By Michael Every of Rabobank

Planes, Grains, & Automobiles – and ‘Coinz’

ECB Chief Economist Lane yesterday backed the view a June rate cut is in the bag and even implied July might be too. He pointed out that the majority of EU inflation was due to an energy supply shock now fading: which would be why European services inflation is still so high now? Lane also had to make clear that the path ahead was bumpy, and that rates would still need to stay higher for longer. As such, some may see this as ‘Mission Accomplished’. Others will recall the George W Bush’s declaration of such, which after an early cakewalk marked the beginning of a disaster still going on today.

On which, drones were just fired at the Israel’s Eilat by Iran-backed Iraqi militia; there is world anger at a “tragic mishap” in Gaza; and an Egyptian soldier was shot dead in a border clash between the Israeli and Egyptian armies at the Rafah border crossing. The risks of further escalation on the first and second fronts are clear, but on the third don’t really justify the 1%+ tick higher in oil seen in thin holiday trading yesterday. That said, there may be a lot set to be revealed about that border, with geopolitical ramifications: who allowed and profited from the weapons-smuggling operations in the vast Hamas tunnel network there?

But back to inflation. The ECB –and all central banks– need to think about inflation differently from how they used to. Simplifying, it’s now about ‘planes, grains, and automobiles – and crypto’.  

Planes: The Economist points out ‘There is an explosive flaw in the plan to rearm Ukraine’: the 15 March allocation of €500m for higher EU ammunition production has run into immediate bottlenecks of skilled labor and “something that was an afterthought until recently: a shortage of explosives.” That’s a structural supply vs. demand shock, if not on the same scale as 2022. Yet what happens when the EU has to spend 3.5% of GDP on defense, not 1.5%? What if after the US election Europe has to suddenly start producing its own shells, navy ships, tanks, helicopters, and planes, because the US pivots to Asia – ‘Mission Accomplished’ on inflation? The US, UK, and Australia, of course all have their own related defense industrial supply chain issues.

Grains: Inflation is evident in commodities again. The CBOT wheat cash market crossed $7 a bushel this morning, when in early March it was just $5.2, marking a 34% increase in 12 weeks. Black Sea, EU, and North Africa producers are all losing tonnes due to bad weather: dryness, late frost, or too wet conditions. Yet in parallel, four Russian state-owned firms are taking control of its vast wheat market, pushing out the private players domestic and foreign. It seems unlikely this is being done in a push for neoliberal market efficiency; and what if Russia were to add Ukraine’s grain output to its tally via conquest? Wheat alone is not going to move Eurozone CPI much, but it’s part of a larger macro picture of rates down > commodities up, and a geopolitical picture of supply down (or with strings attached) > commodities up that can destabilise a swathe of the world’s weaker economies, many of which are very close to Europe.

Automobiles: Europe is close to its decision on how high to set tariffs for Chinese EVs, as the Financial Times says Chinese brands will respond to steep US tariffs by targeting EU consumers with luxury models: the highest end of the value chain with the juiciest profits. Europe does not want to reverse from their automatic gear towards free trade because they are afraid to look in their historical rear-view mirror. However, if it can’t make cars, it won’t be in a position to make shells or other military goods either. Then what? “A giant museum with a nice gift shop”?

Planes, (foreign) grains, and automobiles are also about what Marx described as “the annihilation of space through time.” That used to be deflationary, but now means we can’t just look at domestic issues when thinking about price pressures anymore.

The Philippines is asking the US, and the West, to boost bilateral trade and investment ties to compensate for a drop in Chinese inflows since Manila took a stand over the South China Sea. As the government puts it, if they were economically secure, they could afford to strengthen their defence capabilities further. The unspoken alternative is if that without economic help, allies can’t bring much to the table on the military –like Europe– or may prefer to back away from geopolitical tensions – like parts of Europe. That backdrop encourages the trend towards inflationary global decoupling into ideological blocs.

Or even the US, as the ‘Biden Administration Presses Allies Not to Confront Iran on Nuclear Program’ to keep geopolitical tensions low before the November election, a tactic that has failed consistently. (And what will it do about Iran’s plans to boost oil output to China?) That Si Vis Pack-your-bags, Para Bellum backdrop encourages more geopolitical violence, necessitating higher defense spending and supply-chain disruption.

‘Coinz’: Presidential poll frontrunner Trump has forsworn a central bank digital currency, which will be a relief to many, and sworn to protect Americans’ right to hold crypto, differentiating himself from a Democrat administration that wants to regulate it. I had always expected the latter outcome from both US political parties; but now a second Trump term would not just be inflationary in terms of higher tariffs and larger tax cuts, but also in terms of Americans being able to create their own crypto money at home. I’m not sure central banks’ inflation models include the wildly price-boosting effects of the kinds of crypto craziness we saw a few years ago. But they now should. It’s going to take a serious interest rate to distract some from punting on stonks and coinz (or grains!) in the hopes of keeping their heads above water in the current dog-eat-dog US economic system.  

On which note, I repeat the savage commentary about the RBA and modern financialised central banking in general which I shared yesterday: if you haven’t read it yet, do. Because it’s worth understanding to see how what we take for granted as normal in markets today is deeply dysfunctional for what it needs to do compared to how it used to do it.

China is certainly way ahead of the curve in counter-alternatives – just not ones markets like. As Bloomberg puts it, ‘Xi Tells Politburo Needs Financial Regulations With Teeth’, noting “the country’s financial regulators and local governments must take greater responsibility for defusing risks” and “hidden dangers” in the property sector, local government debt, and small and medium-sized financial institutions via “new rules [which] will strengthen the Communist Party’s leadership in the financial sector” – although what the rules are were not made clear. I await Wall Street analysts’ deep dive on this with bated breath.