A Few Things: Clash of Empires, How The World Works, Freezing Order, Its All About Inflation, Crypto According to Punk6529

April 30, 2022

I am sharing this weekly email with you because I count you in the group of people I learn from and enjoy being around.

“Time is the coin of your life. It is the only coin you have, and only you can determine how it will be spent. Be careful lest you let other people spend it for you.”

- Carl Sundburg

“Most people are other people. Their thoughts are someone else’s opinions, their lives a mimicry, their passions a quotation.”

- Oscar Wilde

“Who would you be and what would you do if you weren’t afraid?”

- David Brooks

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A. A Few Things Worth Checking Out:

1. Gavekal had a fascinating piece titled: The Clash Of Empires Intensifies, discussing the world splitting into two zones—the empire of the land and the empire of the sea.

The empire of the sea—or the “Western bloc”—as dominated by the US.

The empire of the land—or the “Eastern bloc”—dominated by the duopoly of China and Russia.

Their thesis is that that: The Europeans keep buying energy from Russia—if not, they will face a severe recession. But given the sanctions on Russia, Europe won’t be able to make it’s payments in Euros, and hence will no longer enjoy the “imperial privilege” through its chief energy supplier partially funding its budget deficits by depositing Euros in bank accounts that are used for example to buy European Sovereign Debt.

This struggle over energy is accelerating the emergence of two main zones in the global economy. Gold will become the main basis of trade settlement between the two big competing economic blocs.

Some key bits of the piece:

It is obvious that the Eastern bloc cannot have monetary independence without energy independence. In fact, the war in Ukraine is accelerating a trend whereby each zone prices energy independently, such that a “transfer mechanism” is needed for transactions between them. Only gold can achieve this function, as it is the one reserve asset that is not someone else’s liability.

The problem for Europe—a part of the Western bloc—is that it gets most of its energy from the Eastern bloc’s main producer. By demanding that Europe’s hydrocarbon purchases be priced in rubles—and establishing an effective ruble gold standard—Vladimir Putin is proposing that this reference rate be set according to the gold price, rather than US dollars or euros.

- Such an outcome is not acceptable to the US government, which is acting to keep oil priced in US dollars.

- It is not acceptable to Europeans, as this would mean most of the gold held in the vaults of their central banks getting transferred to Russia.

- However, being paid in either US dollars or euros is not acceptable to the Russians, as they can no longer use these currencies.

- This is called a stalemate, and it has not been resolved.

The solution could be a massive revaluation of the gold price, which would satisfy both Russians and the Europeans, as both have plenty of gold.

The likely mechanism would see buyers of Russian gas send euros to the Gazprombank, which would not buy rubles but gold in the open markets of Istanbul, Hong Kong and Shanghai. This need to constantly buy gold for energy settlement should lead to a structural rise in the gold price.

How big would this rise in the gold price have to be to satisfy European central banks and governments? To give these institutions payment security, the rise would have to be big enough for their US dollar foreign exchange reserves deposited at the Federal Reserve to be covered by gold. At present, their gold holdings currently represent just 14.7% of their US treasury holdings. Hence, if this condition were to be satisfied, the gold price would need to be about US$13,000 per Troy ounce.

How much would the rise in the price of gold have to be to compensate Russia for losses on its frozen foreign exchange reserves? Running the numbers, this comes out at about US$8,000 per ounce.

2. Vaclav Smil is a great scientist & thinker working at the crossroads of energy, environment and economy. He’s the author of popular books such as:

He spoke to The New York Times Magazine about his new book: How the World Really Works.

A couple of key bits from the article:

One of the fundamental arguments in your new book is that in order to have a serious discussion about an energy transition that gets us away from burning fossil carbon, we need a shared acknowledgment of the material realities of the world. Which is to say, an acknowledgment that our current way of life is dependent on burning that fossil carbon. But do you believe decarbonization should be the goal? And if rapid decarbonization isn’t feasible, then what’s the best way to stop heating the planet?

