Geopolitics and dollar collapse
Soaring energy costs will drive bond yields up and the dollar down. Military failures in West Asia and Ukraine will combine with soaring energy costs to accelerate the dollar’s decline.
Alasdair Macleod
Introduction
So far, only experienced commodity analysts such as Jeff Currie, formally with Goldman Sachs and now co-Chairman of Abaxx Markets in Singapore appear to realise the full horrors of America’s failed attempt to emasculate Iran and the consequences for energy and other prices.
If Currie is right and evidence is on his side, at Jackson Hole last Friday Warsh severely understated his interest rate policy challenge.
Readers of this Substack will know that we have been beating the drum on this issue for a long time.
Rising commodity prices were already reflecting a continuing decline in the US dollar’s purchasing power, now being accelerated by the US’s failure in its attack on Iran.
The additional risk from Hormuz being closed is now driving treasury bond yields to multi-decade highs, starting with that of the long bond, shown in our headline chart which has already broken out above its 3-year consolidation to stand at 5.21% last Friday.
Clearly, if Warsh sticks to his inflation mandate the Fed’s funds rate will have to rise significantly.
But that creates two further problems: headaches for Treasury funding and of overindebted private sector actors.
Can he “do a Volcker”, driving rates as high as required to stabilise the dollar’s purchasing power and damn the consequences?
The answer is No, because of his dual mandate, the other being to prevent unemployment rising.
If Warsh tackles inflation, he will collapse the entire US economy, taking those of Europe, the UK, Canada, and Japan down as well.
If he suppresses rates, he will be seen to be helping the domestic and global economy.
The inflationary consequences of Hormuz and Bab el-Mandab straits being closed and shortages of diesel, aviation fuel, and sipping bunkers threatening to collapse entire logistical supply chains, means the political imperative will be to rescue the economy and financial markets from crisis.
There can be no doubt that with equity markets surfing on a massive credit bubble that higher bond yields — inevitable whatever the policy on interest rates — will collapse them, because since the financialisation of the US economy in the 1980s equities are about three times as expensive relative to long-term reference rates than they were at the height of the dot-com bubble:
That is something which cannot be prevented.
Add in geopolitical failures…
It is plain to see that financial markets, government finances, and the finances of private sector actors are in an extremely precarious state, ready to collapse even without further external factors.
But there is an additional massive, looming problem for the US in the background which is the loss of geopolitical credibility.
The failure against Iran has already been mentioned, though financial markets have barely adjusted for it and are bound to discover the consequences in the coming months.
But it also appears that the collapse of Ukraine is not far off.
Access to the Black Sea has been closed off, and grain exports with it.
Ukraine has run out of funds, having spent almost all of the EU’s theft of Russia’s $90 billion balances in SWIFT.
Russia is targeting Ukrainian infrastructure including electricity, which is vital for sustaining life in winter.
The pace of attacks is rising.
There’s a growing threat that Russia will attack NATO members overtly supporting Ukraine, principally France, Britain, and Germany.
They have no defence against Russia’s hypersonic missiles.
Furthermore, along with those of the US, ordinance stocks in Europe are virtually expended, effectively ruling out non-nuclear retaliation.
Russia is now warning the Europeans that targeted attacks against military facilities and factories in their jurisdictions are being considered.
Some, including MacleodFinance would argue that destabilising her belligerents economically is the better option.
Rising bond yields tell us that an economic crisis is very close, accompanied by collapsing financial markets and/or their currencies as well.
The Chinese certainly see it, and it would be very surprising if the Russians did not as well.
Whether Russia escalates attacks outside Ukraine or not, it is clear that US influence in Europe and West Asia is waning.
Effectively, she has been kicked out of the Gulf and is bottled up in Israel.
The US has been back-peddling on Ukraine, and unlikely to rescue European belligerents should they be attacked.
Bessent’s latest wheeze, to double down on sanctions against Iran looks like threat rather than fact unless he sanctions China.
In all this there is a conclusion.
With the US backing out of Europe and West Asia and the demise of the petrodollar, the value of the dollar to global actors is set to rapidly decline.
This is not to say that it will cease to be used for pricing and payments of commodities as well as for trade settlement.
These functions will continue.
It’s just that everyone has far too many dollars and are bound to turn sellers just at the moment when the US Treasury needs them to be buyers.
No wonder an existential crisis for the dollar is looming, which is bound to be shared by the other G7 currencies.
A rapid collapse in their purchasing power is now inevitable, driven by a confluence of negative factors.
China is already planning to secure its currency by making it exchangeable for gold, and Russia need only watch her opponents’ economies and currencies collapse instead of attacking them.
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