How I Learned to Stop Worrying and Love the Fed – a Bearporn Saga
tl;dr Short-Term Doom, Long-Term Prosperity
I will start with energy, because that is where the economy starts. Everything is energy. All production, all consumption. Debt is just a claim on future energy/resources, and is typically purchased on the expectation of repayment of principal/interest (money is just tokenized energy), based upon an expectation of real economic growth of the debt issuer (assuming interest rates are positive). When you live in a world where everyone has more energy to use and consume on an annualized basis, economies see real growth. The opposite also usually holds true, absent financialization tricks to mask the decline. So, where are we today? Conveniently BP has excellent data on this stuff going back to 1965, and keeps it here:
You can download a spreadsheet there called “Statistical Review of World Energy – all data, 1965-2021.” It has a handy tab called “Primary Energy – Cons capita,” which tells you what the annual per capita consumption of energy is in gigajoules, broken out into various geographic groupings. Here is what that looks like for roughly the first decade of data:
Notice how energy consumption per capita is trending upwards from 1965 to 1973? Those were pretty good times. America had cheap and abundant domestically produced conventional onshore crude oil, and a massive manufacturing base that thrived off of it in the glory days after WWII when we dominated pretty much every market that existed. Unfortunately, in 1973 this thing called an energy crisis happened, as our conventional production was going into decline, and Europe, Japan, and other economic competitors were back on their feet after WWII and seeking to increase their share of the economic pie (using energy).
Note the consistent declines in global energy consumption per capita and OECD consumption per capita during 1974 and 1975. So, what did the S&P 500 do in 1973 when this energy crisis suddenly arrived on the market?
From January ’73 to October ’74, the S&P 500 lost about half of its value. Business plans, debt, and earnings all ran into the hard wall of an energy crunch and reset market expectations as inflation driven by energy shortages reared its ugly head. The E on the P/E side of the equation changed suddenly, and anything based on TTM or pre-crunch estimates was total garbage.
Around this same timeframe, some relevant events also happened. In 1971, Nixon took us off the gold standard and ended the monetary system (Bretton Woods) that had existed since WWII ended. Prior to that dollars could be exchanged for gold at a set rate, but some stagflation in 1971 made the whole system unstable and unworkable for America, so it had to go. By the time the energy crunch hit in 1973, the US knew it needed to do something to stabilize its supply of energy, its global reserve currency, and its access to real assets to fund future growth. So in July 1974, Nixon sends his new Treasury Secretary, former Salomon Brothers bond trader Bill Simon, to Saudi Arabia on a top secret mission. Bloomberg learned about it from a FOIA request decades later, and wrote a cool article about it:
Here’s the tl;dr on the article, from the article itself:
“The basic framework was strikingly simple. The U.S. would buy oil from Saudi Arabia and provide the kingdom military aid and equipment. In return, the Saudis would plow billions of their petrodollar revenue back into Treasuries and finance America’s spending”
That word petrodollar is also important. In early 1945 FDR entered into an alliance with Saudi Arabia, and Saudi Arabia agreed to sell and price oil in dollars. Most other oil producing nations of the world quickly joined the club, and we liked this. If countries outside of the Soviet system needed energy to grow their economies, they needed reserves of dollars, and debt denominated in dollars. We will return to this topic later.
So, we had obtained a fat stack of funding from the Saudis to dig our way out of this energy crisis thing. The process was pretty rocky, resulting in the 1970s, but eventually this nice man named Paul Volcker ratcheted interest rates high enough so that the stagflation could be beaten into submission, while around the same time enough capital had reached E&P companies to enable capex to flood the market with new cheap energy, turning boomtowns of the 1970s like Houston into ghost towns in the 1980s. Newly developed offshore fields in the Gulf of Mexico and North Sea pumped energy like it was going out of style, and the market had a really good time for about 20 years.
