And what rough beast, its hour come round at last,William Butler Yeats – The Second Coming
Slouches towards Bethlehem to be born?
I’ve been watching the unfolding events in the Middle East since last week’s attack by Hamas on Israel like everyone else. We can all sense that this is a watershed moment. What occurred is the kind of thing that precludes going back to the way things were before.
It was always the thing that sat out there, a rough beast waiting to be born, in our nightmares, thanks to the accelerating chaos of global systems on the verge of dramatic change.
I don’t pretend to understand the history of the conflict with any degree of nuance and nor the depth of the passions existent on both sides. That said, I was asked by Sputnik News to give my thoughts on the effects on capital markets this new phase of conflict birthed.
And from that perspective I answered their questions as honestly as I could. Small events have far-ranging effects because of what they mean to those who will use them for their own purposes. And what was clear from the questions asked was there is, as expected, a Russian angle on this.
The article posted is here. I think it’s a more than fair representation of some of my comments. As always, I will post the entirety of my response to them here for transparency’s sake as well as to illuminate some of the deeper issues as I see them.
You are, of course, free to disagree with me here.
But, that said, these were written first thing the morning of October 14th, after the capital markets closed for the week. Their response to this and the US CPI data that came out on Thursday are very striking.
The markets are telling us that they expect cooler heads not to prevail and that all attempts to hold the old price regimes in the geopolitically important commodity, bond and currency markets are about to go haywire.
In short, it was a flight to quality moment as capital stormed into US assets, a trend that I think is only just beginning. As well we saw “high-quality” European assets strongly bid… but for how long?
I ask that because the whole repeat of “I stand with Ukraine” schtick coming from the EU doesn’t seem nearly as convincing for Israel than it did last year. There’s a definite sense of this being far more complicated a relationship between the US and Europe than it was in February of 2022.
The popular war fatigue is fueling the changes to the political fortunes of major players. Poland’s elections today will be yet another referendum on NATO policy in Ukraine. And I note that Poland has become one of the major buyers of gold in recent months according to World Gold Council data (login required), as it seems they are preparing for a much different world in the future than we’ve been living in.
Because once money starts going to ground the way it did this week, it won’t stop. The sell off in oil, gold, silver and the dollar all reversed themselves strongly and in ways that are definitive. You can check out the slide deck for today’s Patron Market Report to get a sense of what I’m talking about.
The good news is that we’re seeing conflicting reports of conflict between Israel and Hezbollah today, while Israel has postponed their invasion of Gaza for the time being. It will be touch and go this week, however, as there are too many imperatives outside of the Middle East pushing this into a potentially wider conflict.
For now, it looks like the US is being forced to choose between Ukraine and Israel. The UK still wants both conflicts and Europe just wants the US to die. The feeling is mutual in D.C. towards Brussels. If you can’t see that at this point, I can’t help you.
Watch Russia’s response here as everything that has unfolded so far breaks in their favor with higher oil prices, Arab solidarity with the Palestinians, and real fracturing in Europe over continuing Project Ukraine.
Unfortunately, for Israel, they have no good options here, and that means they will likely do what is ultimately in their best interests despite the wider consequences.
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My communications with Sputnik News follows:
The open armed conflict between Israel and Palestine came as a surprise to global markets, Israel’s financial markets being the most significantly affected. We would be very happy and grateful if you share your perspective on the following:
How will the escalation affect Israel’s economy, given that the country has conscripted 300,000 soldiers and this number is likely to grow?
The war economy always looks good in the short term as production numbers go up, but that’s at the expense of the government’s balance sheet. On the day after the attack Israel had to spend a large part of their foreign exchange reserves to defend the shekel. That will continue.
Production numbers up, alongside inflation and the private economy will be diverted to the war effort if Israel follows through on the threats they’ve made to date.
How might this conflict affect global stock markets given that Israel has the third-largest number of companies traded on NASDAQ after the US and China?
The immediate effect of this conflict has been a near biblical “flight to quality” move in US assets across the board – stocks, bonds, the US dollar. The move in equities was mixed. The NASDAQ ended up the week less than 0.1% while the Dow Jones Industrials were up over 1.1%. This is indicative of foreign capital fleeing into US blue chips rather than more speculative tech stocks. War is never good for innovation until after the shooting stops.
What are the risks to the global market from the escalation in Palestinian-Israeli tensions?
It’s all about that “flight to quality” effect. People rightly worry more about the return of their money rather than the return on their money when tensions are high. This is why gold was up nearly $100 on the week, oil broke back above $90 per barrel and the Dow was up 1.1% while high-quality sovereign debt yields fell 25 basis points.
The worry should be this extreme move into US assets out of fear exacerbating an already tight dollar environment thanks to Jerome Powell’s monetary policy that begins breaking capital markets around the world.
I would continue to advise being short Europe as Belgium made the insane error to steal the frozen Russian foreign exchange reserves and hand them to Ukraine. This was a clear provocation by the EU telling Russia there will be no peace between them in the future.
By doing this it ends any illusions that we can return to the pre-war state of international finance. Trust will have to be restored in the global system. If any countries in the EU follow Belgium’s lead, and I expect that they will, it will stop dead cold all foreign investment into the EU, ensuring a complete collapse of their stock and bond markets beginning next year.
This will fuel an even bigger move into the US, especially if Israel calms down in the next couple of weeks.
In your opinion, is it possible to predict further changes in the world economy?
Yes. Trust is gone in the post-Bretton Woods system. Shattered. Kaput. “Stick a fork in it.” as we Americans like to say. That will have immense and predictable effects on global trade and relations going forward.
Those without leverage should not be running around the world dictating ‘values’ to those they depend on for their livelihood. In this case I’m talking about the hectoring bunch of virtue signaling fools running the European Union. They are all in Israel this weekend to pledge their support for Israel goading them to go to full war with the entire Arab world.
The reason they are doing this is to force the US to fight that war for Israel, the same way their anti-diplomacy picked the fight with Russia over Ukraine. Notice how the US didn’t, in the end, commit fully to Ukraine. What happens if they don’t fully commit to Israel?
What happens to Europe at that point? How many friends do you think they have left?
The short answer is none. So, a sovereign debt crisis in Europe thanks to political fallout from ruinous foreign and monetary policy. Gold goes to new highs, if not extreme highs. Oil explodes on tightened supply from OPEC+ as a response to European mendacity, inflation returns with a vengeance, forcing interest rates even higher.
Commercial debt markets seize up and we have a real global crisis. There will be a margin call on the entire global Ponzi scheme. And I hate to break it to everyone, but the US is the biggest of the Ponzi schemes and the Fed has both the liquidity ($1.1 trillion in reverse repos) and the collateral (US Treasuries on its balance sheet) to provide the US banking system (not the world, this time!) whatever it needs to muddle through.