Economic Commentary

It is always helpful to me to scan popular culture media sources to understand what most consumers are reading, watching and listening to. Of course, the source of what people select to read, watch and listen to shapes much of what they end up believing as fact. Early in my education in economics, I was cautioned to be careful of where I got my information. It has been a valuable lesson in my lifetime, and helped to shape my perspective on economics, investments and politics. In the 1980s, as I was making my usual early morning stop at the venerable “Michigan News Agency” on West Michigan Avenue to pick up the six newspapers that I read each day, the young person behind the counter inquired if all of the papers were for me. I assured him that they were and he immediately with raised voice said “Do you have to read all of those papers every day?” I smiled and said, “I not only have to read them, I want to read them.” Online sources of information were not yet available, and news and data aggregators were in their infancy. The value of reading the Financial Times, Wall Street Journal, The New York Times, Investor’s Business Daily, Detroit News, and Detroit Free Press each day was not because they had the same viewpoint, but rather because they had differing perspectives with different analysis of the same events that were of interest to me and critical for me to understand to better serve my clients’ interests. The process caused me to be less, not more, certain of my intuitive assumptions and more aware that differing perspectives were of value even when I didn’t agree with them.

Over time, the tactile feel of newsprint in my hands — that required a good post-read handwashing session — was replaced by electronic sources from Bunker Ramo terminals and Bloomberg machines that aggregated economic data and offered access to real time data and, if you searched hard enough, access to divergent perspectives. As we all have witnessed, the digital world has achieved the success of instantaneous distribution of information while also simultaneously achieving the failure of massive distribution of misinformation. Our current geopolitical, domestic political, global and domestic economic environment has never been more complex and perhaps more dependent on cogent and thoughtful discernment than it is today. Certainly from an investor standpoint there are a good number of concerns and issues before us that require a solid and fundamental understanding that will better allow us to weave our way to success. It is hard to read current headlines without Ukraine, de-globalization, inflation, recession and stagflation being in the conversation, each of which seem to have pushed COVID-19 to the sideline. Most of the above are related so let’s explore them in order.

UKRAINE

It is becoming clear after forty days of Russia’s invasion of Ukraine that this “Military Exercise,” as Putin has defined it, is about the Europeanization of Ukraine. For all of the years Putin has been in power, he has been frustrated that he could not stop Ukraine’s move towards democracy and a market-based economy. For almost all of the Ukrainian region’s history, they have been controlled by either Prussia (when it existed), Poland or Russia. When the Soviet Union collapsed and Ukraine became an independent country, they began their march toward a new identity that was more European than Russian. As we discussed last month, Eastern European history is complicated and the political and cultural scar tissue between Russia and Western Europe is centuries long and runs very deep. The previous political leadership of Ukraine prior to Zelenskyy were not early adopters of the EU, nor were they thrilled with a populist democracy. Populist demonstrations in 2014, primarily in the western regions of Ukraine, led to the EU’s overt support of pro-democracy Ukrainian candidates and, ultimately, Zelenskyy’s victory. Russians have always felt some disdain from the European Union countries who were quite willing to buy energy from Russia but always kept Russia at arm’s length from stronger ties that would bind. This tension helps to inflame the we vs. they, or more practically speaking, east vs. west political power structure. There are many nuances to the centuries old conflict of boundaries and culture in Europe, but there is no denying that the Ukrainian attraction to the European Union, and the mutual admiration of Europeans and Ukrainians of one another, is what threatened Putin the most. If he could not force the Ukrainian people to love and be loyal to Russia, he would punish them for jilting him, and in the process amplify the distance between the east and west. Few know what Putin’s end goal is now that he has achieved some results that he didn’t expect. The European Union is not the United States of Europe that many had envisioned it would become forty years ago. Britain’s exit demonstrated that very well. At best, the EU is an amalgamation of trading and commerce partners that have significantly different histories, cultures and social compacts. For the first time, however, Russia’s invasion of Ukraine has united the EU and solidified NATO in a way that few had imagined. Putin has few allies in this struggle. China’s interest is simply to protect the east, and specifically China, from western interference in China’s internal politics and, more specifically, Taiwan. Putin knows well that China’s interests are just that, and not Putin’s success in Russia’s invasion of Ukraine. More will be learned in the weeks ahead, but the global instability of Putin’s actions cannot be understated, which leads us to the next issue of concern.

