Of Two Minds – Weaponizing Global Depression

February 23, 2023

All this suggests a strategy that’s only available to those few nations with these capacities: weaponize
global depression.

Before we get started, I need to stipulate that I don’t have an opinion one way or the other about weaponizing
global depression: I don’t agree or disagree, I don’t “like” it or dislike it, I have no emotional investment
in whether you “like” it or “dislike” it or if we agree or disagree. I’m addressing the topic because it’s an interesting
dynamic.

The general assumption now is that everything is propaganda, i.e. that every shred of content has been
stripped of the 90% of messy reality to leave the shiny 10% that protects someone’s vested interests and emotional stake.
While propaganda is indeed ubiquitous and overabundant, not everything is propaganda. Propaganda is always certain
about XYZ. Analysis, on the other hand, is always skeptical of neatly packaged, over-simplified received wisdom and alive
to the uncertainties embedded in the messy 90% of reality edited out of propaganda.

We’re quite fond of the illusion that our “likes” and “winning the argument” matter. They don’t. Winning arguments,
collecting “likes” and basking in the warmth of confirming our biases don’t change anything. We cling to
the illusion they matter because it gives us a warm and fuzzy sense of agency when in reality our agency is limited
to our individual/household responses to all that we don’t control or influence.

A third illusion is that policymakers control everything. They don’t. Certain decisions topple dominoes, others
are equivalent to closing the gate after the horses left. They’re for show only; the 90% of messy reality is running off
on its own now and policymakers dancing the humba-humba around the campfire (i.e. the illusion of control)
aren’t going to stop what’s unfolding on its own dynamics.

I’m not trying to persuade you of anything or solicit a “like.” I’m simply discussing an interesting dynamic.

With all that out of the way, let’s look at weaponizing global depression. The key to this dynamic is
the asymmetries built into the global economy.

One important asymmetry is energy, with exporting (producer) nations on one end and importing (consumer) nations
on the other. A very small number of nations/regions occupy the middle: they export or import relatively little
energy, as they are largely self-sufficient and can make do with what they produce themselves. They aren’t reliant on
exports for income or imports to keep their economy from collapsing.

Another key asymmetry is currencies and bond markets which are one integrated system: currencies
are valued by the liquidity, depth, risk premium and yield of the bonds denominated in the currency.

A lot of people have a lot of opinions about currencies, and unfortunately many of these opinions are detached from the
basic reality that currencies and bond markets are one system.

If a currency and its bonds don’t trade freely on the global market, i.e. they’re pegged to another currency (RMB to the USD
for example) or capital controls limit the liquidity and depth of the market for the bonds, this places intrinsic
constraints on the risk characteristics and thus the value of the currency and the bonds.

If the risk is high (or difficult to measure), demand for the bonds and currency will be limited. The issuing nation /
central bank will be constrained in how much new currency / bonds it can issue without pushing the value off a cliff.

In other words, currencies and the bonds backing them have asymmetric risk premiums, liquidity and valuations.
For players in size, for example sovereign investment funds, illiquid bonds are risky because when it comes time to
dump their $10 billion stake, the market is bidless: there are no buyers in that size at any price.

Risk is tricky. It tends to become visible only after it’s too late. Yes, there are hedges, blah-blah-blah, but
at size there are no hedges.

A range of asymmetries arise between exporters of energy and consumers of energy in a global depression.
Once demand for goods and services falls off a cliff, demand for the energy to generate those goods and services also
falls off a cliff. As marginal demand is swept away, marginal enterprises, loans and employment are also swept away.

Far fewer people can afford to jet around the world and frequent restaurants, so demand for jet fuel, etc. also plummets.

Energy consumers aren’t concerned with the cost of producing energy: that’s your problem. As the price of
oil / natural gas drops below production costs, consumers are cheering. (Recall that price is set on the margins:
if demand falls faster than production, price collapses.)

Producers care very deeply about the cost of production and the price of the energy they export. Energy exporters
are still bound by the commodity curse: it’s so easy to make money selling energy, and so hard to compete in
the global economy for other means of production, and so the producers depend on selling energy for a consequential share of
the national income. The exporters have no substitute for the share of their national income derived from exporting
energy.

The asymmetry in currencies and bonds plays out in the consumer nations. The few nations that can issue new
currency and bonds without destroying the purchasing power of the currency can issue whatever currency they
need to fund social welfare for those who lost their jobs. Yes, fewer people can afford pricy air travel, vacations
and eating out, but they’ll make do with preparing food at home and much cheaper forms of amusement.

