Excerpts from "War and Industrial Policy" by Zoltan Pozsak
Summary of main points
Zoltan Pozsak is a financial wizard from Credit Suisse. His analyses and insights are amazing and objective. Without any propaganda, he describes the inconvenient truths as well — like an emerging Bretton Woods III and a new financial world order.
However, his writings are usually in PDF formats and are also very long, making it hard to read them on a mobile device. Thus, I have created an excerpt of his new paper titled, “War and Industrial Policy.” I have made small cosmetic changes like creating lists, breaking longer paragraphs into smaller ones, and moving some sentences around. When I have summarized the points, I have italicized the sentences.
Excerpts:
Global supply chains work only in peacetime. The low inflation world had three pillars:
Cheap immigrant labor keeping nominal wage growth “stagnant” in the U.S.,
Cheap Chinese goods raising real wages amid stagnant nominal wages, and
Cheap Russian natural gas fueling German industry and Europe more broadly.
Implicit in this “trinity” were two giant geo-strategic and geo-economic blocks: Niall Ferguson called the first one “Chimerica”. I will call the other one “Eurussia”.
Both unions were a “heavenly match”: the EU paid euros for cheap Russian gas, the U.S. paid U.S. dollars for cheap Chinese imports, and Russia and China dutifully recycled their earnings into G7 claims.
All sides were entangled commercially as well as financially, and as the old wisdom goes, if we trade, everyone benefits and so we won’t fight. But like in any marriage, that’s true only if there is harmony.
Harmony is built on trust, and occasional disagreements can only be resolved peacefully provided there is trust. But when trust is gone, everything is gone.
Theory of Trade Expectations
“When great powers have positive expectations of the future trade environment, they want to remain at peace in order to secure the economic benefits that enhance long-term economic power. When, however, these expectations turn negative, leaders are likely to fear a loss of access to raw materials and markets, giving them an incentive to initiate crises to protect their commercial interests”.
Divorce and a New Heavenly Match
If there is trust, trade works. If trust is gone, it doesn’t. Today, trust is gone: Chimerica does not work anymore and Eurussia does not work either.
Instead, we have a special relationship between Russia and China (the “king” and the “queen” on the Eurasian chessboard) — a new heavenly match. The special relationship between China and Russia (”Chussia”) is a powerful one: a marriage of commodities and industry, uniting the largest commodity producer (Russia) and the factory of the world (China), potentially in control of Eurasia.
How Chimerica Ended
The “cartoon” version goes like this: China got very rich making cheap stuff, and then wanted to build 5G networks globally and make cutting-edge chips with cutting-edge lithography machines, but the U.S. said “no way”. As a result, Chimerica is going through a messy divorce.
How Eurussia Ended
Russia got very rich selling cheap gas to Europe, and Germany got very rich selling expensive stuff produced with cheap gas. Current accounts swelled for both. Business was so good that Russia and Germany planned a vow renewal with Nord Stream 2. But the ceremony was called off abruptly and turned into divorce, as one side did something the other couldn’t tolerate. Events unfolded quickly and involved NATO, Ukraine, and the balance of power in continental Europe, and the result is another messy divorce.
Wars are about Control and Alliances
Wars, like the currently unfolding economic war, are about control. The control of technologies (chips), commodities (gas), production (zero-Covid), and straits – chokepoints like the Taiwan Strait, the Strait of Hormuz, or the Bosporus Strait.
Alliances are not simple anymore. South Korea’s leader refused to meet with Pelosi and is embracing strategic ambiguity; Turkey is working closely with Russia; India decided to increase its imports from Russia, and participate in Russia’s Vostok-2022 military exercises.
Inflation, Recession, and Global Supply Chains
Pax Americana enabled globalization and globalization underwrote “lowflation.” How can the U.S. control its lowflation/QE-based economic destiny when the emergence of a multipolar world order is fracturing global supply chains?
Thus, the new conflicts with Russia and China imply high inflation for the foreseeable future. The inflation will cause deep recessions — “L-shaped” recession.
Global supply chains, whether they produce military or civilian goods, are facing a Minsky Moment. Big corporations today run “just-in-time” supply chains for which they assume that they can always source what they need without moving the price. But those assumptions are not valid anymore.
Minsky moments are triggered by excessive financial leverage, and in the context of supply chains, leverage means excessive operating leverage: in Germany, $2 trillion of value added depends on $20 billion of gas from Russia … that’s 100 times leverage.
And the concept of operating leverage applies in the military domain too: if Taiwan makes the chips for the missiles the U.S., but it can’t ship them to the U.S. owing to a blockade imposed by China, the U.S. is operationally ill-equipped to support a two-front war. In English……that’s infinite leverage for Pax Americana, globalization, and lowflation.
World Order
Today, the assumption among investors is that globalization is Too Big to Fail. But globalization is not a bank in need of a bailout. It’s in need of a hegemon to maintain order. The systemic event is someone challenging the hegemon, and today, Russia and China are challenging the U.S. hegemon. For the current world order and its trade arrangements and network of global supply chains to survive the challenge, the challenge must be squashed quickly and decisively, in the spirit of the Powell Doctrine. But Ukraine and Taiwan aren’t Kuwait; Russia and China aren’t Iraq.
Chips Fear and Slowing China
The U.S. “buys 70% of its most sophisticated semiconductor chips from Taiwan. There are 250 chips in a Javelin launching system. You want to be buying all that from Taiwan? That’s not secure. This is why the US quickly passed the $52 billion CHIPS Act. But it takes several years to build fabs to gain “semiconductor sovereignty”.
“Inversion” is now being used to shape future outcomes: the U.S. is trying to shape the future by slowing China’s technological progress one technology sanction at a time. Slowing China’s progress buys time, and time is needed to build the fabs needed to regain “semiconductor sovereignty” – to make chips at home for the missiles that defend the U.S.-led world order.
The newly proposed curbs also “would stop the largest makers of memory chips like [South Korea’s] Samsung Electronics and SK Hynix from shipping new technology tools to their factories in China, preventing them from upgrading plants that serve customers around the world”.
Industrial Policy
But the West can’t win by slowing progress. It will also have to progress by building, and that’s where industrial policy comes in.
To ensure that the West wins the economic war, it will have to pour trillions into four types of projects starting “yesterday”:
re-arm (to defend the world order)
re-shore (to get around blockades)
re-stock and invest (commodities)
re-wire the grid (energy transition)
Re-arming, re-shoring, re-stocking, and re-wiring need a lot of commodities – it’s a demand shock. It’s a demand shock in a macro environment in which the commodities sector is woefully underinvested – a legacy of a decade of ESG policies. Underinvestment means supply constraints, and geopolitics means even more supply constraints.
Conclusion
There is going to be a lot of borrowing and spending by governments and corporations to achieve the four things in the section above.
There are lots of serious problems in the world, which is why Bretton Woods III is destined to happen. It’s already happening, and we will explore the Bretton Woods III topic in detail in our upcoming dispatch: “War and Currency Statecraft.”