Unfortunately, the past two decades of western economic policies have been failing most of western society. And once again, we are confronted with another example of political incompetence: The western sanctions against Russia are not working. Today, the Rubel is stronger than before the western sanctions were implemented and doubled in value against the U.S. dollar since March of this year. President Putin is making more money than ever selling Russian oil and gas to the world, mainly to India and China. Another sad piece of the puzzle, in a long line of butchered policy decisions. Decisions made by career bureaucrats of which most never have worked in the private sector and hardly ever have created any jobs other than in government and on the taxpayer’s dime. In other words, most career politicians do not understand how the economy works and have no idea what living in the “real world” is like.
The bottom line is that throughout history, sanctions have never worked – and this should not have come as a surprise. As a matter of fact, the past 100 years of western interventionist policies against countries and their regimes around the world have failed without any exceptions. Sanctions have never led to regime change either, but to the contrary: Sanctions have fostered power and aggression of the very regime they were intended to bring to its knees. From North Korea to Iran, Cuba to Venezuela, and Russia today: Sanctions have empowered the “bad actors” and their supporters. Furthermore, it does not take a “summa cum laude” Ivy League School graduate to point out another obvious fact: Sanctions only hurt the broader population in the country that is being sanctioned as well as the sanctioning countries; they deprive both economies of the most essential basis upon which prosperity and wealth are being built: free trade. As Adam Smith described in his “The Wealth of Nations”, if every country focuses on its strengths and what its economy can produce best and most efficiently, all countries thrive. Pay no attention to the doomsayers and critics who claim that free trade is unfair and not working – they are wrong. Imperial evidence shows that free trade domestically and internationally is the only true form of economic growth that leads to sustainable wealth and increases the quality of life for almost everyone, almost every time. The problem is that we have lost the purest form of economic principals a long time ago, and we have not been dealing with a free market in decades. A market, where the power of innovation and competition unleashes the most potential in the vast majority of market participant. This does not mean that everybody always succeeds. But it means that everyone has a chance to succeed if they focus on their strengths and efficiency. It used to be the productive foundation of a capitalist society, that built the wealth which had made the United States and Europe what they were at the height of their economic and social blossoming. Through the years though, those principles have been diluted and replaced by politics, regulations, excessive tax regimes, and most of all: A failing welfare state that has deprived millions of citizens from acting in a productive and self-responsible way. The reason why today’s economy seems only to be working for “the chosen few” is because of government and government programs creating false incentives that are standing in the way, not because of a functioning free market. The more government intervenes, the worse it gets and the more corrupted a country becomes.
What has that all left us with? Trillions in debt that have likely become the iceberg that is about to sink the Titanic. And the recent Russian sanctions are only the latest spawn of political ignorance and misguided powerplays. We need to keep in mind that none of the career politicians who are responsible for these decisions are personally suffering from the outfall of negative economic consequences. Their lives hardly ever change. Of course, one must condemn the forceful occupation of a sovereign country by a military aggressor. Because it is immoral and against the core values of what a free western society stands for. But it is just as immoral to let one’s own population suffer because of surprisingly poor decisions that have been made over decades by the political class and which have led to leaving their own people hung out to dry. The fact of the matter is that excessive spending, overregulation, and the deliberate cutback on the availability of essential goods in the name of the “environment” have put humanity in dire straits across the world. And the severe consequences are just starting about to show. Particularly in western Europe and some emerging markets in Africa and Asia, politicians have failed to secure an energy supply source essential enough to independently fuel their own economies. And without reliable and stable energy sources, an economy depletes rather quickly. No matter how advanced and superior it used to be, it can turn into a banana republic literally overnight, with all the consequences that resemble a third world country. Once the energy supply stops giving, everything comes to a standstill and chaos emerges. While it takes decades to build prosperity, it only needs a few years of ignorant and falsely incentivized policy to destroy the foundation upon which the wealth was built. The sanctions against Russia with their devastating consequences for many European net importers of Russian energy have become the straw that is finally breaking the camel’s back. Blackouts and energy shortages are becoming more frequent, goods and services are in short supply and becoming more expensive by the day. As a direct consequence, the quality of life and life expectancy in many European countries are likely to drop over the next few years, for the first time ever in modern history. This self-inflicted crisis is going to sustainably decrease European economic productivity, likely lead to a severe recession, and destroy a lot of wealth in short time. In a society, that has already been beaten and suffering from almost two years of Covid-lockdowns that have eaten away on its economic substance. Anyone who takes a close look at most European nations will have to conclude that the continent is barely functioning anymore. German cities have rationed the use of hot water for their citizens, Dutch farmers are no longer allowed to fertilize their fields, and people in France have been substantially restricted in their allowed daily use of electricity. Sadly, the United States is not far behind and while inflation is worse in the U.S. than in Europe, America has not yet experienced the severe energy shortages (other than in California and surprisingly Texas) that some European countries are already dealing with. However, in the United States, too, life expectancy declined by 2.3 years in 2021, the largest decline since World War II. And it had little to do with Covid.
