The World Is Broken, Part 1...

But You Wouldn't Know It From the Stock Market

I've been to more than 40 countries and all seven continents...

I've also been inside the three most iconic symbols of world power: the White House here in the U.S., the Great Hall of the People in Beijing, and the Grand Kremlin Palace in Moscow. (It's one thing to go to the Kremlin, as anybody can... but it's another to actually get inside the palace, as I did with 19 others during a not-so-easy-to-get tour.)

If you travel, as my wife and I do, it's easy to take globalization for granted. (She chronicles our travels here.)

Western chains and styles are everywhere. It's like the world is one big shopping mall... and no matter where you are, there's a Zara, Cartier, and – oh yes – McDonald's and Starbucks. Whether you're at the End of the World Post Office in Ushuaia, Argentina or sitting on a beach in Sharm El-Sheikh in Egypt, surrounded by people from everywhere – pardon the cliché – you quickly realize that people are people... and away from politics, everybody is just trying to get through their day.

Yet here we are...

Globally, we've hit dysfunction junction.

Was it the COVID-19 pandemic? The war in Ukraine? Tensions over Taiwan? Former president Donald Trump? China's leader Xi Jinping? Controversies over Hunter Biden?

Ultimately, it doesn't matter... because if globalization was a business model, we would be saying that it's breaking if not entirely broken.

European Central Bank President Christine Lagarde implied as much in a recent speech when she said...

We are witnessing a fragmentation of the global economy into competing blocs, with each bloc trying to pull as much of the rest of the world closer to its respective strategic interests and shared values. And this fragmentation may well coalesce around two blocs led respectively by the two largest economies in the world.

As she went on to say...

Today the United States is completely dependent on imports for at least 14 critical minerals. And Europe depends on China for 98% of its rare earth supply. Supply disruptions on these fronts could affect critical sectors in the economy, such as the automobile industry and its transition to electric vehicle production.

In response, governments are legislating to increase supply security, notably through the Inflation Reduction Act in the United States and the strategic autonomy agenda in Europe. But that could, in turn, accelerate fragmentation as firms also adjust in anticipation. Indeed, in the wake of the Russian invasion of Ukraine, the share of global firms planning to regionalize their supply chain almost doubled – to around 45% – compared with a year earlier.

This "new global map" – as I have called these changes elsewhere – is likely to have first-order implications for central banks.

And as she continued (emphasis added)...

These developments do not point to any imminent loss of dominance for the U.S. dollar or the euro. So far, the data do not show substantial changes in the use of international currencies. But they do suggest that international currency status should no longer be taken for granted.

This can already be seen in the de-dollarization debates that seem to be popping up daily (if not hourly) on my social media feeds...

The chatter over central bank digital currencies...

And in the rising price of gold, which Lagarde herself suggested is tied to the "increased accumulation of gold as an alternative reserve asset, possibly driven by countries with closer geopolitical ties to China and Russia."

Everybody has apparently figured this out but the stock market, which seemingly doesn't care about anything until the moment of impact...

That's the message from a good friend, who used to manage money but now spends part of his time thinking and writing. His thoughts are always unfiltered because he's just writing for friends. While I don't always agree with him, he is always provocative... and this time, he's on to something.

After reading Lagarde's speech, he wrote...

The good news, monetary authorities seem to understand what is going on. I think politicians and policy makers either don't understand, are still in the denial phase, or don't care, because they don't know any better. Equity markets probably won't care until they do, if I knew when, I wouldn't tell anyone!

With regard to equity markets, the implications are profound. For about the last 30 years globalization is what kept a lid on inflation, and allowed politicians to spend like drunken sailors and our monetary authorities to remain loose, without much in the way of an inflationary impact.

In fact, globalization kept prices down so much, it led policy makers to (erroneously) try to create more inflation with loose money, which was a further boon to equity prices. Policy makers tried to create what wasn't there, and all it did was goose asset prices, and lead to bubbles and blowups.

Globalization, to the degree it happened, was always a bad idea. From the perspective of the expert class, and politicians, it was wonderful.

As he went on to say...

Politicians could spend all the money they wanted and not cause inflation. The whole notion that we could send all the low-end jobs abroad, turn the U.S. into a software powerhouse, run a negative trade balance, but then have China buy all our debt with their surplus, keeping our borrowing costs down, thrilled the expert class.

Nobody really thought it all through. Our country is not solely birthing software engineers, in fact at the rate we are dumbing down, quite the opposite. A country is not secure when giant hunks of its critical supply chain is outsourced to other countries that you are effectively at war with. It is all penny wise, and pound foolish.

Now the opposite of what drove asset prices for the last 30 years needs to happen, for national security and common-sense reasons. We need to de-globalize for a variety of reasons. Unless we want to just give China the keys to our country. Politicians and monetary authorities can no longer behave the way they did, and get away with it, without inflationary consequences. The loose money era is over.

And as he asks, why don't equity markets seem to care?

First of all, people have been trained for 30 years that stock prices only go up, the Fed always comes to the rescue, valuation does not matter, and the dumber and more dis-economic a business model is, the more likely the stock price is to go up!

Also, equity markets never seem to care until they do. It reminds me of when I (stupidly) used to short stocks. It was easy to see a disaster coming for a given company. Financials stretched (obvious clues in the balance sheet, cash flow statement, and notes in the Q or K). Tons of product on the shelves in distribution or at retail, but not actually selling through. Easy.

But equity markets never seemed to care, until it showed up in earnings, which somehow could often take 6-9 months after the problems were obvious to anyone that wanted to look. Even Enron wasn't that hard to figure out, except it was, for most, until all the sudden it wasn't. Same for SVB. Happened in an instant.

Not sure how an economy facing negative secular forces compares to a single stock, in terms of what the actual implications are and when people care, but eventually they always do.

And this time, thanks to social media, it will be crowd behavior at its worst.

There's one other thing, also from my friend...

Interesting how market volatility can keep going down while real-world volatility keeps going up. If this is something that was actually measurable, it might be the largest gap in history between market volatility and real-world volatility.

Depends on the day, of course.

(This originally ran at Empire Financial Research, where I also write two investment newsletters, Empire Real Wealth and Herb Greenberg’s Quant-X System. For more information, click here and here.)