

The reason for a strong association between GDP growth with energy consumption growth is a physics-based reason. Producing goods and providing services requires the “dissipation” of energy products because the laws of physics tell us that energy is required to move any object from one place to another, or to heat any object. In the latter case, it is the individual molecules within a substance that move faster and faster as they get hotter. The economy is a “dissipative structure” in physics terms because of the need for energy dissipation to provide the work needed to make the system operate.

Human beings are also dissipative structures. The energy that humans get comes from the dissipation of the energy found in foods of every kind. Food energy is commonly measured in Calories (technically, kilocalories).

[5] World economic growth also seems to depend on factors besides energy consumption.

The fitted equation on Figure 3 (the equation beginning with “y”) implies that GDP is rising much more rapidly than energy consumption, almost twice as rapidly. Over the entire 30-year period, the actual growth rate in energy consumption averages about 1.8% a year. If energy consumption growth had really been 1.8% per year, the fitted equation implies that growth in GDP would have greatly sped up over the period. (In fact, the growth rate in energy consumption was falling over the 30-year period, but GDP grew at closer to a constant rate. In terms of the fitted equation, these two conditions are equivalent.)

How can GDP rise so much more rapidly than energy dissipation? There seem to be several ways such a higher rate of increase can occur, on a temporary basis:

[a] A worldwide trend toward an economy using more services. The production of services tends to require less energy consumption than the production of essential goods, such as food, water, housing and local transportation. As the world economy gets wealthier, it can afford to add more services, such as education, healthcare, and childcare.

[b] A worldwide trend toward more wage and wealth disparity. Such a trend tends to happen with more specialization and more globalization. Strangely enough, a trend to more wage disparity allows the world economy to continue to grow without adding a proportionately greater amount of energy consumption use because of the different spending patterns between low-paid workers and high-paid workers.

Analyzing the situation, the world is filled mostly with low-paid workers. To the extent that the pay of these low-paid workers can be squeezed down, it can prevent these workers from buying goods that tend to use relatively high amounts of energy products, such as automobiles, motorcycles and modern homes. At the same time, growing wage disparity allows the higher-paid workers to be paid more. These higher-paid workers tend to spend a disproportionate share of their income on services, such as education and healthcare, which tend to use less energy consumption.

Thus, greater wage disparity tends to shift spending away from goods and toward services. The main beneficiaries are the top 1% of workers (who buy mostly services, requiring little energy consumption), rather than the remaining 99% (who would really like goods such as a car and their own home, which require much more energy consumption).

[c] Improvements in technology. Improvements in technology are helpful in raising GDP because technological improvements tend to make finished goods and services more affordable. With greater affordability, more people can afford goods and services. This effect is favorable for allowing the economy, as measured by GDP, to grow more quickly than energy consumption.

There is a catch associated with using improved technology to make goods and services more affordable. Improved technology tends to increase wage disparity because it nearly always leads to owners and a few highly educated workers being paid more, while workers doing the more routine parts of processes are paid less. Thus, it tends to lead to the problem discussed above: [b] A trend toward wage and wealth disparity.

Also, with improved technology, available resources tend to be depleted more quickly than without improved technology. This happens because finished goods are less expensive, so more people can afford them. Once resources start getting exhausted, improved technology can’t fix the situation because resource extraction costs are likely to rise more rapidly than can be offset with the impact of new technology.

[d] A worldwide trend toward more debt at ever-lower interest rates.

We all know that the monthly payment required to purchase a car or home is lower if the interest rate on the debt used to finance the purchase is lower. Thus, falling interest rates can make paychecks go further. Both businesses and citizens can afford to purchase more goods and services using credit, so the overall level of debt tends to rise with falling interest rates.

If we are only considering the period from 1990 to the present, the trend is clearly toward lower interest rates. These lower interest rates are part of what is making the GDP growth higher than what would be expected if interest rates and debt levels remained constant.

[6] The world economy now seems to be reaching limits with respect to many of the variables allowing world economic growth to continue as it has in the past, as discussed in Sections [4] and [5], above.

Figure 6 shows that there have been two major step-downs in world inflation-adjusted per capita PPP GDP. The first one occurred in the 2008-2009 period; the second one occurred in 2020. Figure 7 shows the sharp dips in energy consumption occurring in the same time periods.

In 2021, energy prices started to rise rapidly when the world economy tried to reopen. This rapid rise in prices strongly suggests that energy extraction limits are being reached.

