Discover more from Meaning In History
Ukraine Hawks Run Into Economic Reality
That’s the title of a Youtube interview that Dimitri Simes, Jr., did with Tom Luongo. Simes, Jr., is the son of well known, in certain circles, political scientist Dimitri Simes. Readers may be interested in his biography, noting that, after he supported Trump, he was vilified by the Left and ultimately returned to Russia. Simes, Jr., is also based in Russia, now.
The interview is very timely. We’re seeing the much vaunted Ukrainian offensive fall on its face, and we’ve also seen the NATO summit in Vilnius basically stiff Ukraine. Ukraine will continue to receive aid, but it will not be at the same levels as in the past. By contrast, the economic and financial front has heated up, what with the end of the “grain deal” and increasing financial pressure—on the domestic budgets of NATO countries but also involving increasing pushback from around the world. The summary of the video reads:
In this week’s episode of the New Rules podcast, host Dimitri Simes Jr. speaks with financial and geopolitical analyst Tom Luongo about the growing risk of a European banking collapse, NATO’s shrinking options to keep funding the proxy war in Ukraine, and why Biden needs China to bail out the US economy.
Bear in mind that the interview was conducted in the wake of two important events: Janet Yellen’s groveling, panhandling trip to Beijing, and the Vilnius NATO summit. As we head into fall the US will be facing a commercial R/E crisis, a weakening economy, and Europe will be facing multiple economic and financial woes that, at least proximately, stem from having bought into the Neocon war on Russia. As the summary suggests, it appears likely that push will come to shove on the economic front, and that that will also impact the military front. This is important to bear in mind as we await Russia’s next moves.
NB: As we got to publication the news is that the much discussed new BRICS settlement currency—referred to in the interview—will NOT be on the agenda of the August BRICS meeting. Rumor is that India has sabotaged it. For the time being.
What follows is an edited transcript of the free flowing discussion to present its focus to readers. Here I present the first two parts of the interview
00:00 Intro 01:10 The real reason why dollar dropped 11:17 What is going on with the Western economies? 27:31 How did Europe get to this? 32:44 What does European crisis mean for NATO war plans? 41:03 Is the US economically ready to confront China? 48:14 Apotheosis of the US Empire 57:43 Outro
The real reason why the dollar dropped
DS: I want to start off by talking about the US dollar because last week the US dollar had its worst drop in more than eight months. A growing number of strategists and investors are warning that this could be the start of a multi-year downtrend. What, exactly, is going on with the dollar and how serious is the situation for the Greenback right now?
TL: Well, that's a good question, Dimitri, because I'm a contrarian on this. I'm still a dollar bull, and the reason I'm still a dollar bull is because, while I'm still listening to a lot of people talk about where about what's happening in the world, I keep looking at the depth of U.S financial markets and I keep looking at the liquidity that's out there and I keep looking at Jerome Powell at the Federal Reserve being very hawkish about how many dollars he wants floating around the world, and then there's the amount of debt out there that's still denominated in dollars that demands dollar servicing, and I say, hmm, that's interesting. I just don't buy it.
What I think is going on, or what I think happened last week, is something a little bit more complicated than just, 'Oh well, the de-dollarization meme has now reached a critical mass'--not to say that I disagree with any of that, but I think that's a much broader, longer term conversation to have. I think this is much more about what's happening right now and that there's a reason why Janet Yellen went to China--and it's surprising how very few people are talking about it seriously. Now we're regaled with stories of her eating magic mushrooms at dinner and all this stuff and I don't think any of that matters. I think Yellen went to Beijing to beg the Chinese to buy U.S Treasuries, because the Chinese don't have an open Capital account. Meaning: they can buy a whole bunch of US Treasuries without affecting the Yuan onshore--the exchange rate. The Chinese were the ones who could actually do this--buy a whole bunch of U.S Treasuries.
Yellen needed this to refill the Treasury general account, which she had drained in order to blackmail the world into thinking the US was going to default over the debt ceiling crisis. Now she has to refill the general account and she needed somebody to come in and buy U.S Treasuries and drop yields. In the process, of course, if you're buying a Treasury bond you're selling dollars. So I think it was a a mixture of that along with the fact that they had to have this happen at a very important moment in time. That important moment in time was the fact that the U.S Treasury market was beginning to reach certain levels that were making things uncomfortable for Yellen's partners over in Europe.
Remember, I make a very fundamental distinction between the Treasury Department and the Federal Reserve at this point in time. I don't believe they're on the same page. I don't believe that in any way there's a coordinated policy between Janet Yellen and Jerome Powell because they've never agreed on anything in all the years that they've been colleagues over at the Federal Reserve. Powell's always been a hawk, Yellen's always been a labor economist focused dove. She was the architect of extending extra years of zero bound interest rates and more QE, when the markets were screaming for her to raise interest rates in the last two years of her term.