Those nations that can’t print more currency without destroying its purchasing power don’t have this luxury.
Belt-tightening is all well and good until a “nothing left to lose” revolution sweeps away the ruling elite.

The producer nations dependent on energy exports have an equallky difficult set of constraints. They can try
to cut production to match plummeting demand, but game theory strongly favors cheaters who announce production cuts
but pump as much as they can to maximize revenues as the price of energy drops.

Most energy exporters have built up savings in the form of central bank reserves and sovereign wealth funds, but
they now discover another asymmetry in global depressions: the value of their stocks and bonds has plummeted, and
even precious metal prices are dropping as everyone is forced to liquidate savings to fund
the exporters’ insanely high social welfare / military expenditures.

Why would bonds lose value? As the demand for buyers of newly issued bonds explodes higher (to fund deficit spending),
bond yields rise globally as nations compete for the dwindling pool of capital willing to buy potentially risky bonds.
As bond yields rise, the value of all existing bonds tumbles off the cliff.

So not only could energy revenues fall by half or more, the value of reserves could also fall dramatically.
Nations dependent on energy exports will face a one-two punch with no viable Plan B to replace energy revenues with
revenues from some other source.

Energy producers can cut production but they’ll still be selling fewer units for far less money. Energy prices
below production costs are “impossible” until there’s competition for declining consumer demand. The frictionless
pathway is to slash prices to maintain national income, and sell off the reserves and sovereign wealth fund assets to
fund social welfare and military budgets.

This works for a while, but not for long. A global depression isn’t just deeper than a recession, it’s longer.
Depressions occur when all the policy gimmicks reach diminishing returns and they fail to restore “growth” in credit
and consumption. Eventually the energy exporters have to cut their government spending, and that will inevitably trigger
social and political disorder.

Their difficulties are painfully visible to all, and the demand for any bonds they issue will be low due to the risk that
the national enterprise is spending far more than it’s bringing in and therefore could go bankrupt.

Add up these asymmetries and we find a very few winners and many losers. The winners are limited to those nations
with these five capacities:

1. Self-sufficiency in energy, or close enough to manage with modest imports from friendly neighbors or allies.

2. Not dependent on energy revenues for the bulk of national income.

3. The capacity to sell newly issued bonds without reducing the purchasing power of the currency, i.e. the risk
premium and yield are more attractive than competing issuances of bonds.

4. Maintain a freely traded (i.e. price and risk discovered by the market), liquid market in size for its bonds.

5. A diverse, adaptable economy that maintains deep, liquid, transparent markets for goods, services, risk, credit, bonds
and other financial assets.

Systems are defined by their constraints. Should oil fall to $40/barrel and stay there due to declining demand,
various constraints start limiting policy options. If savings are depleted to maintain the illusion of solvency,’
various constraints start limiting policy options. If there’s no demand for newly issued currencies / bonds,
various constraints start limiting policy options.

Messy realities tend to generate the illusion that an array of policy options still exist, but eventually these
will be pared away by the systemic asymmetries and constraints. Dancing the humba-humba around the campfire (such fun!)
and spewing propaganda (if you’d just agree with me, everything will be fine!) won’t change anything.

The most diverse, adaptive economies with the largest and most transparent markets and the most balanced energy
production and consumption will be the winners, and every other nation will struggle due to the constraints and
asymmetries described above. It’s just the way systems function.

I discuss these dynamics in my book
Global Crisis, National Renewal.

All this suggests a strategy that’s only available to those few nations with all five capacities: weaponize
global depression by jacking up bond yields and tightening credit so the increasingly fragile global economy
slips off the cliff into a recession that quickly becomes entrenched in depression by decades of policy extremes
that are finally generating unintended consequences that cannot be reversed.

The ensuing global depression will be bearable for those with the five capacities, and a system-breaker for everyone
else.

It’s nothing personal, it’s just business. Systemic asymmetries and constraints present opportunities for the
few and risks for the many.

I’m not claiming weaponize global depression is inevitable or even likely. What I am exploring is the potential for
global depression to be weaponized as a policy option or as an unintended consequence of actions that
stretch asymmetries and constraints to the breaking point.

Where does that leave us as individuals and households?
It’s best to take the long, emotionally detached view and and devote ourselves to maximizing
our own
Self-Reliance. The less we depend on high debt, high consumption and fragile global systems, the better off
we’ll be.

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