The most important thing to understand is the scale. An energy transition affecting a country of one million people is very different from a transition affecting a nation of more than one billion. It is one thing to invest a few billion dollars, another to find one trillion. This is where we are in terms of global civilization: This transition has to happen on a billion and trillion scales. Now, according to COP26, we should reduce our carbon dioxide emissions by 45 percent by 2030 as compared with 2010 levels. This is undoable because there’s just eight years left, and emissions are still rising. People don’t appreciate the magnitude of the task and are setting up artificial deadlines which are unrealistic. Now, to answer your question. If you assume that carbon dioxide is our deadliest problem, then of course we should decarbonize totally. But people say by 2050 — they call it “net” carbon emissions. The I.P.C.C., they don’t say zero, they say “net zero.” Leaving that cushion — one billion, five billion, 10 billion tons of CO2 we will still be emitting but taking care of by carbon sequestration. Is it realistic that we’ll be sequestering so rapidly on such a scale. Especially considering that we have yet to develop a widespread and widely agreed upon method of carbon sequestration. People toss out these deadlines without any reflection on the scale and the complexity of the problem. Decarbonization by 2030? Really.

Even though we’re constantly improving, we’re also facing an imminent catastrophe in climate change. I wonder if that makes it hard for people to internalize the improvement. This is also making me think of a paper you wrote about the future of natural gas in which you referred to Bill McKibben as America’s “leading climate catastrophist.” Is he wrong?

What is “imminent”? In science you have to be careful with your words. We’ve had these problems ever since we started to burn fossil fuels on a large scale. We haven’t bothered to do anything about it. There is no excuse for that. We could have chosen a different path. But this is not our only imminent and global problem. About one billion people are either undernourished or malnourished. The fact of possible nuclear war these days. Remember what they used to say about Gerald Ford? He can’t walk and chew gum at the same time. This is the problem of society today. We cannot do three things at the same time. So who decides what is imminent?

Do you think we are facing a civilizational threat in climate change? I cannot answer that question without having the threat defined. What does it mean? You’ve seen it with Covid: Was Covid an unprecedented catastrophe, as many people portrayed it? Or was it nothing, as other people portrayed it? Anti-lockdown, anti-mask people would say, Oh, it’s another flu. Clearly it was not another flu. But you know as well that it was not an unprecedented catastrophe. What do you want me to say? I cannot tell you that we don’t have a problem because we do have a problem. But I cannot tell you it’s the end of the world by next Monday because it is not the end of the world by next Monday. What’s the point of you pressing me to belong to one of these groups? We have a problem; it will be difficult to solve. Even more difficult than people think.

This is one of his discussions from 2019 that helped educate me on Energy Systems :

3. Until 2005, Bill Browder, was one of the largest foreign investors in Russia through his fund Hermitage Capital.

In 2016, his work helped pass a US Law called the Magnitsky Act, named after his lawyer Sergei Magnitsky who was killed in Russia.

Bill has just written a book titled Freezing Order which comes from his work over the last decade, hunting for the cash stolen by Putin and the Oligarchs from looting the Russian Economy.

He spoke to Channel 4 News about his views on Russia and what the West doesn’t understand about Putin.

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B. It’s All About Inflation

One of the biggest questions investors are asking themselves today is when, how and at what level inflation peaks?

A casual survey of clients indicated that they expect US Headline CPI Inflation at the end of 2023 to be between 5-6%.

Where do you think Inflation is at the end of next year?

Inflation has huge implications for interest rates, discount rates and hence asset prices. In a world where inflation is consistently running at 5-6%, where do interest rates need to be? The 10 year US Treasury Yield is currently 2.9%. Do interest rates stay sub-3% if inflation is consistently over 5%?

This then leads to the question of how to position portfolios for an inflationary world.

Are commodities actually a good inflation hedge or are there better ways to protect against inflation and rising rates?

Some are adding Real Assets and commodities to their portfolios as a diversifier and source of inflation protection, while others see a real alpha opportunity where forces of growing commodity demand from a multi-polar world, decarbonisation, on-shoring collide with an inelastic supply response constrained by ESG mandates and continued high cost of capital for commodity industries.

In the short term, a more tactical question is whether the combination of FED rate hikes and quantitative tightening mean that the US economy is headed for a recession and hence long duration US Treasuries are actually attractive at 3%.

Disclaimer: This is not financial advice or recommendation for any investment. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.

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C. The Tech and Crypto Section:

1. @punk6529 is one of the most interesting people on the internet.

He’s an anonymous account on Twitter with +340,000 followers, because he has continued to be smart & early on crypto and technology more broadly.

He shared how he sees the world. This is a benchmark discussion.

2. There's no slowdown in money entering Crypto, but what's all this money going to do?

On this Bloomberg Odd Lots episode, Sam Bankman-Fried, the CEO and co-founder of FTX, spoke with Bloomberg Opinion columnist, Matt Levine, on the money making opportunities that people are exploiting, whether it's directional bets on coins or yield farming or arbitrage, and how much potential profit there is for the taking. 

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