When you map the world that way, when you map the political fight within the US that way, you wind up believing--like I do--that there are within the US power structure persons who are focused on U.S sovereignty and there are those who are globalists.
I like to call that globalist wing 'Davos', but that's just branding, if you understand that. If you buy my argument, then it makes perfect sense that Yellen would go to Beijing to bail out Europe by getting the Chinese to buy a whole bunch of U.S Treasuries last week around the time of the NATO Summit, because Christine Lagarde at the ECB has been working overtime to maintain certain spreads between various types of European sovereign debt--both within the EU and relative to the US, as well as putting a hard cap in effect, doing yield curve control for the entire Eurozone system. If you go look at charts of things like the German ten year--it's been capped at two and a half percent for four months now--the Dutch ten year at three percent, the Italian ten year at 4.3 percent. I wrote about this on my blog recently.
After I wrote about all that I started to think about what happened. The dollar started to drop the minute Yellen met with the member of the finance ministry in China. It was like, all of a sudden someone started selling the dollar and buying Treasuries. And then we saw a massive move in the U.S yield curve last week--it fell like 25 basis points or 0.25 percent across the entire yield curve. And all because the CPI came in just a little a little below what expectations were? No, I don't buy that at all. What I buy is that there was a quid pro quo and that the Chinese got something from the Biden Administration in terms of geopolitics, or trade policy, or War policy. So this is all a very long-winded answer to say that recent events are guiding what's happening here, and that what is happening in the dollar right now is a false move to the downside. That's what I think is happening.
DS: So I think there's a lot to unpack here, but I think I want to start with the fundamentals because a lot of our audience members are people who are geopolitical savvy but they may not know the sort of financial nitty-gritty details the way you do. Could you explain to them why Janet Yellen had to go to China in order to ask the Chinese to help bail out U.S Treasury bonds how did it get to such a point?
TL: Well, again, during the debt ceiling crisis back in May and as we moved into June, the Treasury's general account--basically it's a checking account--was being drawn down and Yellen was out there every other day screaming, 'Oh my God, we're not going to have any money to pay our bills!' Well, the way the Treasury raises money is by selling Treasuries. So she sells Treasury bonds into the market and then she deposits the proceeds into the Treasury general account, and that's how she pays the government's bills. The best estimates have been that she would need to raise somewhere between 1 and 1.5 trillion dollars this summer in order to fund the United States' budget deficit and get the Treasury general account back up to a certain level.
Now, in order for the American government to continue operating in its unbelievably dysfunctional manner, what has to happen is that someone needs to buy those Treasury bonds. It could be they could be absorbed by the American domestic markets, but if you do that you're taking dollars out of the U.S domestic markets, because those dollars have to come from somewhere. Right now, thanks to Jerome Powell's aggressive interest rate policy, we're talking about dollars that the US can't afford to have not circulate, because we're already starting to see credit growth turn negative. We're starting to see the beginnings of a real credit crunch which is going to put downward pressure on the American economy. So far the economic data has been a little bit better than everybody was expecting this late in the year, but that is what it is.
So Yellen had to go to somebody and try and get them to buy Treasuries. This isn't to say that there isn't demand for Treasuries, just not that much demand. She could sell those Treasuries into the market, but that would cause the interest rates on those Treasuries to rise. That would put upward pressure on everybody else's sovereign debt, because all these markets are so intertwined and Traders are going to key off of the U.S Treasury markets to decide where they should be positioned in, say, the German Bund or the UK Gilt. Because of that, for the US to sell Treasuries on the open market became an untenable option, I believe, for the ECB. That's why Yellen had to get the Chinese to buy Treasuries. Yellen didn't want to risk being blamed for a recession by pulling a trillion dollars of base money out of the United States domestic markets, so she went overseas and I think she begged the Chinese to do it. It's the most likely thing that makes sense. Therefore, the other question you have to ask yourself is, what are the Chinese getting in return?
What is going on with the Western economies?
DS: You know this is really interesting, because when you look at what the Biden Administration says in public--they say that the U.S economy has been surprisingly resilient that the labor Market's looking good that consumer confidence is looking good--but you seem to be describing a battle, a panic behind the scenes about the potential credit crunch. So the question is, What is the U.S economy? Is it surprisingly resilient as Biden says, or is it a Potemkin village?
TL: I think it's a little bit of both. I hate to hedge my bets, because I like to be definitive on these things. I think the United States economy is doing better than people would expect at this point in time because this has, for the most part, been a White Collar recession or a white collar employment story. White collar guys are losing their jobs and, because they're not the first ones to run to unemployment a lot--because they were making 150 Grand as a middle manager at Facebook or Twitter or whatever and now they've got their severance package. That severance package may be between three and six months long. They're not going to jeopardize that for 175 or 200 a week on unemployment or 200 a week on unemployment. So the Labor Statistics look better than they actually are. There's still plenty of liquidity flowing through the system because people are going to be living off those severance packages and their savings. So it's more about the timing of when things go bad in the US, as opposed to whether they're going to go bad. It's not a matter of if, it's a matter of when, so Biden's not wrong to say the US economy has been surprisingly resilient.