Since all of that energy came online in the early 1980s, global consumption per capita has generally trended upwards every year until 2018. We kept finding new ways to economically pull oil and gas out of the ground (new fields, deepwater, fracking shale), and get it into the hands of consumers so they could use more of it to grow the economy. This lifted billions of people out of poverty, allowed the agricultural revolution to feed them with nitrogen fertilizers made from natural gas feedstock, and provided predictably priced (mostly) inputs for heavy industry. This was an all around great thing for business, and American Boomers as a group made a metric fuckton of money riding the wave during the entirety of their working lives.
So, what does the most recent decade of BP per capita energy consumption data look like?
Pretty much a plateau globally from 2011-16, small increase in 2016, top in 2018, and downwards trend since (with 2020 being a big down anomaly for obvious reasons). There’s variation around that whether you look at OECD, EU, Non-OECD, but the peak for all of them is 2018. People have less energy to work with today than they did four years ago.
Unless more energy gets injected into the system, it is very hard to stimulate real growth, and financial instruments (like bonds) that track anticipated real growth reflect that with high prices and low (or even negative) interest rates. In a world where everything is growing, I want my loans to at least reflect the real rate of economic growth, otherwise I am losing money. Looked at bond yields over the past decade lately? They didn’t seem to be pricing in a lot of real growth at any duration. Why do you think that is?
People can argue about the definition of peak oil all they want, but 2018 appears to be at least a localized peak when scaled to global population. The key to reversing this is producing enough energy at a reasonable price, so that people can start using more of it. That would reflect an economy that is growing in real terms. That takes lots of money. Which brings us to the next chapter of this story, a very brief overview of geopolitical stuff that happened from the fall of the Soviet Union to the recent start of World War III.
The year is 1991, the Soviet Union falls and this country called Russia suddenly has a lot of available energy reserves that previously weren’t getting a lot of circulation outside of the walled-off Soviet Sphere. These abundant energy reserves were recognized immediately for what they could be: a giant engine of additional economic growth to fuel the 1990s and beyond. That’s what happened. A country in Europe called Germany had this bright idea to build out a massive heavy industrial and manufacturing base, fueled by cheap Russian natural gas, which could easily be pipelined in from the fields in western Russia and eastern Ukraine. The plan worked, and Germany became an economic powerhouse with a massive trade surplus. Germany did not control the energy it used, though, so its position was precarious. To make matters worse from an economic perspective, over time Germany decided it did not like cheap energy due to environmental concerns, and had this very intense political aversion to nuclear power (another cheap, energy-dense method of generating baseload electricity). So, Germany decided to get rid of its nuclear reactor fleet, reduce its number of coal powerplants, and replace them with natural gas power turbines for baseload electricity generation, supplemented by semi-reliable solar and wind power, which is not suitable for baseload generation.
Eventually this brutal mafia boss named Putin takes over the country, and becomes President for Life of Russia’s energy reserves. He does not care for America, has actively sought to collapse us for decades, did not like the fact that he was forced to sell oil in dollars, and would do anything he thought he could get away with to make Russia strong vs. its competitors, especially America.
Fast forward to his invasion of Ukraine earlier this year. The U.S./Eurozone/Allied response was to hit Putin and Russia with sanctions. Much like prior/existing sanctions on Iraqi or Iranian oil, these sanctions did nothing to actually keep his oil and gas off the market. Putin did not like the sanctions or Allied support for Ukrainians, so he decided to weaponize his most strategic resource: natural gas flows to Europe. Eventually we got to here, where Germany’s 30-year economic miracle died almost overnight:
That is decades of GDP that just got wiped out, on top of all sorts of weird multi-sigma anomalies like $1.5 Trillion margin calls in European electricity futures markets. None of the stonks you own have priced in this reality. Not even remotely. Bonds have seen a ton of volatility (check the MOVE index), and it is really hard to find buyers for treasuries with this much uncertainty around future real economic growth prospects, while this thing called the Federal Reserve is raising interest rates, and starting to sell lots of bonds into this market.
