By J Mulraj
Aug 7-13, 2022

Geopolitics or Financial insanity, what will bring about another crash?

A black swan event is an unpredictable event which results in dire consequences (like the start of WW1 with the assassination of an Archduke or the collapse of Lehman triggering a global financial crisis in 2008).

The recent visit to Taiwan by Nancy Pelosi, against severe objections by China, is one potential trigger of a black swan event, if China retaliates. It hasn’t, so far (except firing off missiles over Taiwan) but, being patient, it may.

Or it could be Xi Jinping, beset with huge domestic problems, (mortgage borrowers are refusing to pay EMI on home loans, which has triggered a bank crisis, and inability of even mainstream banks like PBOC or ICBC, the world’s largest bank, to pay out depositor money), may attempt a Taiwan incursion in order to divert public attention at home. He badly seeks a third term, when the party meets in November to decide.

Or maybe it could be Joe Biden, who has just passed the ‘Inflation Reduction Act’, which seeks to raise $ 737 b. in new taxes, mainly a 15% minimum corporate tax, $ 222 b, and a prescription drug pricing reform, $ 265 b. From the $ 737 b. the Biden government will spend $437b. mainly on Energy Security and Climate change, and will reduce Federal deficit by over $ 300b. That, at least, is the plan. The bill was equally tied in the Senate with 50 Democrats voting for and 50 Republicans against, and VP Kamala Harris  making a casting vote in favour. The polity is split down the middle.

The words of authoress Ayn Rand best explain why such foolish behaviour, at a time when USA is facing the highest inflation in 40 years, could be a black swan event: “When you see that money is flowing to those who deal, not in goods, but in favours; When you see that men get richer by graft and by pull than by work, and your laws don’t protect you against them but protect them against you, When you see corruption being rewarded and honesty becoming as self-sacrifice, You may know that your society is doomed”.

What Biden needed to do was learn from USA’s own history. Inflation had reached 9.5% in the US in late 70s, and the then Fed chief had, in 1981, raised interest rates to 20%. This triggered a recession for 2 years, with accompanying rising unemployment,  but inflation was tamed, and the stage was set for a continuing boom.

Inflation is a tax on everyone, and results in a continuous spiral as demands for a wage increase to mitigate it result in increase in producer costs, and further inflation. Uncontrolled, it leads to hyper inflation. Argentina, e.g. is now facing a 70% inflation rate, and has just raised interest rates by 9% to 69.5%.

Biden’s incapacity to understand basic economics was witnessed when he proudly announced a 0% inflation rate last week! That, however, was the figure for MOM (month over month) increase in inflation, whilst the YOY (year over year) increase was + 8.5%. Minneapolis Federal Reserve President Neel Kashkari believes that the Fed needs to raise interest rates 1.5% in 2022 and more in 2023, even at the risk of a recession.

The idiocy of Pelosi’s Taiwan visit has already resulted in a cessation of communication by China, with USA. Including in crucial fields like climate change and  military communication. Russia has stopped mutual inspection of nuclear facilities with USA, on the grounds (correctly) that if sanctions prevent Russian inspection of US facilities, why should it allow the reverse?

Imagine a plausible scenario, where an accidental firing of a missile cannot be communicated, because contacts between China and USA are terminated, and triggers a wider conflict! And for what purpose? Only to satisfy Nancy’s ego?

Xi Jinping’s angst arises over his claims that Taiwan is an integral part of China. But history says otherwise. In 1895, a victorious Japan signed a treaty, called the Treaty of Shimonoseki with a vanquished China, ruled by the Qing dynasty,  under which, under Articles 2 and 3, the latter ceded control,  in perpetuity, of Formosa (as Taiwan was then known) to Japan. Japan, in turn, ceded control over Taiwan under the Instrument of Surrender, after WW 2. China considers Taiwan to be a province it once controlled, and wants to reunify with.

Taiwan’s TSMC is the world’s leading manufacturer of computer chips, a basic need for electronic, defence, automotive and several other industries, making control over it a desirable outcome.

So Nancy, Joe and Xi could all become the black swans.

Or it could even be Putin. His troops have taken control over a Ukrainian nuclear electricity plant at Zeporizhzhia. The potential of either a missile attack, or even something like cutting off of power needed to cool it, can result in a catastrophe, and become a black swan event.

As if this is not enough, the world is staring at a global famine which could take millions of lives. Africa is most vulnerable. Russia controls 45% of global ammonia nitrate, 20% of potash and 14% of phosphate fertiliser export. Exports are hampered because the ports are in the Black Sea, which, being a war zone, is not covered by insurance. China stopped export of fertiliser in July, and of phosphate, an ingredient to manufacture fertiliser, in September. As a result of both Russia and China’s cessation of export of fertiliser and its inputs, there will be a massive shortage of wheat globally, resulting in a famine.

Mother nature is also hitting out, for having neglected her. Rivers in Europe are running dry, hitting countries like Germany, which depend on river transport for raw materials and products. Water levels in the Rhine, the Thames, the Sienne and other rivers, are low or absent, which will affect not only logistics, but food output.

Impervious of all this, last week the BSE sensex added 1074 points to end at 59462.

India’s largest bank, SBI, reported a modest 6.7% increase in net profits (below anticipated Rs 8,300 crores) thanks to provisions for mark-to-market losses on its Treasury bonds. As interest rates rise, the market value of bonds fall. This higher provisioning for MTM (mark to market) losses will manifest itself in other bank stocks. Financial sector accounts for a 29% weightage in the sensex.

Michael Burry, who made millions anticipating the 2008 crash and shorting the market, feels that the current rally in stock markets wont last. He opines that the liquidity generated by the STIMMIE (stimulus) cheques in USA, is running out. It is this liquidity that has helped retail spending and GDP growth, which will slump once the money runs out.

If interest rates continue to rise to tame inflation, as they ought to, and the US economy start to slump after the liquidity runs out, the recession will be confirmed. Even though there has been negative GDP growth for two successive quarters, the definition of a recession, Biden refuses to acknowledge it. But, as pointed out above, his knowledge of economics does not really inspire confidence in his ability to spot one.

All in all, dark days ahead. A black swan event looks quite likely. Let’s hope it’s just an ugly duckling.

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