Something Different About Inflation This Time

The market is dealing with something different: world-wide physical scarcities in energy and food. In this environment, what worked in the past can backfire. The monetary sanctions against Russia are proof.

After sanctions initially caused a quick 70% decline in the ruble, Wall Street and Western governments predicted Russia’s economy would collapse by 35% or more. Instead, the ruble has ferociously rebounded from its initial low and is the world’s strongest major currency so far this year thanks to Russia’s abundance of natural resources, which allows the country to demand payment in rubles. While it loses volume due to restrictions, it gains in higher pricing caused by the sanctions.

Predictions of a mild Russian recession have replaced forecasts of a catastrophic decline. Meanwhile, food and energy prices have continued to rise, and the odds of recessions in Japan, Europe and America have increased.

Prices Were Rising Before the War

Today’s shortages and high prices differ from past periods of spiking oil because they don’t have political causes. Rather, they reflect fundamental scarcities.

Some have argued the opposite, comparing the war in Ukraine to the Saudi oil embargo of the early 1970s and the Iran-Iraq war. But this time around, commodities were rising prior to the war’s outbreak. Moreover, prices had been rising even though China, the biggest driver of commodities, has been in a COVID-induced slump. In fact, 2022 will be the first year this century in which China’s demand for oil drops.

Historically, if the uptrend in oil prices is gradual, the markets can handle the increase. But if central banks slam on the brakes here to stop inflation, it will boomerang. Commodity prices will fall, but the downturn in economic growth will be even sharper. In this scenario, subsequent stimulus to reignite growth will, courtesy of the fundamental scarcities, lead to a major snap-back in commodity prices. Central banks should take note.

Not Much the Fed Can Do

I think the market’s sharp plunge was a response to worsening inflation and policymakers’ very limited options. For much of this century the Fed has negotiated a narrowing line between inflation and deflation. Now there’s no room left to negotiate, meaning we either accept much higher inflation or live with the consequences of a major, protracted economic decline.

That we’re at this point reflects the world’s stark division into two halves. The globe’s Western and Northern half is rich but lacks the materials to sustain that wealth. The Eastern and Southern half is poor but rich in materials.

Inflation is the lesser evil of the two “flations.” At least with inflation, you can get growth, which potentially can lead to new planet-saving ventures and technologies. But that won’t happen unless both halves of the world cooperate in addressing critical problems.

It’s a positive sign that some major U.S. newspapers have recently editorialized in favor of cooperation. For investors, the halcyon days of ever rising stock prices have probably passed. But if you’re in the right place in this highly fractured market, there still are enormous opportunities.

Likely to Avoid Catastrophe

The silver lining is that despite the sharp market decline, the technical picture doesn’t suggest an economic catastrophe. Smaller-cap stocks have been outperforming the heavyweights, an historical pattern pointing to inflation rather than economic doomsday.

I continue to believe that investors can make tons of money in the right stocks, but intense volatility is likely here to stay.

I think the only path out of the resource scarcity conundrum is for the world to cooperate in managing commodities, which hopefully will keep the inevitable uptrend relatively gradual. Keep your fingers crossed.

Editor’s Note: As Dr. Stephen Leeb just made clear in the above article, we face a new world of investing risks and opportunities.

Now, amid high inflation and historic commodity demand, Dr. Leeb recommends you buy a small-cap stock that’s positioned to dramatically profit from rising prices. Click here for details.