Another clue that energy production limits are being reached comes from the fact that the group of oil exporters, OPEC+, found that they couldn’t actually ramp up their oil production as quickly as they promised. Once oil production is cut back because of inadequate prices, it is hard to get production to rise again, even if prices temporarily rise because the many pieces of the chain supporting this extraction are broken. For example, trained workers leave and find jobs elsewhere, and contractors go out of business because of inadequate profits.

If we think about it, Items [5a], [5b], [5c] and [5d] are all reaching limits as well. Item [5d] is probably clearest: Interest rates can no longer be lowered. In fact, nearly everyone says that interest rates should now be raised because of the high inflation rates. If interest rates are raised, commodity prices, including prices for fossil fuels, will fall.

With lower fossil fuel prices, there will be pressure for oil, gas and coal producers to reduce their production, even from today’s lower levels. Because of the tight connection between energy and GDP, lower energy production will tend to push economies further toward contraction. Of course, this will make resource exporters, such as Russia, worse off.

As the world economy enters recession, we can expect that Item [5a], the shift from goods toward services, to turn around. People with barely enough money for necessities will reduce their use of services such as haircuts and music lessons. Item [5b], globalization and related wage disparity, is already under pressure. Countries are finding that with broken supply chains, more local production is needed. In the US, recent wage gains have tended to go to the lowest-paid workers. Item [5c], technology growth, cannot ramp up as resources needed from around the world are increasingly unavailable, due to broken supply chains and depletion.

[7] We are likely facing a collapsing world economy because of the limits being reached. Adding sanctions against Russia will further push the world economy in the direction of collapse.

Many sources report that Russian exports of wheat, aluminum, nickel, and fertilizers will be “temporarily” disrupted. A few sources note that Russia plays an important role in the processing of uranium fuel used in nuclear power plants. According to the Conversation:

Most of the 32 countries that use nuclear power rely on Russia for some part of their nuclear fuel supply chain.

We have become used to efficient air travel, but sanctions against Russia make this less possible, especially for flights to Southeast Asia. A Bloomberg article called Siberian detour requires airlines to retrace cold war era routes gives the example of direct flights from Finland to Southeast Asia being canceled because they have become too expensive and are too time-consuming with the required detours. It becomes necessary to fly indirect connecting routes if a person wants to travel. Many other routes have similar problems.

US President Joseph Biden is warning that food shortages are likely in many parts of the world as a result of the sanctions placed against Russia.

According to a video shown on Zerohedge,

“It’sgoing to be real. The price of the sanctions is not just imposed upon Russia. It’s imposed upon an awful lot of countries as well, including European countries and our country as well.”

If the world economy was doing well, and if Russia was a tiny part of the world economy, perhaps the sanctions could be tolerated by the world economy. As it is, the Russia-Ukraine conflict acts to hide the underlying resource shortage problem. This is possible because, with the conflict, the resource shortages can be described as “temporary” and “necessary” in the context of the terrible things the Russians are doing. The way the West frames the problem provides a scapegoat to deflect anger toward, but it doesn’t fix the problem.

Russia started out being very disadvantaged because commodity prices, in recent years, have not been rising high enough to ensure an adequate living for Russian citizens and high enough tax revenue for the Russian government. Adding sanctions against Russia will simply make Russia’s problems worse.

[8] There is little reason to believe that Russia will “give up” in response to sanctions imposed by the United States and other countries.

The attacks by Russia of Ukrainian sites seems to be occurring, for many related reasons. It can no longer tolerate being inadequately compensated for the resources it is extracting and selling to Ukraine and the rest of the world. It is tired of being “pushed around” by the rich economies, especially the United States, as NATO adds more countries. It is also tired of NATO training Ukrainian soldiers. Russia seems to have no plan to gain the entire territory of Ukraine; it is more of a temporary police action.

Russia’s underlying problem is that it can no longer produce commodities that the world wants as inexpensively as the world demands. Building all the infrastructure needed to extract and ship more fossil fuel resources would take more capital spending than Russia can afford. The selling price will never rise high enough to justify these investments, including the cost of the Nord Stream 2 pipeline. Russia has nothing to lose at this point. The current situation is not working; going back to it is no incentive for stopping the current conflict.

Russia is in some ways like a heavily armed, suicidal old man, who can no longer earn an adequate living. The economic system of Russia is no longer working as it should. Russia is incredibly well-armed. The situation reminds a person of the story of Samson, in his old age, taking down the temple of the Philistines and losing his own life at the same time. Russia has no reason to back down in response to sanctions.

[9] Leaders of the world, including Joe Biden, appear to be oblivious to the situation we are facing.

