Two important "black swans"

[OrmontUS]

Well, not really, as they are in full view (I am ignoring a third one which involves US domestic politics and should not be discussed here):

1. Russia is throttling down the fuel supply to Europe as winter approaches. Already, the cost of some classes power in Europe - exacerbated by the reduction in hydro power caused by the draught - is approaching an order of magnitude higher than a year ago. Ukraine has started a well-publicized counter offensive, which they claim is the beginning of their pushing Russian troops out of Ukrainian territory.

They have been assisted in this effort with massive quantiles of military assistance from the US, UK and EU as well as increased hardship for the population of the UK and EU as well as a far more subdued level (despite the political stress it generated) in the US.

It is important that this effort produce tangible significant results over the next month or two, otherwise, it is my feeling that the population of Europe will be unwilling to go through a harsh winter with little ability to provide heat “the good old fashioned way”. In that case, Russia will be in a position to dictate terms to end the war. If, on the other hand, Ukraine’s military is successful and begins to look like they are about to enter Crimea - which Russia has annexed - I suspect the war will become even more devastating to Ukraine’s cities. The net result is that, best case for Ukraine, is that Russia will pull back to its pre-war border and continue to hold Crimea. “Productive” regime change in Russia is simply wishful thinking.

For those who have forgotten to track another timeline, Ukraine’s next national election is scheduled for Sunday, March 31, 2024.

2. The Chinese economy, either the second or first largest in the world depending on which fingers you are counting, continues to remain in chaos due to their chosen methodology of dealing with “Zero COVID” in the face of the much more transmissible Omicron strain, financial upheavals caused by the meltdown of their real estate bubble and a significant drought causing a reduction in the availability of hydro and nuclear power. This affects world markets on a number of levels; loss of productivity, a market eagerly buying discounted Russian oil/gas, breakdown in supply chain, potentially irrational behavior by a government looking to distract its population, etc.

It is obviously over-simplistic to blame any portion of our government for “creating” inflation based on the above market and fiscal forces. That said, as other nations are feeling its effects, we too feel the inflationary pressures caused by the distortions the two factors listed above are causing. It is also easy to project a drop in manufacturing as supply issues along with inflation causes unexpected levels of price increase. From an equity standpoint, this immediately affects miners, shipping companies, manufacturers - shortly followed by retailers and so on. While higher interest rates will slow down the “puffing up” of the economy, our domestic population has grown accustom to purchasing on credit and support against default by the federal government over the past couple of years and clamping down on inflation may pit the Fed against the realities of politicians which have to promise a chicken in every pot in order to get elected.

It is important that the Fed address the “expectation” of inflation as that can cause a distortion in procurement habits which makes it a self-fulfilling prophesy (by front loading purchases to be paid for with devalued dollars).

We are not isolated from what happens across the world and have to be prepared for, and acquire protection from, “unexpected” actions.

Jeff

[WendyBG]

Jeff, how have your investments changed to protect against these potential issues?

Wendy

[OrmontUS]

They have gone down.

While, in the past, I’ve always tried to time the market - sometimes with pretty good effect, sometimes to no particular advantage. This time around, I decided to stand pat. So far, I’ve probably lost my entire stake in Lukoil because of the Ukraine thing (but that made up less than 1% of my portfolio, so more of an object lesson and embarrassment than anything else). Total portfolio was up about 25% and is now up 12%. I expect that it may drop below acquisition cost at the bottom, but most of the companies I hold have longevity (including Lukoil which is very profitable right now - just not for me). In any case, hopefully what goes down goes up.

In large part, I am substituting 6 month Treasury notes for cash, but keeping significant powder dry. The only other fixed income stuff we own is a couple of years worth of maxing i-Bonds. There may come a time when bonds make sense to buy - but probably not yet.

For reasons I’ve mentioned above, I think we are likely in for a rougher ride than the market currently reflects.

Jeff

[Leap1]

Jeff,

Having been in Ireland and discussed Ukraine…the Europeans have no link between how the war is going and their economies in how they were decide to release Russia.

Meaning if the war goes on for a decade the pressure will stay on Russia. The current offensive is not going to determine Europe decisions.

NG and oil cuts or prices out of Russia are only making the Europeans angry not more dependent. The attitude is screw any of that.

The Chinese are at a dead end growth wise only because of water. The rest of the window dressings are logistics that can be fixed over and over again but wont promise further GDP growth.

The US will have a chicken in every pot…not just you with one chicken. smiling If you want your investments to make money you need better and more consumers and savers. If you want to see the federal deficits and debt load go down you need better and more consumers and savers. The reality is the opposite of the last 40 years of lying.

[OrmontUS]

Leap:
The US will have a chicken in every pot…not just you with one chicken. smiling If you want your investments to make money you need better and more consumers and savers. If you want to see the federal deficits and debt load go down you need better and more consumers and savers. The reality is the opposite of the last 40 years of lying.