There are billions upon billions of dollars of formerly productive assets sitting in Europe now, completely cut off from reasonably priced energy supplies that allow those assets to be economically competitive. Capitalism really does not like these sorts of inefficiencies, and is designed to fix them, so that costs of production can be as low as possible and competitive. It takes staggering amounts of resources and capital to just move production like that from where it is no longer competitive, to areas where it can be (like on the opposite side of the Atlantic, close to America’s and Canada’s abundant energy resources). Russia probably wouldn’t mind buying that stuff at firesale prices and building out a manufacturing economy of its own next to its own energy resources, but America really would not like that, and the existence of sanctions makes that maneuver pretty difficult. As far as America is concerned, we paid for all of that stuff through an investment called the Marshall Plan about 70 years ago, specifically so that Russia could not have it.
And now we come to the Federal Reserve and the Petrodollar. The federal reserve has only two priorities: (1) full employment; and (2) price stability. Employment is currently close to all-time highs. Price stability is at a place not seen since the 1970s. As we have reached the edge of our petri dish during a supercycle of energy and economic growth, the fuel is dwindling, from both natural (depleting reserves) and unnatural (war) causes. The show simply cannot go on at these levels. We are constantly bumping up against the limits of energy, and it is creating chaos in the availability of reasonably priced energy, which affects commodities and food, which causes inflation, and which restricts real growth. The energy crunch is here.
You can’t just print more dollars and create more energy instantaneously. Europe is about to try by printing Euros to provide subsidies for energy that it doesn’t produce, which isn’t priced in Euros, alongside price caps over the world’s most essential commodity, which it doesn’t control. The UK is getting in on this act, too. This will cause two things: (1) hyperinflation; and (2) energy shortages and rationing.
Meanwhile, that Putin guy is now demanding payment in Rubles for his oil and gas. He wants valuable real assets (foreign currency, hard assets, technology transfers, whatever) for his stuff, just like America gets from the Petrodollar. He is also refusing to sell it to anyone who tries to cap the price of his stuff. This, more than the Ukraine invasion itself, has caused World War III. It is a direct attack on the supremacy of the Petrodollar, which America cannot abide. The Petrodollar is central to our national security strategy. Recently Saudi Arabia has entered the chat, and agreed to sell its oil to Europe and Asia at reduced rates (not fully priced in dollars). It is not clear to me at this point if this is a temporary relief valve to our allies to relieve forex pressures, or if the Saudis have allied with Putin. The fog of war is real, and events are unfolding in real time, but markets hate uncertainty.
Turning back quickly to the hyperinflation issue, what will be the effect of the European countries printing not-dollars to subsidize energy they don’t produce or control in sufficient quantities to meet their needs? The hyperinflation will definitely affect citizens and some businesses quite harshly (Goldman Sachs says 20%+ in the UK, and a government spokesperson affirmed that this was a reasonable estimate). It will also have the effect of concentrating national wealth in a handful of energy production and distribution related industries that are vital to the national security of those countries. Enter the Federal Reserve and America’s greatest weapon (we actually use it, unlike our nuclear stockpile): interest rates and the Petrodollar.
Used properly interest rates and the petrodollar become a many birds with one stone solution to a lot of nagging problems. One, with recent large pro-Putin protests in the Czech Republic, Germany, and other Eurozone countries facing staggering and bankrupting energy bills, there is a risk that these countries could leave Team America, and try to cut a deal with Putin. It would take a while to get past the sanctions, but where there’s political will there’s a way. This outcome is unacceptable to America and can never be permitted.
