More Valuable Than Gold

It was another bloodbath on Wall Street today, as the three major indexes took another beating.

Both the Dow and S&P are well into correction territory (down 10% or more from recent highs).

The rate-sensitive Nasdaq lost over 4% today. It’s now mired in an official bear market (down 20% from its most recent highs), which will likely get worse before it gets better.

Markets will have their good days, but you can expect that the overall trend will remain down as long as the Fed is taking away the punch bowl.

The Fed is now playing a desperate game of catch-up.

Inflation is now at the highest levels since 1981. That inflation is not a one-month blip (the March 2022 CPI was 8.5%), but is part of an established trend. Inflation for the full-year 2021 over 2020 was 7.0%. Inflation in January was 7.5%, and in February was 7.9%.

In other words, the inflation trend is not only persistent, it’s getting worse. The Fed missed this trend entirely and is now racing to catch up.

The Fed raised its target rate 0.50% at this month’s FOMC meeting. Another 0.50% hike is likely in June. Jay Powell seemed to rule out the possibility of a 0.75% rate hike, but the Fed is nonetheless tightening at an aggressive pace.

The Fed Is Destroying Money

Rate hikes will also be accompanied by reductions in the money supply of $80 billion per month or more. This is called quantitative tightening (QT) and is the opposite of the notorious quantitative easing (QE) that the Fed has practiced since 2008. The Fed is destroying money now.

Coming on top of the 0.25% rate hike in March, the May and June rate hikes will have pushed interest rates from 0.0% to 1.25% (or higher) in a mere three months. Combined with QT, this will be the fastest form of monetary tightening since the days of Paul Volcker.

Of course, the problem is that the Fed is tightening in the face of economic weakness. No surprise there: It’s a persistent habit of the Fed.

The Commerce Department recently reported that first-quarter GDP in the U.S. declined 1.4% (annualized). The Atlanta Fed GDPNow forecasting tool estimates second-quarter 2022 growth in GDP will be 1.8%. If that second-quarter estimate stands, that means growth in the first half is pretty close to zero.

There’s little reason to believe that economic growth will accelerate over the second half of the year. The main reason is that the sanctions against Russia will continue, along with all the economic disruptions they’ve created.

Sorry, the Russians Aren’t Leaving

Bloomberg News tells us the German foreign minister, Annalena Baerbock, has declared that “sanctions against Russia will only be lifted after a complete withdrawal of its troops from Ukrainian territory.” There’s only one problem with that policy: The Russians aren’t leaving.

It remains to be seen how much Ukrainian territory Russia will seize and what the final terms of a peace settlement might be. But there’s no way Russia is withdrawing entirely from Ukraine.

They have built a land bridge from Russia to Crimea at a high cost and are not giving it up.

This means the sanctions will never be lifted (unless Baerbock and other Western policymakers changes their views). It also means there will be enormous destruction to global supply chains.

Then there’s China. We now know that lockdowns don’t work to stop the spread of COVID. But China is doubling down on its insane “zero COVID” policies anyway.

It’s cracking down even harder in Shanghai, one of the world’s major trading hubs. There’s no end in sight. The impact of these lockdowns on global supply chains is profound. Chinese exports are at two-year lows, and it’s a serious drag on the global economy.

When considering the supply chain disruption from the war in Ukraine, and new pandemic lockdowns in China, it’s not a stretch to suggest that the U.S. economy may fall into a steep recession before the end of 2022.

But as troubling as that prospect is, for many around the world it’ll be much worse.

The Coming Famine

Most analysts are aware that Ukraine and Russia together provide about 25% of all the grain exports in the world including wheat, barley and corn. That’s a huge percentage. But when viewed from the perspective of importing nations in Africa and the Middle East, the two warring parties provide 70–100% of the grain imported by those countries.

Among the largest importers are Egypt, Lebanon, Sudan, Kenya, Somalia, Jordan and many others. Together, those large importers have a combined population of 700 million people, or about 10% of the global population. There is no ready substitute for those imports.

The U.S., Canada and Australia are all major grain producers, but they already consume their grain domestically (mostly as animal feed to supply beef and pork) or have existing export markets that also rely on the grain.

This looming grain shortage is amplified by global shortages of fertilizer, which also comes from Ukraine and Russia to a great extent. Many farmers cannot get fertilizer at all, and those who can are paying twice–three times last year’s price.

That will result in further grain shortages and sky-high food prices as the higher fertilizer costs (and transportation costs due to higher diesel prices) feed through the supply chain. The end state of these various forces is a potential humanitarian crisis of unprecedented proportions late this year and early next year.

It’s not a stretch to estimate that the total number who die of starvation as a result of this food shortage will be greater than the total number of people killed on the battlefields of Ukraine. So yes, the war can get worse. And it will.

Given today’s economic turmoil, people ask me if I’m buying gold. I am, but I’ve spent more time lately shopping for large-capacity freezers so I can stock up on food (I have three already).

The food shortages should hit hard by this fall.

Buckle Up!

Overall, the remainder of this year and 2023 will challenge investors in ways not seen since the Great Depression. We’ve grown accustomed to stock market declines of 20% and even 30%, (which happened in 2008, 2018 and 2020).

But a real stock market crash can be 80% or greater (as happened from 1929–1932 and in the Nasdaq in 2000–2001). That’s the order of magnitude investors need to keep in mind.

The course for investors is clear. Equity exposures should be reduced. Allocations to cash should be increased significantly, perhaps as high as 30%. Allocations to hard assets including real estate, farmland, gold, silver and natural resources are a must.

One way to keep a hand in the stock market but still bet on natural resources is to look at energy stocks and mining stocks; both sectors should outperform major indexes.

But if there is a severe recession, as I predict, there is one bright spot: Recession is often the one reliable cure for inflation. It’s a steep price to pay, but it can be effective.

But there’s also the real possibility that we’ll suffer from both weak growth and inflation at the same time.

We may be returning to that unpleasant combination of low growth and high inflation known as stagflation. If so, it will be a return to the late 1970s when the “misery index” was created to describe the stagflation combination of high interest rates and high unemployment at the same time.

My advice is to buckle up.


Jim Rickards
for The Daily Reckoning

The Daily Reckoning