---

Let’s make a couple of over simplifications:

The money supply is finite and a zero sum game

There is no inflation and no quantitative easing or interest rate increases by the Fed

You are absolutely correct that there is a gap in the earnings and assets of the wealthy and the poor. It is also true that the wealthy have had the advantage over the past few presidential administrations (of both parties) of having their taxes cut as well as laws being passed which allow lobbyists to buy the attention of politicians of both parties in order to favor their favorite projects - whether engaging in wars, pumping up pharmaceutical costs, creating colleges whose major finance source was student loans and so on.

There seems to be a country-wide effort not to teach students history, economics and the habit of thinking in a format which would allow them to properly evaluate the actions of the politicians which represent them.

That said, there is no implication that simply raising taxes in order to turn the money over to those in the lower strata of the economic system will turn out to be more profitable to the companies and people at the top - and without any sort of remedial education, any expectation that the money will remain in the hands of the poor and create a long-term nest egg for the future.

So what would I recommend? Simplifying the tax code, which should increase the taxes on the top strata of the economy.

Evaluate changes in structure to both our K-12 and our university educational structure to enhance learning and cut unnecessary spending. That includes removing the tax-free status of college sports teams and separating their structure from the school’s, separating the structure of teaching students from the research arms of universities and forcing the profits of those structures to be directed towards subsidizing education. And so on.

Creating non-partisan ways of cutting the huge amount of military and pharmaceutical/health spending and using the savings to both reduce the budget shortfall and bring the price of meds down to the costs the rest of the world pays.

Just remember, that in order to have a capitalistic system, you need the “job creators” who are willing to put their own chips on thee gaming table. In order to entice that action, there has to be sufficient incentive to counteract the mathematical (or perceived) possibility of loss. Keeping the profits made after the spin of the wheel or throw of the dice is what makes the effort worth the risk.

Jeff

Jeff

[jaagu]

It is important that this effort produce tangible significant results over the next month or two, otherwise, it is my feeling that the population of Europe will be unwilling to go through a harsh winter with little ability to provide heat “the good old fashioned way”.

======================================

I think your feelings are unreal. The population of Europe will go through the winter without severe trouble, and your worries are unfounded about resolve of Europeans to standup to Russia and see it crushed militarily and economically to the point where Russia will never again threaten Ukraine and EU. Even Liz Truss is ready for a nuclear war with Russia.

Jaak

[OrmontUS]

Jaak,

I might agree with you if Europe had boycotted Russian gold trading, refused to pay for gas/oil in Rubles and so on. Sure there are sanctions, but they are so porous that, while they have negatively affected Russia, they have certainly not dealt a decisive blow. The West’s attitude since the beginning of the war is to avoid giving Ukraine weapons which would allow them to attck across the border into Russia. That means that they are using this as an opportunity to allow Ukraine to continue to bleed Russian military strength and capability - which reduces the likelihood that it will be able to muster sufficient resources to attack other European countries.

Sure Russia is the demon and Ukraine the angel, but this war is not about saving Ukraine, but rather it’s about weakening Russia without a single US, UK or EU soldier being involved on the battlefield. Ukraine has this major chance to upend the Russian military by retaking a significant chunk of their former territory in the south of the country. If this push flounders, it will be difficult to quickly mount another try.

That said, there is a limit to the domestic hurt that politicians will be willing to inflict on their population once Russia has been sufficiently damaged as things would reach the point of diminishing returns.

Ukraine’s military was not able to take its lost territory back for nearly a decade and it’s unlikely that they will win a war of attrition against Russia sufficiently to push them back to their starting position. So, the question becomes “how much more physical damage to Ukraine’s infrastructure will Ukraine be able to take without losing stability”? Can they put up with a year or two more of Russia continuing to punch holes in apartment buildings in Ukrainian cities outside of the warzone?

They can probably negotiate an end to the conflict, but only at the cost of giving up their claim on Crimea - something they are still not ready to contemplate.

If the ware doesn’t end, it will continue until such time as the levels of available ammunition in Western warehouses gets low enough that it would become a danger to the gifting country to continue sending it to the front. Of course, Russia runs the same risk. There will be some interesting books written about this war.

Jeff

[flyerboys]

jeff (and Jaak too)

I think (and have posted before) that the deal will be hard and bloody to get because Putin will not be interested in backing off until his army or economy is collapsing, as I doubt the Russian people will “become difficult” unless the army or economy or both collapse.

However, I do think Ukraine will slowly strengthen, and Russia will weaken towards a collapse, and that therefore an armistice deal will come. It will require Russia to leave all of Ukraine except Crimea and the Donbas, but with credible international supervision leading to referendums in X number of years for Crimea and the two Donbas provinces as to their future allegiance and status.