Leaders of the world have created ridiculous narratives that overlook the critical role commodities play. They seem to believe that it is possible to cut off purchases from Russia with, at most, temporary harm to the rest of the world economy.

The history of the world shows that the populations of many civilizations have outgrown their resource bases and have collapsed. Physics points out that this outcome is almost inevitable because of the way the Universe is constructed. Everything is constantly evolving, even economies. The climate is constantly evolving, as are the species inhabiting the Earth.

Elected leaders need a story of everlasting growth that they can tell their citizens. They cannot even consider the physics-based way the world economy operates, and the resulting expected pattern of overshoot and collapse. Modelers of what are intended to be long-lasting structures cannot accept this outcome either.

Limits which are defined based on affordability of end products are incredibly difficult to model, so creative narratives have been developed suggesting that humans can move away from fossil fuels if they so desire. No one stops to think that economies cannot continue to exist using a much lower quantity of energy, any more than an adult human can get along on 500 calories a day. Both are dissipative structures; the ongoing energy requirement is built in. Factories close when electricity, diesel and other energy products are cut off.

[10] The sanctions and the Russia-Ukraine conflict cannot end well.

The world economy is already on the edge of collapse because of the resource limits it is hitting. Intentionally stopping Russia’s output of resources like fertilizer and processed uranium is certain to make the situation worse, not better. Once Russia’s output is stopped, it is likely to be impossible to restart Russia’s production at the same level. Trained workers who lose their jobs will likely find jobs elsewhere, for one thing. The shortfall in output will affect countries around the world.

The United States dollar is now the world’s reserve currency. The sanctions being applied indirectly encourage counties to use other currencies to work around the sanctions. There seems to be a substantial chance that the US economy will lose its role as the center of international trade. If such a change takes place, the US will no longer be able to import far more than it exports, year after year.

A major issue is the huge amount of debt most countries of the world have. With a rapidly slowing world economy, repaying debt with interest will become impossible. Debt defaults will further wreak havoc with the world economic system.

We don’t know the exact timing of how this will play out, but the situation does not look good.

by QTR’s Fringe Finance via Zerohedge.com

It was just a couple of weeks ago that I wrote an article arguing that the economic sanctions we have cast upon in Russia, due to its invasion of Ukraine, likely mark the beginning of a period where China and Russia would bifurcate the global monetary system, leading them to eventually challenge the U.S. dollar’s reserve status. 

Now, Saudi Arabia is joining the fray, further threatening to tip the balance of the global monetary scales that have kept the U.S. dollar afloat for decades.

The fact that predictions of a “new economy” and “new monetary system” only exist on fringe blogs like mine and haven’t gone mainstream given the current economic situation with Russia (even amidst our abuses of printing the dollar over the last several decades) is baffling to me.

As I noted to Andy Schectman in a recent podcast, our quality of life in the United States and our nation’s entire economy is an elephant balancing, on one leg, on the toothpick of the U.S. dollar’s reserve status.

Our quality of life relies solely in our unique ability to import the goods and services that we use and need on a daily basis, while exporting US dollars. We’ve been able to print trillions of U.S. dollars into existence over the last couple of years – monetary policy that is anything but sound, regardless of whether or not your currency has global reserve status – because of the luxuries afforded to us by the dollar’s global reserve status.

But this reserve status, and the $30 trillion in debt we have accrued and convinced ourselves we will never have to pay, quickly go from being long-term liabilities that we can theoretically ignore to current liabilities that we must address if the dollar is ever legitimately challenged.

Challenging the dollar’s reserve status would be an obvious and immediate catalyst that would flip everything we think we know about economics in our country on its head. Our monetary policy blind spots, that we have been willfully ignoring for decades, would instantly become leverage for the rest of the world.

The stage appears to remain set for this to happen. Globally, if you are an enemy of the United States, the situation hasn’t looked better to challenge the U.S. dollar, maybe ever, than it does now:

• We have run up a mountain of debt and grossly expanded our money supply in an extremely short period of time
• We are the most reliant we have ever been on other countries to import goods and services
• We have a presidential administration that (1) doesn’t understand basic economics and (2) is limiting our nation’s ability to produce commodities, which act as a foundation for a country’s inherent wealth
• We are about to enter into a economic recession
• Inflation is setting records and is already bankrupting the middle and lower class of our nation, before even considering a potential challenge to the dollar

And while a week or two ago I was only worried about China and Russia, now that the world has been forced to pick economic sides, other nations are throwing their respective hats in the ring, too.