DE-GLOBALIZATION

The late 1970s began the race to globalization. The rapidity of change in digitization of data and the ability of transfer data rapidly advanced numerically controlled processes. This breakthrough in technology broke down borders and allowed manufacturing to reduce labor and scale automation. Companies now could expand their manufacturing processes globally and chase the lowest cost of labor, benefiting manufacturing, distribution and cost. The benefits to emerging economies were huge. It resulted in the expansion of economic and political stability, and built middle class opportunities in developing countries. For developed economies, the benefits were more constrained and fell to fewer people but in greater amounts. Globally, GDP surged and poverty declined; however, the benefits were uneven and serious middle class erosion occurred in the United States and Western Europe. Supply chain management followed suit, and just-in-time inventory of product and processes exploded, resulting in concentration of producers who could deliver components for the cheapest price to producers. Suppliers of commodity-based component parts like computer chips were extreme outliers in this evolution. As the demand and capacity of chips to deliver manufacturing outcome benefits grew, supply became more concentrated. As the demand for electronic goods dependent upon commodity ingredients grew, the suppliers of those commodities became more concentrated. As Europe’s demand for energy grew, they became more dependent upon the east (Russia) and Middle East for supply of product. The pandemic that began in 2020 accelerated the implosion of this globalized concentration of commodities and processes, forcing many to re-think and re-order entire manufacturing processes and supply chains. De-globalization is the rationalizing of processes that create centralized dependency. Globalization — as it pertains to innovation, creation of product, manufacturing and distribution — is fifty years in the making and will not be significantly changed in the short term. In physics we learned that any action has a reaction associated with it. The problems amplified by the pandemic are not the fault of globalization in general, but rather by logistical and manufacturing processes that became too concentrated and less diversified, which accelerated risk. Creating more domestic suppliers of component parts within the United States, or any country for that matter, is not inherently difficult to do; it simply is a cost allocation calculation to mitigate or reduce supply chain risk. Commodity supply chain solutions are significantly more difficult to achieve as mining capacity is more geographically and even continent driven. The pandemic interrupted the supply of necessary product, which increased costs of product globally and domestically, which is accelerating inflation and causing central banks to increase interest rates, theoretically to slow the pace of the economy and bring prices under control. Central banks globally have used interest rates either to stimulate growth or control rising prices and, in normal economic cycles, those tools seem effective. The ideal objective in normal economic cycles is to achieve a “soft landing,” or a slowing of the growth rate — moderation of demand followed by a resumption of a moderated growth cycle. Recent events with COVID-19 in China, and the interruption of oil and gas in Europe caused by Russia’s invasion of Ukraine, have some fearing stagflation.

STAGFLATION

The term generally means that inflation continues to be persistent but growth of GDP turns negative and unemployment increases. Some commentators refer to the 1973 and 1974 energy crisis as a stagflationary period, when we had both high interest rates (10% municipal bond rates and 14% mortgages) with high unemployment. The energy crisis in 1973 and 1974 was created by an oil embargo, which is a lack of supply. Today’s global energy deficit is not due to a lack of supply or sellers, but rather to a coordinated effort not to buy oil from Russia; therefore, it is a lack of buyers causing the commodity price increase. In 1973 and 1974 we did not have the reserves or capacity to change the condition we were in. Today, we find ourselves with reserves as well as the production capacity to sustain a period of global interruption. Interest rates in 1973 and 1974 were at historical highs, and though yields have increased by about 100 basis points recently, on a real or actual level interest rates remain at historical lows. Stagflation is not an economic condition that happens with instant velocity. We have weakened consumer confidence which has resulted from the Ukraine invasion. We have an employed consumer (unemployment at 3.6%, which is at pre-pandemic levels) with increased wages (+5.6% year-over-year) and pandemic restrictions on the economy that have been all but eliminated. The Weekly Economic Index indicates current GDP growth at an annual basis of 5.53%. The landscape before us economically, while inclusive of some geopolitical turbulence, will be a tough economy for stagflation to attack.