Geopolitics and Markets Review - 9th January 2023:

Predictions for 2023.

One of the hardest years to predict in the financial markets ever?

Jerome Powell has been possessed by Paul Volcker and he is going to crush inflation. This provides us with two possible scenarios.

---

Scenario 1:

1) Powell is successful. He keeps interest rates higher for longer and inflation somehow returns to 2%. Although supply chain pressure is past us, geopolitics is contributing to isolated supply chains. Countries will trade more in smaller supply chains. I believe we will continue to see shortages of specific products over the coming years caused by exogenous shocks. We are seeing that currently with bird flu contributing to egg shortages. The flip side of this coin is based on the method of inventory supply. When a company receives stock from its supplier that it wants to sell, it can receive it just-in-time, or just-in-case.

Just-in-time inventory reduces excess supply and creates a smooth production process. In other words, there will be no volatile shifts in production. When supply chains were undisturbed in the age of globalization, many companies used just-in-time. But, during Covid-19, many companies moved to just-in-case inventory systems. This strategy details holding excess stock to avoid running out in sudden demand increases.

The change in the inventory system could contribute to what Flexport CEO Ryan Petersen has said could lead to a “shipping recession”. If companies are holding excess supply, then there is less demand for shipping.

The decreased demand for ocean shipping could benefit the Chinese Belt and Road Initiative. If they can expand and offer favourable, long-term trade contracts over the Eurasian landmass, they will remove a proportion of trade from ocean shipping and back to the land. This is one of their long-term geopolitical aims. In a period of decreased ocean shipping demand, could they increase the value of goods traded through their trade system?

The tensions don’t show any sign of improving yet in Russia and Ukraine. The Ukrainians rejected a ceasefire by the Russians last week. The Ukrainians have been preparing since 2014 after the Minsk Accords, as admitted by Angela Merkel. It was all about buying Ukraine time to defend itself. Ukraine can now defend itself. And they don’t want to let off the brake after regaining large amounts of territory that was taken from them.

Geopolitical tensions remain strong in many areas of the globe. China work on long-term plans, one of which is reunification with Taiwan. Iran continues to suffer political tensions through the protests. Also, tensions with Saudi Arabia for de-facto Middle East and OPEC leader exist in the background.

Last week, Turkish and Greek forces fired warning shots at each other from patrol boats. The presence of Mediterranean gas sources and the border wars of the islands in the area still provides friction between the two.

In short, tensions remain high. Trade will be affected and only the most self-sufficient nations will be able to return inflation to 2%. The US with its internal productivity and security in many areas of necessity could mean they are one such country.

---

Scenario 2:

2) Something breaks before Powell possessed Volcker can bring inflation down to 2%. Is 2% even possible in this new geopolitical landscape? We saw the US set export control on its semiconductor industry to China. This won’t be the last element of the trade war we see in the next decade. Countries will need to be as self-sufficient as possible to avoid supply chain constraints. And they will act in their own self-interest, as everyone always does. Countries don’t have allies. They have strategic agreements that benefit both parties until they don’t.