Saudi Arabia, which is a nation of major consequence economically due to its significant oil and gas reserves, has reportedly embraced the idea of accepting Yuan instead of dollars for Chinese oil sales.

Not unlike Russia and China’s plans to de-dollarize, that date back nearly a decade, the Saudis have been considering this idea for six years already. And not unlike Russia and China’s new economic tie-up, the catalyst for speeding up the process has been U.S. foreign policy:

Saudi Arabia is in active talks with Beijing to price some of its oil sales to China in yuan, people familiar with the matter said, a move that would dent the U.S. dollar’s dominance of the global petroleum market and mark another shift by the world’s top crude exporter toward Asia.

The talks with China over yuan-priced oil contracts have been off and on for six years but have accelerated this year as the Saudis have grown increasingly unhappy with decades-old U.S. security commitments to defend the kingdom, the people said.

The consideration by Saudi Arabia is consequential.

It shows that other nations, when forced to choose sides between the U.S. and its foes, don’t feel obligated to commit to the U.S. dollar, further undermining the world’s perception about the dollar’s strength.

Not unlike Russia, Saudi Arabia is a country that, regardless of how much its currency may “devalue” versus a fiat basket of currencies, is still backed by finite resources.

This gives the country and its currency intrinsic strength. Russia seems to understand this. In fact, just this morning, Russian Foreign Minister Sergei Lavrov, likely alluding to this fact, said that economic sanctions against Russia make the country “stronger”.

Saudi Arabia is now another serious name on the list of contenders who have the currency bite to back up the economic rhetoric bark of challenging the dollar.

As The Wall Street Journal notes, the Saudis have “traded oil exclusively in dollars since 1974, in a deal with the Nixon administration that included security guarantees for the kingdom.”

The U.S. dollar’s ties to oil have been crucial in helping prop up the currency’s demand globally. These ties have also helped drum up the psychological buy-in necessary for the world to collectively accept that “the next guy” is going to want their U.S. dollars.

But given the alliance between Russia and China – and the newfound alliance between Saudi Arabia and China – it looks as though that confidence game might be coming to an end right before our very eyes.

In other words, the dollar could be fading from the global picture like Marty McFly’s brother from that family photo in Back to the Future.

We may not notice it right away…

…but eventually it’ll be clear.

Far be it for me too be a harbinger of too many uncomfortable predictions at once, but, as I wrote last year, I also strongly believe that China will eventually back its forthcoming digital currency with gold to further strengthen its economic and monetary posture globally.

The contrast between a forthcoming divided global economy would be stark: nations like China and Russia seem genuinely interested in the idea of sound money backed by commodities, while the United States seems preoccupied with jargon filled academic circle jerks trying to convince ourselves that debt is money that “we owe to ourselves”, to quote Paul Krugman, and that money literally grows on trees.

If given the choice between the two ideologies, where do you think the world is going to wind up?

I’m not sure we’re ready to embrace the answer here in the United States, but we better get ready to.

Consumer

Costco – $COST

a quarter ago, I mentioned that we estimated, at that time, overall price inflation to have been in the 4.5% to 5% range. For the second quarter and talking with senior merchants, estimated overall price inflation was in the 6% range.

Our comp traffic and frequency for February was up 8% worldwide and 8.2% in the United States.

Rational Research @RationalResear$COST operating income up 35% year-over-year for the quarter ended 2/13/22. Not many retailers doing that. -February US comp ex gas/fx up 12.9% with traffic up 8% -Inflation estimate now 6%, up from 4.5% -Costco leasing 7 ocean vessels, up from 4 #winning @CJOppelMarch 3rd 20222 Retweets14 Likes

The Buckle – $BKE

TJ Maxx – $TJX

As for the first quarter, we are planning U.S. comp store sales to be up 1% to 3% over an outsized 17% U.S. open-only comp store sales increase last year. For the start of the first quarter, we are very pleased that our U.S. comp sales growth is strong as we are seeing excellent consumer demand for both our apparel and home categories.

Rent a Center – $RCII

“In the fourth quarter, the combined effect of significantly reduced government pandemic relief, decades-high rates of inflation, and supply chain disruptions impacted our target customers’ ability to access and afford durable goods, which negatively impacted our results. We anticipate these external headwinds will continue for the foreseeable future, resulting in year-over-year declines in revenue and earnings for 2022, on a pro forma basis, while free cash flow should increase for the year,” -CEO

Ruth’s Chris – $RUTH

• Quarter to date through February 20, 2022, Company-owned comparable restaurant sales increased 4.3% compared to 2019.  

