Global inflation badly underestimated
Analysts and commentators severely underestimate the inflationary consequences of the Iran war. The current energy stoppage is far worse than the 1973 oil embargo.
Alasdair Macleod
“The only surefire protection to one’s wealth is to get out of all forms of credit and into the safety of gold, which is real legal money.
The Iran war and its consequences have made this decision increasingly urgent.”
General commentary plays down the consequences of today’s Hormuz crisis, has entered a stalemate.
The fact of the matter is that the US and its Israeli lobby will not accept Iran’s red lines, and the war which is already lost will continue.
Not only that, but the Houthis are severely restricting Saudi pipeline oil flows Yanbu, emasculating the Saudi economy and destabilising the nation.
Admittedly, the 1973 crisis which was similarly driven by a conflict between Arab petroleum exporters and Israel led to a substantial increase of the oil price from $3 per barrel to $12.
So far, the Iran war has only led to a mere doubling, but it’s 3-2-1 derivatives add a further $60 per barrel.
The 1973 crisis led to the combined economic slump and inflation shock, peaking at 11.1% in 1974 in the US, 24.2% in the UK in 1975, 13.7% in France in 1974, and 23.2% in Japan in 1974.
Why should it be different this time?
In 1973 the oil embargo led to less than a 10% drop in global oil supply.
This time, it’s probably about 15% and counting.
Furthermore, 20% of global LNG supplies are cut off, supplies which didn’t exist in the early 1970s: gas was usually flared off.
Downstream products such as fertilisers, urea, ammonia, and sulphur have become major Gulf exports in recent years, because of access to cheap natural gas.
Additionally, G7 nations face protectionism from other exporters of these commodities.
China has announced a ban on fertiliser exports to protect her domestic market, withdrawing supplies available to importers.
The chart below illustrates the relative importance of China’s move.
Other exporting nations are likely to follow, leaving Russia as the sole significant global supplier, assuming that they are allowed to do so.
As the second largest fertiliser exporter, China’s ban combined with the Gulf’s supply restrictions is simply horrendous for agriculture, particularly coupled with restrictions of diesel supplies vital to farming.
G7 economic policy options
Broadly, there are two policy options.
Governments intervene, or they don’t.
If they don’t intervene, markets will restore the balance between supply and demand for all production and consumer prices affected, which is everything.
The consequence would be an immediate slump as consumers cut out all unnecessary spending, businesses go bankrupt, unemployment soars, and stock markets crash.
At least those with a roof over their heads should remain housed, because their mortgage lenders will go bust and liquidators will be unable to call in mortgages from non-payers.
The ensuing slump could be worse than the 1930s depression.
Governments facing a collapse in tax revenue and escalating welfare costs which they would be unable to pay would find it impossible to finance their debt obligations, and their currencies being fiat would simply collapse to their true value, which will be nothing.
Therefore, G7 governments will intervene to prevent this outcome — not that they will succeed in doing so.
Political intervention will be aimed at expanding government credit without limit to subsidise prices where essential consumer products cannot be rationed, to provide emergency funding for failing businesses, and to suppress interest rates to support financial markets and protect government finances.
Intervention will involve massive credit expansion, undermining the purchasing power of their fiat currencies.
It will depend on very short-term finance through the issuance of T-bills because bond finance will be too expensive or unavailable.
The slump will still be worse than the thirties’ depression, only concealed slightly by currency devaluation.
Consequences for personal wealth
The depression caused the US stock market to collapse by 89% between September 1929 and mid-1932.
The equity bubble today almost certainly dwarfs that which preceded the Wall Street Crash, going by the level of margin debt and the already high level of long bond yields which will rise considerably further as the inflationary impact hits government finances.
The 1929—1932 difference from today was that the dollar was firmly on its gold standard of $20.67 to the ounce.
That meant that the 89% decline in the Dow was measured in a gold substitute and reflected the true position.
Today’s US markets are measured in fiat dollars, which will lose significant value at the same time as equity values collapse.
The best illustration of the difference between the two comes from the reichsmark era in 1920—1923 Germany.
This is illustrated in the next chart:
In the runup to hyperinflation, gold began to outperform the German equity index assembled by Collet & Fohlin, indicated by the gap between the two closing.
The C&F Index rose from 375 in February 1921 to 1,250 in October, before declining to 750 in June 1922.
That was measured in reichsmarks.
In gold, it had peaked at 152 in February 1921 before declining to only 3 in November 1922.
During the hyperinflation period which followed, considerable volatility ensued before the index became worthless valued in gold.
Given the similarity and inevitability of debasement conditions evolving in today’s financial markets, it would be a brave investor who hangs on to stocks for a hyperinflationary blowoff.
The only surefire protection to one’s wealth is to get out of all forms of credit and into the safety of gold, which is real legal money.
The Iran war and its consequences have made this decision increasingly urgent.
Do not be misled by negative sentiment over gold.
The current decline presents a likely final opportunity to stack at depressed values.
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