All this suggests a strategy that’s only available to those few nations with these capacities: weaponize global depression.
Before we get started, I need to stipulate that I don’t have an opinion one way or the other about weaponizing global depression: I don’t agree or disagree, I don’t “like” it or dislike it, I have no emotional investment in whether you “like” it or “dislike” it or if we agree or disagree. I’m addressing the topic because it’s an interesting dynamic.
The general assumption now is that everything is propaganda, i.e. that every shred of content has been stripped of the 90% of messy reality to leave the shiny 10% that protects someone’s vested interests and emotional stake. While propaganda is indeed ubiquitous and overabundant, not everything is propaganda. Propaganda is always certain about XYZ. Analysis, on the other hand, is always skeptical of neatly packaged, over-simplified received wisdom and alive to the uncertainties embedded in the messy 90% of reality edited out of propaganda.
We’re quite fond of the illusion that our “likes” and “winning the argument” matter. They don’t. Winning arguments, collecting “likes” and basking in the warmth of confirming our biases don’t change anything. We cling to the illusion they matter because it gives us a warm and fuzzy sense of agency when in reality our agency is limited to our individual/household responses to all that we don’t control or influence.
A third illusion is that policymakers control everything. They don’t. Certain decisions topple dominoes, others are equivalent to closing the gate after the horses left. They’re for show only; the 90% of messy reality is running off on its own now and policymakers dancing the humba-humba around the campfire (i.e. the illusion of control) aren’t going to stop what’s unfolding on its own dynamics.
I’m not trying to persuade you of anything or solicit a “like.” I’m simply discussing an interesting dynamic.
With all that out of the way, let’s look at weaponizing global depression. The key to this dynamic is the asymmetries built into the global economy.
One important asymmetry is energy, with exporting (producer) nations on one end and importing (consumer) nations on the other. A very small number of nations/regions occupy the middle: they export or import relatively little energy, as they are largely self-sufficient and can make do with what they produce themselves. They aren’t reliant on exports for income or imports to keep their economy from collapsing.
Another key asymmetry is currencies and bond markets which are one integrated system: currencies are valued by the liquidity, depth, risk premium and yield of the bonds denominated in the currency.
A lot of people have a lot of opinions about currencies, and unfortunately many of these opinions are detached from the basic reality that currencies and bond markets are one system.
If a currency and its bonds don’t trade freely on the global market, i.e. they’re pegged to another currency (RMB to the USD for example) or capital controls limit the liquidity and depth of the market for the bonds, this places intrinsic constraints on the risk characteristics and thus the value of the currency and the bonds.
If the risk is high (or difficult to measure), demand for the bonds and currency will be limited. The issuing nation / central bank will be constrained in how much new currency / bonds it can issue without pushing the value off a cliff.
In other words, currencies and the bonds backing them have asymmetric risk premiums, liquidity and valuations. For players in size, for example sovereign investment funds, illiquid bonds are risky because when it comes time to dump their $10 billion stake, the market is bidless: there are no buyers in that size at any price.
Risk is tricky. It tends to become visible only after it’s too late. Yes, there are hedges, blah-blah-blah, but at size there are no hedges.
A range of asymmetries arise between exporters of energy and consumers of energy in a global depression. Once demand for goods and services falls off a cliff, demand for the energy to generate those goods and services also falls off a cliff. As marginal demand is swept away, marginal enterprises, loans and employment are also swept away.
Far fewer people can afford to jet around the world and frequent restaurants, so demand for jet fuel, etc. also plummets.
Energy consumers aren’t concerned with the cost of producing energy: that’s your problem. As the price of oil / natural gas drops below production costs, consumers are cheering. (Recall that price is set on the margins: if demand falls faster than production, price collapses.)
Producers care very deeply about the cost of production and the price of the energy they export. Energy exporters are still bound by the commodity curse: it’s so easy to make money selling energy, and so hard to compete in the global economy for other means of production, and so the producers depend on selling energy for a consequential share of the national income. The exporters have no substitute for the share of their national income derived from exporting energy.
The asymmetry in currencies and bonds plays out in the consumer nations. The few nations that can issue new currency and bonds without destroying the purchasing power of the currency can issue whatever currency they need to fund social welfare for those who lost their jobs. Yes, fewer people can afford pricy air travel, vacations and eating out, but they’ll make do with preparing food at home and much cheaper forms of amusement.
Those nations that can’t print more currency without destroying its purchasing power don’t have this luxury. Belt-tightening is all well and good until a “nothing left to lose” revolution sweeps away the ruling elite.
The producer nations dependent on energy exports have an equallky difficult set of constraints. They can try to cut production to match plummeting demand, but game theory strongly favors cheaters who announce production cuts but pump as much as they can to maximize revenues as the price of energy drops.
Most energy exporters have built up savings in the form of central bank reserves and sovereign wealth funds, but they now discover another asymmetry in global depressions: the value of their stocks and bonds has plummeted, and even precious metal prices are dropping as everyone is forced to liquidate savings to fund the exporters’ insanely high social welfare / military expenditures.
Why would bonds lose value? As the demand for buyers of newly issued bonds explodes higher (to fund deficit spending), bond yields rise globally as nations compete for the dwindling pool of capital willing to buy potentially risky bonds. As bond yields rise, the value of all existing bonds tumbles off the cliff.
So not only could energy revenues fall by half or more, the value of reserves could also fall dramatically. Nations dependent on energy exports will face a one-two punch with no viable Plan B to replace energy revenues with revenues from some other source.
Energy producers can cut production but they’ll still be selling fewer units for far less money. Energy prices below production costs are “impossible” until there’s competition for declining consumer demand. The frictionless pathway is to slash prices to maintain national income, and sell off the reserves and sovereign wealth fund assets to fund social welfare and military budgets.
This works for a while, but not for long. A global depression isn’t just deeper than a recession, it’s longer. Depressions occur when all the policy gimmicks reach diminishing returns and they fail to restore “growth” in credit and consumption. Eventually the energy exporters have to cut their government spending, and that will inevitably trigger social and political disorder.
Their difficulties are painfully visible to all, and the demand for any bonds they issue will be low due to the risk that the national enterprise is spending far more than it’s bringing in and therefore could go bankrupt.
Add up these asymmetries and we find a very few winners and many losers. The winners are limited to those nations with these five capacities:
1. Self-sufficiency in energy, or close enough to manage with modest imports from friendly neighbors or allies.
2. Not dependent on energy revenues for the bulk of national income.
3. The capacity to sell newly issued bonds without reducing the purchasing power of the currency, i.e. the risk premium and yield are more attractive than competing issuances of bonds.
4. Maintain a freely traded (i.e. price and risk discovered by the market), liquid market in size for its bonds.
5. A diverse, adaptable economy that maintains deep, liquid, transparent markets for goods, services, risk, credit, bonds and other financial assets.
Systems are defined by their constraints. Should oil fall to $40/barrel and stay there due to declining demand, various constraints start limiting policy options. If savings are depleted to maintain the illusion of solvency,’ various constraints start limiting policy options. If there’s no demand for newly issued currencies / bonds, various constraints start limiting policy options.
