Zoltan Pozsar: ‘Welcome To The War Economy’

“Welcome to the war economy, where heads of state matter more than heads of central banks,” Zoltan Pozsar wrote, in an ambitious new piece called “War and Interest Rates.”

The note, a lengthy affair with many more hits than misses, was made more topical by tensions surrounding Nancy Pelosi’s Taiwan visit, a stopover Beijing views as a wholly intolerable affront to Chinese sovereignty and a flagrant repudiation of the “One China” policy the US routinely claims to respect.

“The low inflation world stood on three pillars,” Pozsar said. They are (or were): “Cheap immigrant labor keeping service sector wages stagnant in the US, cheap goods from China raising living standards amid stagnant wages [and] cheap Russian gas powering German industry and the EU more broadly.” If that summary seems unduly terse, Pozsar conceded only that it’s a “slight” simplification.

I’ve argued repeatedly this year that the low inflation seen in advanced, developed economies over the past several decades was due more to structural macro trends and geopolitics (disinflationary “enablers” as the Fed’s Thomas Barkin called them) than central banks, whose concurrent efforts at inflation targeting and nominal “independence” were later credited for outcomes born of secular dynamics, not tinkering technocrats.

When the trade war, the pandemic and the conflict in Ukraine upended those dynamics, inflation promptly became unanchored.

“Nativism, protectionism and geopolitics destabilized the low inflation world,” Pozsar said, citing Donald Trump’s immigration policies, his administration’s “hardline approach to China” (and the bipartisan support it garnered in Congress), Xi’s quixotic efforts to eradicate an endemic virus (which are “causing occasional cardiac arrests in global supply chains and backlogs at ports”) and, of course, Vladimir Putin who, frustrated that sanctions on the Nord Stream 2 pipeline upended Moscow’s “efforts to make Europe dependent on cheap Russian gas,” and likewise frustrated by “the shifting balance of military power in Europe,” resorted to a hot war in Ukraine.

Now, Pozsar contends, central bank tasseography is a less useful pursuit. Those aren’t the policymakers you should be following. Those are the wrong tea leaves. “Translating speeches from Russian and Chinese and catching high fives as opposed to fist bumps are becoming more important than parsing subtle grammatical nuances in central bankers’ policy utterances,” he wrote, juxtaposing Putin’s famous dap with Mohammed Bin Salman at the 2018 G20 in Argentina (observed by a frowning Trump, visible in the frame) with Joe Biden’s royal tap, resentfulness poorly disguised as pandemic protocol.

For Pozsar, an ongoing, slow-burning economic war between the US, Russia and China may “drive more and more inflation.” He rekindled his description of Russia as a “G-SIB of Commodities” and called China a “G-SIB of Factories,” characterizations which, clever as they are, undercut Pozsar’s pretensions to outside-the-box thinking. Everything is couched in the language he speaks most fluently: The dialect and vocabulary of Western financial market plumbing.

China and Russia, two of the world’s largest producers of commodities and consumer goods, “provid[e] two pillars of the low inflation world” and as such can be viewed as “the main ‘guarantors of macro peace,’ providing all the cheap stuff that was the source of deflation fears in the West, which, in turn, gave central banks the license for years of money printing,” Pozsar wrote.

Now that the macro peace has been replaced by economic war, Barkin’s disinflationary “enablers” are gone. “Central banks are adapting to a world that’s gone from having too much stuff and not enough demand, to a world that has not enough stuff and too much demand,” Pozsar said, on the way to underscoring a point which should be obvious to all, but, for various reasons, isn’t. “Today’s inflation is more about supply and less about demand, and is more about geopolitics than (domestic) politics,” he wrote.

It’s possible (and regular readers will attest to my exhaustive efforts to convey this point) that inflation as it’s manifesting in 2021/2022, simply isn’t controllable by central banks, irrespective of how draconian they’re willing to be in their tightening efforts.

“If we’re right that the economic war is the right context to understand inflation, then Western central banks will not have any good options to slay inflation,” Pozsar remarked, noting that monetary policymakers “can surely reduce demand by raising rates, but what if supply curves shift inward faster than demand curves?”

That, effectively, is the very same argument I made last month in “Bond Bulls And Banana Republics.” Lacy Hunt, you’ll recall, argued that “supply chain disruptions from the pandemic, aggravated by the Russian invasion of Ukraine, shifted the AS curve inward, exacerbating the monetary-induced price surge” (emphasis mine). As I emphatically suggested, Hoisington had it backwards. Policy largesse exacerbated a supply-induced price surge, not the other way around.

That distinction is critical. Indeed, it’s all that matters in the debate about monetary policy in the new macro regime. It’s possible that no amount of demand destruction will be sufficient to counter the speed with which supply curves shift. That’s why a true apocalypse is hyper-inflationary. There’s virtually no “aggregate” demand in the desolate, post-nuclear monochrome. But because paper money is only useful as a commodity in such a scenario (i.e., useful because it can be burned), no amount of it will be sufficient to purchase whatever scarce fuel, food and clean water is still out there.

Before delving into a long discussion about inflation, Pozsar condensed the outlook. “Getting right where inflation goes from here is basically a matter of perspective,” he said. Either you think inflation is cyclical, the result of “a messy re-opening” following the pandemic, and turbocharged by fiscal and monetary largesse which inflated demand against a temporarily supply-constrained backdrop, or you think it’s structural, where that means “a messy transition to a multipolar world order, where two great powers are challenging the might and hegemony of the US.” If the former is the correct perspective, inflation has likely peaked. “If the latter,” Pozsar warned, “inflation has barely started, and could actually be understood as an outright instrument of war.”

I’ll have more on that later, but the key point for Pozsar is that Jerome Powell isn’t engaged in a tightening “cycle” in the traditional sense, where rates correspond to the business cycle. For Pozsar, this isn’t a “cycle,” it’s a structural shift. He described it in Biblical terms. “We are not dealing with a business cycle, but rather with something straight from the Book of Genesis — a ‘seven fat years, followed by seven lean years’-type of thing.”

So, again, this is no hiking “cycle.” It’s a tightening “campaign,” made necessary by the end of cheap labor, goods and energy. Demand didn’t adjust fast enough to the new reality, so a Fed which once endeavored to “generat[e] demand structurally to soak up an excess supply of cheap stuff” is now attempting to “curb demand structurally to adjust to shortages.”

“Remember nominal GDP targeting?” Pozsar asked, before quipping: “We’re still doing it, but now in the opposite direction.”

Pozsar’s latest deserves more than one dedicated article. For our purposes here, I’ll note that this is not the Pozsar from three months ago who, in my opinion, strayed into the realm of provocative essays more for the sake of them than for the sake of macro theorizing, let alone rates strategy. Thankfully (to his credit and to my great relief), Zoltan has now found a way to incorporate his (still provocative) overarching macro/geostrategic thesis into a coherent assessment of the vexing policy choices faced by central banks. For now, I’ll leave you with one particularly pointed excerpt:

In this context, the market’s recession/no -recession soul -searching is ridiculous: If the inward shift of supply curves across multiple fronts (labor, goods and commodities) is the main driver of today’s inflation; if demand needs to be curbed significantly to slow inflation; and if a substantial reduction of aggregate demand means an “L” -shaped path for the economy, why is it so bloody hard to see that we need a recession to curb inflation? Instead of the question of “whether,” why don’t we think about the “depth” of the recession needed to curb inflation?

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