The combatants will deny even the possibity of contemplating such a deal until they do it. Putin screwed up, Ukraine is now psychologically too independent to back down, and Russia will have to pay. The most interesting question to me is what form would reparations take?

david fb

[Leap1]

That said, there is no implication that simply raising taxes in order to turn the money over to those in the lower strata of the economic system will turn out to be more profitable to the companies and people at the top

Jeff,

This is where your focus can stay and historically has merit…historically.

It is not much of a reality. Meaning raising taxes on the wealthy has happened slightly but that is not the heart of it and not the workings of what we need at all. It is a misnomer to think it has to happen. Or at worst some ten years out going forward we will see creep to cut off inflation but NOT outrageously. Regardless of some raising taxes on the wealthy is not the goal.

Instead spending money to enhance the consumer base instead is the goal. That is more than double dipping for the billionaires. Why? Because corporate bankruptcies over the next decade will decline. Meaning that more consumers and savers means greater profits.

All of the virtual spiral fills the tax coffers. Not higher taxes.

The same was said of Reagomics, a virtual cycle. That is why I voted for Reagan.

“It’s the economy stupid”.

We are in a recession that will deepen into 2023. The real rebound will probably be in 2024.

The public has turned to social issues. Those who thought they would benefit with the public because of inflation and a recession are not going to benefit at all. There is no virtual economic spiral out of them.

You can say no handouts if you need to denigrate others. But denigrate a generation of the wealthy first for the same things. Every little loss has been socialized for the wealthy. Denying everyone else aint playing any longer.

[steve203]

…but with credible international supervision leading to referendums in X number of years for Crimea and the two Donbas provinces as to their future allegiance and status.

Dictators have no use for democracy or fair elections. I remember when Argentina invaded the Falklands. A panel of experts were talking about Argentine claims on the islands, and noted that the UK had suggested a referendum of the island residents be held, so the people could clearly speak on whether they wanted to be part of Argentina, or the UK. Anything that involved a binding vote of the people involved, was a non-starter with the Argentine junta.

Putin would never agree to a referendum that he could not control.

…old Soviet Union joke: old man at the polls, opens the envelope containing his ballot. A guard runs up to him “comrade, what are you doing?”. The old man said “I was wondering who I was voting for”.

Steve

[Leap1]

fb,

The only fly in the ointment, Putin will be ousted. Not necessarily an assassination. He will be set aside. The next leader of Russia will set another course. Ukraine in total will get liberation.

The forces in Russia to balance against an internal revolution will replace Putin. Putin’s grip in public has become stronger. In the party and security forces he has probably lost some important ground. The public is under hard control and in that reality Putin has lost even more ground.

[syke6]

Ukraine’s military was not able to take its lost territory back for nearly a decade and it’s unlikely that they will win a war of attrition against Russia sufficiently to push them back to their starting position. So, the question becomes “how much more physical damage to Ukraine’s infrastructure will Ukraine be able to take without losing stability”? Can they put up with a year or two more of Russia continuing to punch holes in apartment buildings in Ukrainian cities outside of the warzone?

That is the million dollar question. And one we’ll have a least a partial answer to in the next couple of weeks. Russia has been stalled offensively for at least 3 months. Russia’s offensive gains are minimal and offset by losses else where. If the full might of the Russian military cannot move forward, it is moving backward.

Ukraine claims to have launched an offensive. The real story is that Ukraine can launch an effective offensive at all when the Russians can’t and haven’t been able to for months. The betting odds have definitely changed.

This is important because if Russia can’t advance and can’t hold back Ukraine, then, well, Russia can’t hold back Ukraine.

[flyerboys]

The betting odds have definitely changed.

All Russia can do now is

1. hang on and hope to make it to winter without too much retreat or defeat or casualties,
2. apply ferocious squeeze on energy supplies and amp up propaganda and manipulation against key opponents in the EU, especially Germany, especially as “General Winter” gets strong
3. pray, since preying hasn’t seemed to work, and those Russian Orthodox Bishops owned by the government have to be put to some use
4. or (fading possibility), Putin still has some card he is willing to play that could still be decisive?

david fb

[jaagu]

Sure Russia is the demon and Ukraine the angel, but this war is not about saving Ukraine, but rather it’s about weakening Russia without a single US, UK or EU soldier being involved on the battlefield.

=======================================================

That is not true - EU is all in on saving Ukraine:

“On June 23, 2022, the European Parliament adopted a resolution calling for the immediate granting of candidate status for EU membership to Ukraine. On the same day, the European Council granted Ukraine the status of a candidate for accession to the EU.”

Europeans are sick and tired on Russian threats, political interferences and energy blackmail. They do not want to do anything with Russia as long as Putin the killer is in charge. EU and NATO may not economically devastate Russia in the next year, but it is a slow economic death bed for Russia. It will get worse for Russia every month from now on as the sanctions and world economic pressures mount.