As the Federal Reserve raises interest rates and sells its massive bond stockpile to combat inflation arising out of the energy crunch, much like it did in the 1970s, all sorts of second and third-order effects start happening, like sovereign debt crises. Countries keep reserves of dollars to buy energy, and as a result of regularly needing to transact in dollars, issue dollar-denominated debt. As interest rates in the US rise and bonds are sold, the global supply of dollars decreases. It is harder to get dollars, and foreign currencies dependent upon a stable or growing supply of dollars depreciate. They need to use more of their own currency to get the same amount of dollars that they used to. Much like the energy situation, a supply/demand imbalance arises. Also, quite a lot of the record high levels of corporate debt around the world are priced in dollars. That debt was also issued predicated upon growth assumptions that probably did not include an energy crisis, World War III, and stagflation. As you might imagine, this can cause a lot of problems.
Why then, do you ask, would America keep raising rates and selling bonds when markets are screaming “hey guys, big energy crisis over here, maybe turn on the liquidity a bit more”? Well, the amount of liquidity it would take to patch the gaping hole in German GDP is beyond anything we can reasonably do. That would lead to hyperinflation in America, which can never be allowed. The only thing that truly threatens the accumulated wealth of a nation (which the Federal Reserve protects in America) is hyperinflation. It killed the Weimar Republic, and it will kill what we currently recognize as the European economy. The wealthy and wealth of this country can survive market crashes, but not hyperinflation. Hyperinflation is an economic weapon of mass destruction, and you just can’t predict the outcome with any reasonable certainty (other than real bad).
Also, we are kinda tapped on liquidity after the Covid money fountain, and finding ourselves at the end of a business/debt cycle while we bump up against the chaotic limits of available energy. So, what happens when the Federal Reserve raises interest rates and sells bonds to continue tightening liquidity into this mess? Something in the global economy pops, starting in Europe (remember that $1.5 Trillion margin call in electricity futures). Hyperinflation destroys their economies, and they need a bailout/reset. In return for the bailout, we can give them the dollars they desperately want (we can create them at will). In return we only ask for all of their critical, national-security adjacent energy assets, which American capital can then operate for them starting from Europe’s new, lower baseline of reset economic growth. Some of the plant and equipment (natural gas turbines, very nice), along with intellectual property, can also be used to develop a more robust manufacturing economy here in America, close to comparatively cheap and abundant supplies of energy. We have done this with our allies before. In March of 1941, before America entered WWII, we sent the UK about 40 mothballed, decrepit destroyers from storage, and all we asked for in return was postwar dissolution of the British Empire and control over the global monetary system. It was a really amazing deal for America. We have profited immensely.
The other part of the puzzle is the staggering amounts of capital that will be needed to properly invest in energy and manufacturing infrastructure in America over the next decade. We basically have to onshore Germany, and replicate their trade balance that just vanished, plus some if we want actual growth. That is just a crazy amount of money, but we have to do it. The problem is that a huge chunk of our economy’s money is tied up in the stonks you retards have been buying hand over fist at a time when bond yields were screaming “NO REAL GROWTH.” Reversing this trend means inversing you. Your stonks gotta be crushed so that we can reset our growth baseline back to something reasonable, providing a multi-year runway of growth that will not bump up against energy limitations and make everything chaotic again. Once that happens, the Fed can turn the money spigot back on and the high interest rates will ensure that capital is allocated efficiently to the sectors where it will be most productive, like energy and manufacturing.
In the short to medium term this is going to be a rather volatile and unpleasant process, if you are not aware of what needs to happen. The old world of globalization is over. The heavy industry and production will be relocated here on our fortress continent, where we can keep our investment safe from bad actors like Russia in an increasingly dangerous world. The pivot is not coming until the reset happens. If you love America, sell your stonks and wait for the crash (or gamble on the timing of it like a degenerate with puts or UVXY, which I am doing), then go long as balls American treasuries, energy, manufacturing, and short dollars so the rest of the world can buy all the stuff we are about to make so we can all prosper. The Fed is on our side. You can make money in any market as long as you are flexible.
In the meantime I will conclude with a few fun bearporn centerfolds that I collected from around the internet:
Submitted September 08, 2022 at 02:18AM by BigGayBearAteUrTendy
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