Big Lots – $BIG

clearly, in California, there’s a major crime epidemic going on, enforcement of penalties or shoplifting have been largely kind of abandoned there. And certainly, you’ve heard of other retailers essentially even closing stores because they can’t operate them viably. So we saw California spike pretty significantly. And relative to what we were seeing as late as June or July and our last round of physical inventories, there was a significant step up there.

Potbelly – $PBPB

Supply Chain

Expeditors – $EXPD

“Roughly two years of pandemic-induced disruption have led to unprecedented conditions throughout our industry, with little relief in sight. There is still too little international air capacity, as travellers have been kept from flying abroad; the ocean ports are too congested to accommodate many of the ships that need to load and unload their containers; and worker shortages are severely limiting overland capacity to support the freight that is able to arrive in port.

“We have worked our strong carrier relationships to secure as much capacity as we could get on behalf of all of the shippers looking for space during the quarter, but the severe imbalance between capacity and demand continues to heavily impact our industry. There is simply not enough carrier capacity in the air or on the oceans to accommodate the heavy demand for cargo space, particularly from China to the U.S., where historically high average buy and sell rates have been the most elevated.

“Despite the lack of space, we experienced record-high air tonnage in the fourth quarter, as we used more air charters than at any other time in our company’s history, even with extremely elevated rates. Ocean container volumes, by contrast, declined during the quarter, as we were somewhat limited in our ability to secure necessary capacity from ocean carriers, and hampered by the time and resources required to process shipments and meet sharply growing customer demand. -CEO

The Harpex – Harper Petersen

Housing

Home Depot – $HD

Now I’ll comment on our outlook for 2022. The broader housing environment continues to be supportive of home improvement. Demand for homes continues to be strong, and existing home inventory available for sale remains near record lows, resulting in support for continued home price appreciation. On average, homeowners’ balance sheets continue to strengthen as the aggregate value of U.S. home equity grew approximately 35% or $6.5 trillion since the first quarter of 2019. The housing stock continues to age, and customers tell us the demand for home improvement projects of all sizes is healthy.

Lowes – $LOW

Redfin – $RDFN

Home prices spiked to an all-time high of $363,975 as the market continued to heat up during the four-week period ending February 27. The median home-sale price was up 16% year over year, the biggest annual gain since August, and the typical home sold for 0.8% above list price, the largest premium since October. Intense competition among buyers driven by an extreme shortage of homes for sale is driving prices up unseasonably fast.

Mortgage Rates – Freddie Mac $FMCC

Toll Brothers – $TOL

Turning back to the demand side of the equation. The housing market and demand for our homes in particular is being propelled by strong demographics from both the millennial and boomer generations; a substantial imbalance between the tight supply of homes and continued pent-up demand; the wealth effect of rising existing home equity; migration trends and the greater appreciation for home. We believe these long-term tailwinds will continue to support demand for our homes well into the future.

We continue to see people move from states where home values, taxes and cost of living are higher to less expensive regions. This dynamic is spurring demand in markets across the country and particularly in the Sunbelt and Mountain states, where we have expanded in recent years. For these buyers, affordability is less of an issue.

We have also not seen an impact on demand from the recent increase in mortgage rates. I remind you that our customers are generally better insulated from affordability concerns compared to buyers in the entry-level market. Our buyers tend to have higher incomes and they benefited from multiple years of appreciation in their investment portfolios and their existing homes.

Also keep in mind that rates have no impact on monthly payments for about 15% to 20% of our customers, who pay all cash, and that another approximately 30% of our buyers borrow at jumbo rates, which are currently 0.625 point lower than conforming for our clients. And overall, our customers average less than 70% loan to value in their mortgages.

Q: And then I know you haven’t seen any impact on demand yet, but have any of those warning sign metrics started to weaken for you at all?

A: Very good question. The warning signs are web traffic, foot traffic. And right now, web traffic and foot traffic is up significantly.

Tempur Pedic – $TPX

In the first quarter, we have seen softness from the lower end consumer, which we believe is temporary. We believe we are maintaining labor and advertising expenses that would otherwise naturally flex with sales.

If you look at our Tempur flagship stores, they started off the first quarter solid. And then when you move into Presidents’ Day, I would call it strong with same-store sales so far in Presidents’ Day running over 20%. If you look at entry-level bedding, lower end customer, that’s been a challenge probably beginning in the fourth quarter. We continued into the first quarter.

