Month: April 2022

The war in Ukraine and COVID-19 pandemic could spell the end of globalization

Posted on by j.giglio

Times are changing. The global pandemic and Russia’s unprovoked invasion of Ukraine have sparked debate on the future of globalization — nations trading with few barriers, focusing on the industries and services they do best.

The war in Ukraine has strained ties between countries that were already under pressure due to the coronavirus pandemic. It has exposed the risks inherent in economic interdependence among nations with different ideologies and security interests.  It may well be that globalization as it has been known is dead in a post-COVID-19, post-Ukraine war world.

The war has had a big impact on the global economy, especially as supply chain shocks threaten everything from energy supplies to auto parts to exports of wheat and raw materials, and sent prices skyrocketing.  It has also raised concerns about food shortages because Russia and Ukraine are among the major breadbaskets of the world.  Many countries have banned the export of food grains, fearing supply disruptions and higher prices due to shortages.

The CEO and chairman of Black Rock, the world’s largest asset manager, said in a letter to shareholders last month that “The Russian invasion of Ukraine has put an end to the globalization we have experienced over the last three decades.” He added that companies and governments will now be forced to further “reevaluate their dependencies and reanalyze their manufacturing and assembly footprints.”

The pandemic dramatically demonstrated vulnerabilities in long supply chains and made countries look closer to home. While it is impossible to predict the outcome of the war, Russia’s invasion of Ukraine on Feb. 24 has upended a world order that has been in place since the end of the Cold War in the 1990s. It signals changes to globalization as the world has known it.

The combination of technology and a relatively stable geopolitical landscape promoted steady expansion of global trade over the last 50 years. In 1970, trade accounted for 25% of global GDP, meaning one quarter of all goods produced were traded with international partners. By 2000, global trade had doubled to 50% of all goods and services produced.

But the trend toward globalization recently started to run in reverse. The world trade share of GDP output peaked in 2008 at 61%.  In 2020, global trade accounted for just 51.6% of worldwide GDP, the lowest since 2003.

Even before the pandemic, the 2008 financial crisis dealt a blow to globalization, as cross-border investments, trade, and supply chains all contracted.  In the last decade, globalization has suffered multiple setbacks in the form of Brexit, the US-China trade war, the pandemic, and now the Russia-Ukraine war.

The conceit that economic interdependence promotes political stability has been shaken. Russia, the ninth largest economy in the world, is being economically isolated from the West, which has responded to Russian aggression with harsh economic sanctions. Consider that the European Union is Russia’s main trading partner, accounting for 38 percent of its exports. Of course, this is partially neutralized by its dependence on imports of Russian gas and oil.

Governments and corporations are recognizing the limits of having supply chains spread out in multiple locations.  For instance, shortages of surgical masks and personal protective gear at the outset of the pandemic in 2020 showed the vulnerability of the world’s dependence on Chinese factories for all sorts of goods.

All this means global trade may have crossed the Rubicon and is heading toward cold war-era trade blocs, one led by the U.S. and the other by China.

Globalization may not fully recover from the pandemic and the war in Ukraine.  A version of it based on different principles and moves away from pure efficiency to consider security, reliability, and partnerships may be in the offering.

Billionaire Tax

Posted on by j.giglio

The return of inflation has changed politics. For months the Federal Reserve and the White House dismissed inflation as the dog that had not barked in over 40 years. Inflation has now started to spiral out of control and the country may be on the brink of a recession.

Inflation is one of the main reasons why Biden faces record low poll numbers and Democrats may lose control of both the House of Representations and the Senate in the November mid-term elections.

The president’s political response has been to include a “Billionaire’s Minimum Income Tax” in his $5.79 trillion fiscal 2023 budget proposal.  Despite the name, it would require that households with a net worth over $100 million (the top 0.001percent of U.S. households) pay a rate of at least 20 percent on their income as well as unrealized gains in the value of assets like stocks and bonds. The Biden Administration refers to the name of the proposal as a “billionaire minimum income tax” despite the $100 million threshold.

Attempting to impose a minimum tax rate of 20 percent on the likes of Jeff Bezos and Elon Musk may be good politics in an era when the prevailing wisdom is that the super-rich don’t pay their fair share of taxes, but this proposal is highly questionable from a governing standpoint.   Essentially the proposal is taxing gains from their wealth.

It is beyond debate that the gap between the richest and the poorest Americans has widened in recent decades. According to the Pew Research Center, in 1970 upper income households had a 29 percent share of US aggregate income. By 2018 it was 48 percent. Middle income household income was 62 percent of the total in 1970, by 2018, it was 43 percent.

