Massive Miscalculations, Putin's Pain, Inflation Inflections, Yield Curve Musings (April 2022)
Like an airline crash, the outbreak of war often is the result of a series of failures, mistakes, or miscalculations. Western Europe is undergoing a massive reset in policy whereby the structure in a few years is likely to look completely different than it does currently.
Mistake 1; Maintaining Balance
Paraphrasing the advice of Henry Kissinger, neither Russia nor China should be a better friend to each other than they are to us. The West has ignored that advice and as a result, Russia believed it had the support from China (exemplified by the limitless friendship statement) to take action against Ukraine.
Mistake 2; Trusting an Adversary
The European Union, with Germany in the lead, believed it could safely switch from traditional power sources (mainly nuclear) to reliance on Russian natural gas and petroleum with little impact. Indirectly, the European Union provided Russia with the resources to wage war. Germany is being pressured to terminate purchases from Russia, but it will take time to switch sources.
Mistake 3; Trusting the West's Complacency
Russia could easily attack and conquer Ukraine in a repeat of its success with the absorption of Crimea.
Mistake 4; Ignoring Innovation
Traditional means of warfare would carry the day and Russia would easily be able to overwhelm Ukraine. Perhaps the largest surprise to date has been the stunning success of Ukrainian fighters in western Ukraine with the destruction of over 500 tanks and the recent sinking of the Moskva Missile Cruiser (by a country without a navy).
Mistake 5; Galvanizing the Opposition
Post the invasion of Ukraine, the major EU countries massively increased defense spending and contributed to assisting Ukraine since their own security was threatened. Additionally, Finland and Sweden might join NATO.
Mistake 6; Misunderstanding Motivations
Russia has been attacked numerous times over the centuries, and Putin saw the opportunity to seal a major lane of attack particularly since Ukraine was leaning more to the West recently.
Mistake 7; Misreading Resolve
The disastrous withdrawal from Afghanistan appears to have been interpreted as severe weakness, thereby probably bolstering Putin’s view of a repeat of his experience in Crimea.
Mistake 8; Putin's Pain
For Russia, not only has there been a massive loss of troops, material and resources from the invasion, but it will be left with a panoply of restrictions and sanctions which will hobble the country for decades. Furthermore, his actions have galvanized Europe such that Sweden and Finland are likely to join NATO. Even if Russia were somehow able to win over the next couple of months, it would be left with a hobbled economy. Russia, the EU, and the US feel they cannot lose and therefore the conflict might continue for months. A typical measure for determining the resources a country has to support a conflict is the size and advancement of their economy. Russia comes up short on both scores with a GDP of EUR1.39B compared to EUR13T for the European Union and approximately $20T for the United States. However, as we have experienced in Vietnam and Afghanistan, the will of the combatants is often a decisive factor. In this area, the Ukraine has far exceeded expectations.
As of two years ago, the denizens of the national capitals were bemoaning the lack of inflation questioning whether a cycle of falling prices would in turn result in a depression. Lest we forget, the luminaries were claiming excess savings was the culprit and the “GenXers” were happy with minimal purchases and appeared to be a generation of renters within walking or biking distance of the local Starbucks. Today, the story is completely different, with inflation evident in nearly all goods and services. The underlying causes are manifold; below are listed a few:
Increased money supply
Retiring Baby Boomers
Covid Prompted increased expenditures on homes
Covid payments for not working
Supply chain disruptions
Despite the Hawkish rhetoric emanating from the Fed, some question the resolve. Michael Burry of Big Short fame blasted Fed policy again. The bank has no intention of fighting inflation, he tweeted. Serial half-point rate hikes are for getting elevation before stocks and the consumer tap out. The same goes for rapid-fire QT, the Scion Capital founder said. "The Fed's all about reloading the monetary bazooka. So it can ride to the rescue & finance the fiscal put."
Yield Curve Musings
William Dudley, a former president of the Federal Reserve Bank of New York, called a recession "virtually inevitable." He is among the economists arguing that if the Fed had begun raising interest rates last year, it might have been able to rein in inflation merely by tapping the brakes on the economy. Now, they say, the economy is growing so rapidly – and prices are rising so quickly – that the only way for the Fed to get control is to slam on the brakes and cause a recession.
This stance appears not fit given the high levels of employment; we will attempt to provide additional thoughts in our next installment.
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