Floor N Decor – $FND

From a macroeconomic perspective, we are planning on 2022 to be a good year. The secular demand in housing continues to exceed available supply, which has led to an acceleration in home price appreciation. We believe these factors, combined with record levels of homeowner equity and aging housing stock should further support home remodeling spending. In addition, we serve a higher-income consumer, and they have substantially higher wealth and home equity relative to pre-pandemic levels and there continues to be innovation in our category. With that said, we are monitoring factors such as today’s Russian invasion of Ukraine and other geopolitical events, rising interest in mortgage rates, modest decline in existing home sales, inflationary pressures impacting the consumer and uncertainties related to the pandemic.

We are planning on our comparable store sales growth of 10.5% to 13% driven by our business model, a good macroeconomic backdrop and raising retail prices throughout 2022 to offset the anticipated higher supply chain and vendor product costs, which is remarkable considering the [average] comp growth we had in fiscal 2021 as well as the second half of 2020.

Odds and Ends

Gas Prices

Energy spending as % of income

AAII Bull Bear

CNN Fear Greed

US Federal Reserve Balance Sheet

https://rationalresearch.substack.com/p/facts-from-the-week-march-6-2022?token=eyJ1c2VyX2lkIjoyMjYzMTcwLCJwb3N0X2lkIjo0OTc4OTI4NCwiXyI6Ims4ZlpuIiwiaWF0IjoxNjQ2NTg3NjA2LCJleHAiOjE2NDY1OTEyMDYsImlzcyI6InB1Yi01NDAwMiIsInN1YiI6InBvc3QtcmVhY3Rpb24ifQ.az3VLMAFX4eqMZi8GxG4ozzcRMbUUxlJpVD47T8bhI8&s=r

The pundits are rushing to tell us that the way to stop Russia’s aggression is by hitting the Russkies where it hurts (i.e. their oil and gas).

Our view is that any sort of blockade of Russia’s exports will only lead to an inflationary super storm.

Now, before you accuse us of peddling “pro-Russia” talking points. Nothing of the sort. What we are trying to do is point out how Russia is way more critical to the world economy than it was some 20 years ago.

Some 20 years ago Europe (and the “West”) had the North Sea, which produced as much as Russia and the US. Today, the North Sea is a shadow of its former self. And if US shale continues to disappoint, it won’t be long before Russia becomes the world’s biggest oil producer “beyond reasonable doubt”.

Do you think that Rosneft, Lukoil, or Gazprom are in trouble of being sanctioned when they supply some 36% of Europe’s oil needs?

And natural gas (not that this is unappreciated).

Furthermore, there are probably a couple of commodities that few have given any thought to, coal in particular.

Russia exports almost as much thermal coal as Australia (granted the chart below is a few years old but volumes wouldn’t have changed materially in that time). Russia also exports about as much coking coal as the US and about 40% of Australia.

Hmmm… switch off Russian natural gas (for a theoretical exercise), and the world will need a stink load more of coal of which Russia is one of the top 5 global suppliers. Guess you could always turn to uranium?

Granted Kazakhstan isn’t Russia, but they are rather friendly. Of course, uranium produced (yellow cake) isn’t the stuff that goes into nuclear reactors. That is enriched uranium, which Russia (Rosatom) accounts for 50% of world enriched uranium production. That is absolutely extraordinary. Roughly 20% of the US electricity supply comes from nuclear. You know who’s really screwed?

Our French mates run the place on nuclear, and guess what? Over half of this enriched uranium comes from the Russkies.

And who accounts for a fair whack of grain exports?

And without fertilizer crops don’t grow. Here are the world’s top fertilizer exporters (as of 2020 and the value of exports in US dollars).

Should the rest of the world be sanctioning Russia’s commodity exports, we’d likely see Weimar Republic style inflation in those countries, particularly Europe.

You might say, “Surely, there must be other countries Western governments can turn to.”

Here is a neat little picture to make this easy from a geopolitical perspective. The options available to the West from “friendly” states.

One word: yikes!

Can you see now why the calls for sanctions of Russian exports are not only naive, but also self-destructive?

Have a great weekend!

– The Team at Capitalist Exploits

Capitalist Exploits is an investment research firm positioning for asymmetric payoffs in global macro opportunities with a focus on deep value

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“This bout of heavy inflation in the US is perhaps best played through maybe Bangalore real estate, wherein a lot more of services get exported because the wage rates in the US are rising very rapidly and there is not a visible pipe but an indirect pipe which one can visualise where services there have a greater propensity for engineers in Bangalore,” says Neelkanth Mishra, Co-Head of Equity Strategy, Asia Pacific and India Equity Strategist, Securities Research, Credit Suisse.