I said this at the beginning of the year I literally made 10 predictions for 2023 and one was, "no official recession in 2023" because GDP growth will limp along in a positive way up until Q3 or so. Then in Q4 or Q1 of next year we're going to have a problem. So we're headed towards a recession that we can't avoid now because we're seeing credit deflate rapidly and we still haven't quite seen the turnover in housing and other sectors of the economy to allow for that to happen. So let me let me put a little bit more color on that. We have net migration happening out of States like Illinois, New York, California, Washington and others. Where are people moving? They're moving to lower cost, lower tax, lower cost of living places. It's cheaper to own a house and maintain a house in Florida than it is in California. You can sell an overpriced house in California and move to Texas--not pay state income tax, pay much lower property taxes, and have much lower carry costs. Buy more property for less money, pocket the difference, and live off the interest along with your severance package. There's a lot of that going on and that will help. It's a reorganization of where capital is trapped while also uncovering just how over inflated asset prices in places like California and New York actually are.
Now the commercial real estate market is going to be a real problem and it's staring us in the face. It's right out over the horizon. But again, I say all that but I don't want to focus on just the United States here, because if the United States is in that kind of trouble and interest rates are as high as they are and, moreover, it looks like we're beginning to get some sort of political happening on Capitol Hill. Hey NATO didn't just declare World War Three last week at Vilnius. This is a big deal for the markets. Once we get away from the ever that ever growing threat of an escalation of the Ukraine conflict turning into World War Three, money that's been sitting on the sidelines can now start to flow into the market a little bit. I think it's going to be another six or eight weeks worth of halo effect.
But I also think, globally, that the markets will begin to start focusing on what's really happening, and I personally think Europe and the UK are the vulnerable markets right now. And that's part of the reason why I believe Yellen had to run to China and beg for them to buy Treasuries and then have to give up something in return. And, honestly, what happened in return is Ukraine got left out to hang over at the NATO Summit.
DS: I guess it's interesting that you point to Europe as being the potential X Factor here because there had been sort of an air of triumphalism after last winter. There had been a widespread expectation that there would be a major gas crisis, that there could be blackouts, and it turned out that things were bad but not quite so bad. So European leaders took that as a victory and said that the worst is behind us and that we're going to be moving ahead on a new economic path that's going to be more sustainable both ecologically and geopolitically. From what I'm hearing from you their optimistic prognosis doesn't stand up to close scrutiny.
TL: They're the Potemkin village because they can't afford to continue raising interest rates at this moment in time because, well, the Bundesbank is effectively bankrupt. The German auditor came out two weeks ago and said, 'Look, the the Bundesbank has no equity left after it bought three and a half trillion dollars worth of its own debt and the rest in order to prop up the bond markets in order to enforce negative bound interest rates.' They're dealing with structural inflation that is not going away and Lagarde at the ECB has finally admitted it. She's at two and a half percent rates, while European inflation is at six percent. In the United States we're staring at three percent inflation, we're gonna fall next month into the twos, and then it's going to start to level off and probably start to rise into the end of the year--I'll get to that and we'll get to why in a minute, but that's the United States. Well, Powell's at five percent, so you've got three percent positive real yields in the United States and you've got negative four percent over in Europe--at a minimum. Then if you look at the UK you're at negative six percent still. So they have to keep raising interest rates.
Because of this they're now dealing with a stronger Euro than they should have, they're dealing with a stronger pound than they should have. Now these currencies have moved from near fair value to about 15 overvalued. What's that going to do to their export markets, which are not particularly strong in the first place? The key to all of this is what you implied in your question, which is: Oil prices have [garbled]. But oil prices are starting to rise. Oil closed last week--amidst all of this turmoil, while bonds were getting bought and gold, and everything was getting bought last week except the dollar, including commodities. Copper was 393 a pound. Oil closed--Brent crude closed—above 80 for the first time in nine or ten weeks. West Texas intermediate did the same thing. Natural gas prices in the US are rising--since the Europeans have cut themselves off from cheap Russian gas and cheap Russian oil they've got to buy it from the United States, which they're doing at an extreme premium. Biden is going to have to stop burning the SPR to subsidize Europe's energy needs, which is what he's been doing. That policy is going to end.