It gets even worse when you look at wealth inequality. The richest 1 percent of the population owns 56 percent of all US equities.  The least wealthy 40 percent of the population owns no assets at

all—nada.

Rather than waiting for a taxpayer to sell an asset and tax those gains, the administration plan would allow the federal government to start collecting revenue now. The proposal raises complicated questions about how the IRS and taxpayers would assess the value of assets that are not publicly traded.  It would be more efficient to simply tax the profits from sales of stock and other assets at the same rate as ordinary work income.

Another basic question is whether Biden’s proposal would raise the $361 billion over a decade that the White House says it would. Taxes based on capital gains coming from tradeable assets such as stock and bond prices are certainly more volatile than income earned by taxpayers. What are the assumptions about stock and bond prices over the next ten years that are behind the $361 billion projection and how do you value non-tradeable assets?

Broad-based taxes are more likely to deliver projected revenues than those that focus on a subset of the population. But Biden promised during the campaign that he would not raise taxes on anyone making less than $400,000 a year, effectively locking out 98.2 percent of taxpayers from any proposed tax increase.

Like the COVID-19 pandemic, Russia’s war in Ukraine has contributed to stagflation pressures in the United States and other advanced economies where prices are increasing beyond what many ordinary people can afford.

Global food prices set a record last month according to the United Nations. People are on edge. The only certainty when people go food shopping these days is the price will be cheaper today than tomorrow.

Inflation is a very real problem, but Biden’s political response of proposing a minimum income tax on the ultra-wealthy doesn’t address it.  Instead, it is all about political virtue signaling.

With household budgets stretched due to inflation, the Fed finally raises interest rates

Posted on by j.giglio

The Federal Reserve (Fed) has chosen to do the bare minimum when it comes to raising its benchmark interest rate. Last month’s 0.25 percentage point increase was no more than the markets had expected.

It was the first time the Fed has raised rates in more than three years and marked a reversal of a zero-interest rate policy and injecting unprecedented levels of cash into the economy. Still, real interest rates – nominal rates adjusted for inflation – remain extremely low. Taking interest rates to near zero has caused one of the greatest asset bubbles in history. The Fed has its hands full to achieve a soft landing and get inflation back to its 2 percent target over the next three years.

That may be the triumph of hope over experience. After all, the Fed ignored all the warning signs, spending much of the last year telling Americans that inflation would be but a transitory problem.

The Fed feared that a larger hike would hold back the economy. On the contrary, the real threat to economic growth and living standards may come from a sustained period of high inflation, not small changes in short-term interest rates.

Inflation skyrocketed to 7.9 percent over the past year, according to the February report from the Bureau of Labor Statistics (BLS), the fastest increase since January 1982 when the U.S. economy confronted the twin threats of higher inflation and reduced economic growth.  Excluding food and energy, both of which moved sharply higher during the month, core inflation still rose 6.4 percent, the highest since August 1982.

Wherever you look, prices of essential materials, products, and services are shooting up at rates unseen in a decade or more. The most recent inflation problems have also been compounded by fast-rising gas prices.  In February, gasoline cost 6.6 percent more than in January, which translates to a nearly 40 percent annual increase.

The White House has largely blamed the inflation problem on supply chain disruptions during the COVID-19 pandemic, corporate greed, and now Putin’s war.  Blaming Putin is utter nonsense.  For sure oil prices have increased over the last two months, but consumer inflation rose from 2 percent to over 7 percent in the last year.

Food, housing, cars, recreation – it has all gotten more expensive.  This is attributable to an unprecedented government spending blitz coupled with persistent supply chain disruptions that have been unable to keep up with stimulus-fueled demand, particularly for goods over services.

That’s putting upward pressure on wages. But although wages are increasing, inflation is rising faster, meaning that workers are falling further behind.  Inflation-adjusted average hourly earnings fell 0.8 percent in February, contributing to a 2.6 percent decline over the past year, according to the BLS.

After allowing for inflation, the Fed funds rate is still exceptionally low, especially in real terms.  Indeed, with the CPI measure now expected to top 8 percent, raising nominal interest rates by just a quarter of a point hardly even counts as monetary tightening.  A larger hike would have sent a clear signal that the Fed is serious about getting inflation under control.

Inflation is something a large majority of Americans have not experienced in any meaningful way. Those who are under 50 have no memory of the high inflation rates from 40 years ago, so the current price increases come as a shock.

While the consensus view is that the Fed will raise the benchmark interest rate six times this year, these passive increases may be too little and too late to get inflation under control. The longer the Fed waits to raise rates aggressively, the harder it will be to bring down inflation and the worse it will be for the American economy and the living standards of ordinary people.