As if all of this was not troublesome enough already, it seems that the past 50 years of reckless spending and ballooning central bank balance sheets, of which the past 14 years have been at a pace never encountered before, are finally crushing down on both sides of the pond. Nobody who paid attention to what had been happening ever believed the fairytale of “transitory” inflation but knew that inflation was here to stay. It is truly remarkable that the Federal Reserve and other central banks seem to get it wrong every time; and not only are they getting it wrong, but most of the time they are negatively contributing to an already dire economic situation by pushing the wrong policies.
However, as negative of an outlook as one may have, there is still hope that voters in a democracy will ultimately get it right. Mainly because politicians who seek re-election will have to realize that the situation as it presents itself today will only lead to social unrest, uproar, and finally end their own careers in office. Along with James Carville, who brilliantly ran Bill Clinton’s presidential campaign in 1992, we would like to emphasize that “it’s the economy, stupid”, that will have the biggest impact on any election over the next two years. Politicians will realize that re-elections for the members of the ruling party under the current circumstances are highly unlikely, from Europe to the United States. Therefore, there is a fair chance that we will get to see some policy reversals in a last-minute effort by those in power, trying to soften the blow of the next election outcome at least a little bit. As hypocritical this is, it could bring some economic relief and improve the sentiment, at least in the short term. Looking at the latest CNN poll, 85% of Americans are saying that the country is headed into the wrong direction. Hence, it is likely that the midterm elections in the United States will bring some change and could lead to a more positive environment for the economy and equity markets during the remaining two years of the Biden administration. We also do not believe that the Federal Reserve can follow through with all expected rate hikes over the next 12 months and will have to reverse course later this or early next year. A continuously hawkish stance on interest rates would push the economy into a depression and completely suffocate any GDP growth for the near-term future. We believe that the same will be true for Europe as well.
It is our opinion that the United States will need to get used to an inflationary environment for the time being, high commodities prices, and further rising energy costs, accompanied by sluggish future economic growth – if any at all. Also, it is our view that the U.S. already is in the middle of a recession, and we do not expect positive economic changes for the remainder of the year. At the same time, we see a similar scenario for continental Europe, even though inflation in Europe should stay below the numbers in the United States. The biggest roadblock for America is the U.S. dollar and what we believe is going to be a continuation of the decades-long decline in purchasing power, despite the latest short-term strength the Greenback has shown. U.S. government spending under President Biden and a Democratic majority in congress has driven the U.S. national debt beyond the 30 trillion-dollar threshold this year and is unprecedented. Additionally, the country must account for US-$170 trillion in unfunded liabilities, US-$34 trillion in Medicare and US-$22 trillion in Medicaid liabilities while America’s annual GDP is at only US-$23 trillion. Even compared to most European nations, if the United States was a company, it would have had declared bankruptcy years ago. And there is no reason why a currency issued by a country drowning in debt and a negative book value should be as strong as it is. It is quite ironic to hear U.S. politicians talk down on Bitcoin and other virtual currencies, claiming that there was no “value” behind them, when their country’s own official legal tender is backed by nothing but trillions of debt. At the end of the day, a currency is just a mutually recognized tool to accommodate trade and the exchange of goods efficiently, without having to physically deliver 12 camels in return for the receipt of a motorbike. Of course, the value of a currency is always relative to the value of other currencies issued by other nations, and it is no secret that it does not look much brighter elsewhere either. However, with global commodities being traded in U.S. dollars, the rise in commodities prices in combination with an overall falling dollar value will make goods in America even more expensive than in many places abroad and lead to even more imported inflation for consumers in the United States.
Regarding the stock market, we would like to remind investors that it still is a leading indicator and we have seen a major global decline between 15 and 30% this year so far. We believe that there is room for further downside of up to 10%, depending on whether corporate earnings can keep up with expectations or not. Generally, we expect markets to remain in bearish territory and volatility to stay elevated across the board. However, with the stock market being a leading indicator, a lot of bad news has already been factored in and with the significant corrections this year, the core of negative developments should be priced. Hence, with every further week of a market decline, the likelihood of a recovery on Wall Street increases while Main Street is more likely to keep on staying depressed for a lengthier period of time.
We stick to our past buy recommendations and advise long-term investors to take advantage of the decline in prices when it comes to value and defensive stocks. Geographically, we are still in favor of Switzerland, the United Kingdom, and Norway, as well as Southeast Asia including Australia as far as stocks and the respective currencies are concerned. We remain bullish on commodities as well as commodity-related stocks and see the latest weakness in the price of gold, silver, wheat, corn, and soy as a mid-term buying opportunity. Value equities and hard assets should remain more favorable in a time of high inflation versus consumer cyclical stocks, bonds, and cash. Also, for the high-risk investor, it could prove fruitful to start rebuilding or expanding a position slowly but surely in China. The Chinese economy shows a contrarian development towards Europe and the United States, and the Chinese Central Bank has recently lowered interest rates to boost economic growth and development. However, there is quite an extensive political short-term risk associated with investments in China.
In order to hedge equity exposure, we recommend using the ProShares UltraShort FTSE Europe ETF (EPV) and the ProShares UltraShort Consumer Goods ETF (SZK).
Oliver E. Hohermuth, Principal and Chief Investment Officer