Let us start with what has happened in the last few weeks and months. . You track the FII shareholding data pretty closely. What is happening with the FII side of the market? Markets are not falling much but FIIs are selling. Is it only because of primary market issuances?
The FII behaviour is more because of what is happening globally. There is elevated uncertainty in global financial markets. The Fed is trying to tighten aggressively as they are starting to realise that they are perhaps behind the curve. This is happening unfortunately at a time when global demand indicators are starting to weaken.

We have been tracking our proxy for global retail sales. They were significantly above trend for almost all of 2021 and then there was a very steep fall. It was protected by pre-buying in October-November but in the December sales in the US, the numbers were really weak and when one puts this together with consumption weakness in China, the expected weakness in real estate construction, etc, the global end demand situation is looking a lot weaker than what the supply constraints would suggest.

At this time, it is going to be very difficult for policymakers to stimulate the economy and this is a very new situation for global markets because over the past decade, we are used to a situation where whenever demand weakens and stock markets take a tumble, the monetary and fiscal taps get opened. This time the primary focus especially in the US seems to be inflation and therefore as growth weakens, we may not see that stimulus coming through. As that readjustment of expectations happens, the global markets are likely to stay quite volatile.

Emerging markets, in particular, have seen outflows and that is the usual trading pattern whereas as the US is tightening, you pull money out of emerging markets and the FIIs selling that we have seen is a reflection of that. For India per se, the cyclical rebound is doing very well and we expect it will continue to pick up in the next couple of quarters.

Whenever people think that the Fed will start tapering and raise rates, they believe we are back in 2013 when demand just collapsed across asset classes. Do you think this time around India and the overall world will be much better prepared?
The emerging markets are definitely better prepared. Their current account deficits are not really as high as they were in 2013. It is the case not just for India but for several other emerging markets as well. Many of the EMs have prepared themselves with much larger reserve positions. I do not think they are in a weaker position but at the same time, remember that even though inflation may be a primarily US phenomenon right now because in Japan, in China and large parts of Asia, inflation is not that big a policy headache right now. The reality is that most asset classes globally are benchmarked off the US 10-year treasury yield and that is why the volatility in global markets can be quite broad based.

This will be perhaps a time when the equity and bond markets both will see weak demand. So this is a readjustment process. I do not think the world has ever seen the US inflation being 1.5-2% points higher than India’s inflation for several months in a row. I am getting used to this and I think that uncertainty is going to be causing a lot of volatility across markets.

Last time around, Budget was a great event, markets had rallied overall and you as a strategist can also say that it coupled with what happened with the global rally. What to expect going into the Budget?
The challenge for policymakers in India at state and central level is shifting again. For most of the last decade, it was about fiscal consolidation and getting the fiscal deficits back in line. What is happening right now is that the markets are primed for higher deficits and so they are expecting that the Centre and the states will have high deficits. Tax collections are going up but the governments are unable to spend.

The biggest variable to track right now is the cash balance that governments have with RBI which is more than 2% of GDP right now. This is coming primarily as the government functioning was very badly impaired by the lockdowns and activity restrictions. As we get into the Budget and not just the central budget but the states budgets as well which will also get presented over February and March, the key variable to look out for would be what they are deciding to spend on, how much can they scale up spending because the fiscal, the tax revenues are good.

The temptation would be to consolidate aggressively but at the same time, the best way to get debt to GDP down is to grow the denominator, basically grow nominal GDP faster and especially when the markets are primed for higher deficits, it makes sense to spend a lot more. So, that would be the first focus area. At the same time, one of the key takeaways from the last year’s Budget was that it was very progressive; it showed clean accounts; it showed parts where the government was very focussed on growth, very reformed focus and announced privatisation of PSU banks and several other such steps.

Even if there are no concrete steps that affect the fiscal numbers, if the Budget speech comes up with some such announcements, say on the personal taxes or personal income taxes or some removal of exemptions, that will be taken very positively. I do not know if that will be enough to offset some of the global market turbulence but it will help India hold up better.

Last year, there was a higher expenditure. This year, the government may have some savings from vaccination, the Covid programmes. Do you think expenditure on such a high base cannot grow very strong and that is why the quality of expenditure would be the key?
Absolutely right and if you are going from 6.8% to a situation where you can theoretically consolidate to 5.8% or even a 5.5%. this would be faster than what you had guided to which is 4.5%. Again we are talking only about the central government by FY26. The fact is if you consolidate too fast, you are going to shrink expenditure and there is some natural expenditure shrinkage which should be expected and there should not be that much vaccination requirement next year. The foodgrain supply also should be lower. Fertiliser prices globally are starting to come off and so the fertiliser subsidy can come off as well. It is possible that some of the disinvestment proceeds may improve next year as well. So we will have more space and keeping up expenditure and finding avenues where one can spend a lot more is going to be the biggest challenge for the Centre.