Ukraine knows that they are the instrument of EU and NATO for the military defeat of Russia. It will happen as the thought of Russia succeeding in Ukraine is abhorrent to Europeans and NATO. EU and NATO will continue to support Ukraine for as long as it takes. The weak Russian economy will never be able to survive the economic power of EU and NATO. It is ridiculous to even think Russia can survive economically before it collapses.

EU and NATO will never allow Russia to keep any Ukrainian territory including Donbas and Crimea.

Jaak

[jaagu]

That said, there is a limit to the domestic hurt that politicians will be willing to inflict on their population once Russia has been sufficiently damaged as things would reach the point of diminishing returns.

===================================================

There is no limit to the willingness of EU and NATO politicians and people to inflict pain on Russia in the long term. The hatred of Russians and Putin are sky high.

Jaak

[jaagu]

If the ware doesn’t end, it will continue until such time as the levels of available ammunition in Western warehouses gets low enough that it would become a danger to the gifting country to continue sending it to the front. Of course, Russia runs the same risk. There will be some interesting books written about this war.

Jeff

===================================================

Western factories can resupply their warehouses many times faster than Russia can resupply its own warehouses. Russians can no longer import the high tech weapons components from EU and NATO that it needs, and Russia does not have the skills to make their own weapons components. Russia is a weakling compare to EU and NATO weapons capability.

Russia is a giant with feet of clay!

Jaak

[DrBob2]

All of the virtual spiral fills the tax coffers.

Do you mean virtual or virtuous?

DB2

[saunafool]

Russia is throttling down the fuel supply to Europe as winter approaches. Already, the cost of some classes power in Europe - exacerbated by the reduction in hydro power caused by the draught - is approaching an order of magnitude higher than a year ago.

It is clear that Russia intends to cut off the gas to Europe this winter. Everyone has been planning for it basically since the invasion. There are some bright points–US exports of LNG to Europe have exceeded forecasts, and the EU says stockpiles are sufficient for this year. Next year and beyond are in question.

I’d argue that time is against the Russians because as Europe finds more options (LNG imports, more wind farms, nuclear…) , Russian leverage decreases.

It is also interesting how extreme weather events affect all forms of power generation. Low river levels mean less cooling water for thermal power plants (coal, nuclear, gas), impeded river traffic (which can include fuel/energy supplies), and can affect the cooling available for refineries, petrochemical operations, and a host of other industries. That said, rain almost inevitably starts in September/October in Europe and river levels should start rising soon.

It is important that this effort produce tangible significant results over the next month or two, otherwise, it is my feeling that the population of Europe will be unwilling to go through a harsh winter with little ability to provide heat “the good old fashioned way”. In that case, Russia will be in a position to dictate terms to end the war.

I agree that financial pain across Europe is likely to cause political distress for the parties in power. I’m not sure it will translate into abandonment of Ukraine and appeasement of Russia.

The fundamental problem is that no one trusts Russia/Putin. Fatigue is starting to set in–with refugees, high energy prices, instability…but just because people are fed up doesn’t mean there is anyway out. Even if it gets worse this winter (which it almost certainly will), what peace is there to be had? What kind of deal could you broker with Putin that anyone would trust?

So, my war forecast unfortunately is stalemate/quagmire for an unfortunate amount of time. Russia is just too big with too many resources to collapse or quit on the war. On the other side, the Ukrainians have shown resourcefulness and courage and the ability to stop the Russian advance, but unless there is a shocking turn of events, they just don’t seem capable of pushing the Russians back to their borders.

I guess we’ll see in the next few weeks/months if the dynamic changes…

Until then, hope for a warm, wet winter in Europe.

[DrBob2]

It is clear that Russia intends to cut off the gas to Europe this winter. Everyone has been planning for it basically since the invasion. There are some bright points–US exports of LNG to Europe have exceeded forecasts, and the EU says stockpiles are sufficient for this year. Next year and beyond are in question.

It seems China is buying Russian LNG and reselling it to Europe.

www.zerohedge.com/markets/china-aggressively-reselling-russi…
In July, the SCMP reported that according to Chinese customs data, in the first six months of the year, China bought a total of 2.35 million tonnes of liquefied natural gas (LNG) – valued at US$2.16 billion. The import volume increased by 28.7% year on year, with the value surging by 182%…

What was behind this bizarre surge in Russian LNG imports, analysts speculated? After all, while China imports over half of the natural gas it consumes, with around two-thirds in the form of LNG, demand this year had fallen sharply amid economic headwinds and widespread shutdowns…

As the FT reported recently, “Europe’s fears of gas shortages heading into winter may have been circumvented, thanks to an unexpected white knight: China.”

DB2