This is where the bubble that the European leadership lives in is leading. They don't have any real idea about what's happening out there. They think they do, and they also think that they can just make demands from on high and everything will just happen. They're used to these things happening, because they're used to having regulatory and political and economic control over the United States, but they don't anymore. They don't have control over our Capital markets anymore. They can't allow their Banks to go bust and then have their interest rates become our interest rates and force the Fed to pivot and go back to the zero bound. They don't have that power over us anymore. LIBOR is dead, SOFR is the law of the land. And the United States has got a Federal Reserve chairman who's absolutely not on board with the previous system. The economic bloc that's between a rock and a hard place is Europe. They're energy importers. They're not particularly good exporters of anything that really matters anymore. Germany's being de-industrialized like you wouldn't believe. Italy is being squeezed politically to the point where its vaunted industrial engine is being crushed. And then energy prices are set to rise.
This is part of the reason why I think inflation is going to return later in the year and it's going to be exactly the same kind of inflation we had at the beginning of this process. There'll be a second wave of commodity cost-push inflation. I don't think people are going to stop demanding food. I just don't think they're going to stop stop demanding food and energy. So people may attenuate and change their patterns a little bit, but the fundamental bid under strategic commodity prices is going to stay there, and as credit prices come down commodity prices are going to rise. Even if they rise 10 percent from where they are, even if oil only rises from 80 a barrel to 88 a barrel or ninety dollars, that's still a 10 or 12 percent rise. You don't think that's going to show up in the the CPI is a six seven percent inflationary hike over the course of the next year to 18 months? Hard to argue with that. I mean, even the bank of Japan is finally having to admit that they're not going to be able to hold a two percent inflation target.
DS: And you know what's really interesting is, because over the past year we've heard a lot of talk that a new Global recession in the style of 2008 could be upon us, and much of the rhetoric has focused on how this new explosion this new bubble could come from the United States, but what you're saying is that there's a greater chance that the next Global recession, if it does take place, emanates from Europe due to a commodity wave just causing inflation all over the place.
TL: And a banking collapse. Yes along with a planned destruction of the offshore leveraged dollar markets by the Federal Reserve chairman, the most powerful Central Banker in the world. Guys, don't bet against the Fed! I find it really funny. For years all I heard in financial markets is, 'Don't fight the Fed, don't fight the Fed!' The minute the Fed starts raising interest rates everybody's like, 'Fight me bro, I'm fighting the Fed!' I'm like, what's wrong with you? It doesn't make any sense. Don't fight the Fed, they're raising interest rates! But all you heard was, 'Oh, the Fed's going to pivot, oh this is going to happen, oh the Fed can't raise rates, blah blah blah.' And guess what? Everybody missed the boat.
The foundation for where we are today was laid during the beginnings of the Trump Administration when Powell was made FOMC chair, John Williams was made head of the very powerful New York Fed, and they began the process of replacing LIBOR--our debt indexing--with SOFR, and ditching LIBOR. I've talked about this in multiple venues. I know this is a little technical and a little weird, but it's important to understand. The United States capital markets that we think we all know, were all based on the needs of city of London Banks. Because they were the ones that were setting the interest rate, the overnight interest rate that all of dollar denominated debt was written against. So if you wanted to buy a mortgage or credit card it's gonna be LIBOR plus six, or a car loan is going to be LIBOR plus two. Now over the last five years that's over. SOFR, the secured overnight financing rate, has been rolled out and is now officially the law of the land, because LIBOR died on June 30th of this year officially. And the change-over from LIBOR or two so far has been a five-year staged rollout by the Federal Reserve.
Now whatever those London Banks want doesn't matter, because SOFR, the overnight lending rate in the United States, is set in the actual repo rate markets by US banks and by traders as a secured rate that's based on Market data. So if the market here is under stress, you can argue it doesn't like five percent, but it can trade and be liquid at five percent. That's different than if, for example, the U.S ten year pushed through 4.1 percent this last week, and that would have pushed the German 10-year to 2.75. LIBOR would have blown out by 50 or 100 or 150 basis points. In the past that would have put massive pressure on U.S credit card debt, on U.S credit revolvers for corporations. Everything that was a variable interest rate would immediately respond to LIBOR, which would then put pressure on Powell to lower interest rates to get everything back under control. Well, that doesn't exist anymore. Now LIBOR can blow out and no one in the United States could care less. They wouldn't get a pricing signal that would change anything. They wouldn't be contractually bound to alter their interest rates.
This is a very important, very subtle point about how the world now operates. We're operating in a different regime than the one we've had for over 100 years. LIBOR was basically the law of the land here in the United States for 100 years and now it's not. So this is a very, very important moment in time. And all of these big geopolitical events are happening all at the same time. That's why the BRICS are going to announce that they're starting a mutual trade settlement system in August, and why Christine Lagarde is desperate to get the digital Euro started by October. She needs to because she knows she's got a banking crisis on the horizon and she needs to do something drastic in order to invalidate all the debt that's out there that nobody can service anymore.
Thanks for reading Meaning In History! Subscribe for free to receive new posts and support my work.