In observance of the holidays, there will not be a Geopolitics & the Day After circulated next week. Merry Christmas and a Happy New Year!

As we round out 2022, economic instability continues and promises to create new challenges in the new year. America and Europe are both struggling with supply-side issues but on different ends of the supply chain spectrum. A post-lockdown China is dealing with a Covid surge, despite what the government claims. Stock markets are gearing up for a possible recession in the US in the first half of 2023, while the Fed’s mixed messages threaten to prolong financial instability. And, as we have been discussing over the last several months, the era of “Great Moderation” has ended and a new era of transformation, or “Great Disruption”, has begun.

American supplies abound as Europe sees supply squeeze

Europe’s $1 Trillion Energy Bill Only Marks Start of the Crisis

Bloomberg News, Bloomberg

America’s biggest ports face a new kind of paralysis

Schumpeter, The Economist

Supply-side issues are impacting both America and Europe in disparate ways. In America, where the port of Los Angeles was flooded with shipping frigates to the point of overcapacity only a year ago, the dockyards are now quiet as the number of new shipments has dropped dramatically. While some of this business is being redirected away from the West Coast towards the East Coast, importers’ demand for newly shipped goods has decreased as supplies have become abundant in the post-Covid demand frenzy. The outcome is that a cessation in supply-chain pressure, with supplies now plentiful, may explain why goods-price inflation is easing. Nonetheless, goods only account for one-third of consumer spending, with the other two-thirds committed to services.

Conversely, European supply problems have become considerably exacerbated in the energy sector. This year, Europe has been hit with $1 trillion in surging energy costs as the fallout from the war in Ukraine continues to damage the European economy. As Europe’s gas storage reserves dwindle, the continent will need to acquire supplies without the help of Russia, drastically tightening the LNG market. While more facilities are coming into operation to import LNG from suppliers like America and Qatar, markets are expected to remain tight until 2026 when additional availability comes online. To combat energy costs in the short term, Europe has disbursed $700 billion to assist both companies and individuals manage increasing costs. Additionally, the EU has requested both businesses and individuals reduce their energy consumption, which has curbed demand by 50 billion cubic meters this year. A 27 billion cubic meter shortfall nonetheless remains. This, coupled with rising interest rates and ballooning debt point to the possibility of a significant recession in the next year; a fact that China’s reopening further complicates as Chinese LNG demand tightens an already squeezed market. With 2 of 5 gas reserve indicators in Germany blinking critical, the worst may yet be to come. 

Post-lockdown China

Our model shows that China’s covid death toll could be massive

The Economist

China’s Great COVID-19 Wave Has Begun

James Palmer, Foreign Policy

The elimination of China’s zero Covid policy has brought on a wave of Covid infections in China. While social media posts and informal surveys of Covid infection show a rising tide in infection, Chinese government statistics claim a decline in infection rates since relaxing the zero Covid lockdown policy. This is in part explained by Chinese classifications, such as the fact that “asymptomatic” Covid includes individuals that have mild symptoms but were not hospitalized. Nonetheless, official government statistics are considered untrustworthy. As such, the Economist and other organizations have performed analyses to determine the potential impact that the post-lockdown Covid surge may have on China in the coming months. In the worst-case scenario, as many as 1.5 million Chinese may die, with 96% of the population becoming infected; while in the best case about 90% becoming infected, with measures such as vaccination boosters, successful antiviral treatments, and excess hospital capacity mitigating the death count below 72,000. Currently, there does seem to be some good news for China on this front; while calls to the emergency room have increased six-fold in recent weeks, hospitals have not yet shut down. Additionally, many in Beijing, where the caseload is increasing dramatically, are self-imposing some lockdown measures which may further mitigate the spread of the virus. Time will tell to which end of the spectrum China ultimately ends up in the fight against Covid in a post-lockdown China.

Markets remain unstable as possibility of recession looms

Stock Market’s Brutal Year Leaves Wall Street With Little Faith in a Rebound

Jess Menton, Bloomberg

Where Has All the Liquidity Gone?

Raghuram G. Rajan & Viral Acharya, Project Syndicate

The year has been tough on the stock market, and the holiday season isn’t lightening Wall Street’s mood. This year, the S&P 500 has lost almost 20% and the Nasdaq has fallen over 30%. While analysts predict the market will improve in the second half of 2023, they still expect the economy to struggle through a recession in the first half of next year. Higher borrowing costs and economic uncertainty will likely dampen stock gains in 2023. Analysts claim that three factors could put an end to the bear market: a trough in corporate earnings estimates, a steeper bond-yield curve, and cheaper valuations in stocks more sensitive to economic cycles.

Central banks have played a role in some of the instability threatening the economy. Quantitative easing, where central banks bought long-term bonds from the private sector and issued liquid reserves in exchange, has made the financial sector dependent on easy liquidity. Because QE has gone on so long and at such a great scale, financial markets have become accustomed to readily available liquidity. The financial sector devoured these issued reserves, leaving a large gap between spare liquidity and the issued reserves, which risks a financial crisis in the event of a market shock. This puts monetary policymakers in a bind; central banks need to raise rates to fight inflation, but if they are also supplying liquidity to stabilize government bond markets, they send mixed messages about their policy stance and could ultimately prolong the fight against inflation. 

The great disruption has only just begun

Gillian Tett, Financial Times

Read the full article here

The “Great Moderation”, a time of low inflation and steady growth where the business cycle was almost dead and analysts felt comfortable making long-term predictions, has finally ended. Business executives seem to agree that their companies, and the world in general, are experiencing remarkable disruptions in their operations. These disruptions come from the Russian invasion of Ukraine, the rise of AI, COVID-19, and deglobalization. Francis Fukuyama’s book, The End of History and the Last Man purported that global trends were going in one direction: democracy, globalization, and capitalism. Contrary to his thesis, history has not ended, and these tenants of a liberal world order have experienced worrying backsliding. The Great Moderation has been an aberration, rather than the norm, in the history of humanity. Our long, shared history of violence and instability seems to be rushing back. However, such disruptions as the ones we are seeing allowed America to become a dominant superpower after Europe’s destruction, showing that times of instability can be an opportunity for some.