For the states the revised headline deficit in FY21 was 4.7% for states. In reality, if one looks at how much they borrowed and how much cash they ended the year with, it will be lower than 3% which is not very different from what it was pre Covid. For FY22, the states are at 3.6% but the borrowing is again below what was expected and their cash balances have actually climbed further and which suggests that they will end this year also with a deficit lower than 3%.

So at a time when everyone expects India as an economy to have incurred the cost of higher fiscal deficit by pushing up yields, the term premium in India is at a ridiculous level. But the benefits from that in terms of higher government spending have actually not come through. Just to give you a number, in the September ‘21 quarter, the GDP in real terms was about 0.3% higher than September 2019 quarter, the pre Covid base quarter but the government spending was 17% lower. This is the government’s final consumption expenditure and comes at a time when the governments the world over are boosting expenditure to support aggregate demand so that their economy does not contract.

In India the GDP is growing despite the government spending shrinking and this is something that needs a lot of attention of the markets and as well as for policy makers because the markets just look at the headline deficit and then say oh, my God there is a problem! What they are not observing perhaps or not paying enough attention to is the fact that there is Rs 4.5-5 trillion cash that the governments are sitting on and how that gets spent is going to be very important. As you said, it should be spent productively; the quality of expenditure needs to be good so that the multiplier is good and that will I think be a good support for growth going forward.

In terms of fiscal deficit consolidation path, the oil tailwind with the excise duty is no longer there. How should one look at divestment programmes and the oil revenues which will now not be there?
Oil revenues will be lower. They are not going to be there. The total cut by the Centre and the states put together at an annualised level – and this happened in November so fourth months have already been seen in FY22 – we will see eight months of that reduction. The total was Rs 1-1.5 trillion which is large but in the context of government taxation, I do not think that is a very large number. This is coming at a time when because of formalisation and better compliance, the tax to GDP, excluding the oil revenue, is not doing that badly while corporate profits are doing well. So corporate tax growth will be strong and therefore the process of consolidation in theory can continue.

However, as I said earlier, the objective should shift from just managing the year to year fiscal deficit to looking at debt to GDP and seeing how fast can we bring it down because at 90% debt to GDP, we are in a very tricky position if the cost of borrowing goes up like it has. Then very quickly, one can get trapped into a trap where your interest costs start climbing and then the deficit starts climbing and that forces a reduction in the GDP and that sort of brings down ratings and a lot of other risks can emerge.

So one need to get that 90% down to 70% over the next decade and the best way to do that in my view is to grow the denominator and that must happen with the Centre and the states coordinating on how to spend productively in a way that once the economy really takes off, it can be withdrawn. The simplest way to spend and some states may be tempted to do that is to give salary hikes to state employees. I am not saying that that should be done or that will be done, but that is one way of increasing expenditure which will have some growth impact but it will then create a permanent liability which one cannot pull away from and that is what happened 10 years back. These are the most important issues as we go into the budgets for the centre and the states.

In terms of inflation, if the hyperinflation continues or the inflation goes ahead, what is the best way to play it as an investor?
The one nuance that I would like to bring is that this is not global inflation. In our financial markets globally, we need to worry about it because the US, which effectively sets the cost of capital for most asset classes, is going through a bout of very heavy inflation but this is not yet a global inflation problem. The debate in Europe as well has been whether this spike in inflation to 5% is something that will persist and as we are seeing US inflation go up, we have to see what are the goods and services that the US can import because then the differential starts to become a lot more attractive.

In conventional high inflation situations, one starts buying commodities but the Chinese inflation is less than 2%. The outlook on hard commodities like steel and iron ore is not that strong; the outlook on oil and gas is more geopolitical driven and depends on what is happening in Russia and Ukraine or what is happening in West Asia. So this bout of heavy inflation in the US is perhaps best played through maybe Bangalore real estate, wherein a lot more of services get exported because the wage rates in the US are rising very rapidly and there is not a visible pipe but an indirect pipe which one can visualise where services there have a greater propensity for engineers in Bangalore.

Budget 2022 | US inflation | Investment Strategy: Can one play the US inflation via Bangalore real estate? Neelkanth Mishra explains how – The Economic Times (indiatimes.com)