Third Quarter Look-Ahead — VegaX Research Report
The second quarter of 2022 was tough for investors; this is no secret to our readers. Degradations in global supply chains, rising inflation, the ongoing military conflict between Ukraine and Russia, and the subsequent geopolitical turmoil have led to a precipitous decline in financial markets across asset classes.
There are some interesting developments in the crypto space at the moment, but nothing substantial enough to catalyze another bull run — at least not anytime soon. Ultimately, the crypto asset market is beholden to macroeconomic factors at the moment. While it may be true that crypto will lead other asset classes on the way up, macroeconomic conditions are too important to ignore. As such, this piece will cover a wide range of macroeconomic topics that our analysts are paying close attention to.
America The Bountiful?
Much of the news coverage with regard to global food shortages has focused on the disruption in Ukraine’s ability to export its yearly crop of grain to countries in the region. At the time of writing this piece, diplomats from Russia, Ukraine, Turkey, and the UN are meeting in Istanbul to ensure the export of said grain crop — as a means to ease the global food crisis.
This is certainly a positive step in curtailing global famine. In addition to this, our team has been closely monitoring the ongoing drought conditions in North America, the western hemisphere’s breadbasket, and a net exporter of agricultural products. Californian farmers are suffering from a lack of rainfall, the west coast state produces “in the neighborhood of two-thirds of the nation’s fruits, about one-third of its vegetables.” First-order effects of drought conditions are reasonably well-known: farmers in highly affected regions are unable to generate sufficient yields to fully supply grocery chains, and water conservation becomes critical. But what few are considering are the second and third-order effects of a prolonged dry season.
A recently published article from The Hill notes that over 75% of the United States is experiencing some sort of drought — consequences of extended droughts are exacerbated on the west coast by seasonal wildfires. Droughts and wildfires do not mix well: extended periods of drought try out forests and grasslands, making the land more susceptible to bigger burn radiuses. The larger the wildfire, the more potential for property damage, harsher air quality, and the displacement of animals and humans. According to figures from the National Oceanic and Atmospheric Association (NOAA), the forecast for the middle part of July looks to be a continuation of drought conditions.
On third-order effects: drought conditions also impact meat production, specifically beef raised in the West/Midwest regions of the United States. Lack of rainfall this season has decimated grazing fields upon which cows feed, the USDA released a report noting that 83% of pasture and range land are in “poor” or “very poor” condition. Moreover, the cost of supplemental feeds has shot up astronomically; a bale of hay costs over $100 this year. These factors have prompted many ranchers to attempt to sell thousands of heads of cattle in an effort to reduce their operating costs and hopefully survive the season.
The question is: if there are fewer heads of marketable beef in the coming months, what could that mean for the price of beef?
Sagging Sentiment & The Fed’s Dilemma
Investors and consumers are hurting this year: asset prices have taken a nosedive, with the S&P500 roughly 20% down from its recent highs, and the prices of nearly all essential goods increasing quickly. The official CPI (consumer price index) print was announced on July 13th at 9.1%, yet another 40-year high. Worse yet, when compared with May’s 8.6% print, the 9.1% YoY figure indicates that inflation in the United States is accelerating despite the Fed’s efforts. While the scope of this piece does not include an in-depth analysis of the basket of goods and services that comprise the consumer price index, note that prices don’t rise in unison and that bureaucrats ultimately select (cherry-pick) the basket upon which the index is based.
The Fed is stuck between a rock and a hard place. The United States central bank has two choices: first, to continue its aggressive Quantitative Tightening campaign by increasing interest rates another 0.75–1% at the end of the month. Or, they could reverse course, and print USD in an attempt to revitalize the economy. As previously stated, these are both painful courses of action. The longer that interest rates increase, the more the American people suffer (and the world, as we will cover in later sections). But, if they abruptly begin to print money in an environment where demand is thoroughly destroyed, there is a non-zero risk of catastrophic hyperinflation in the USD.
Inflation is a tricky problem for central bankers to solve, as per their admissions, the tools at their disposal are “blunt,” and have a litany of unintended consequences. For average citizens, inflation is the silent tax — going off of the official numbers, inflation in the United States is reducing consumers’ purchasing power by 3.6% (this figure is accelerating) every year.
Europe’s Green Energy Gambit
Europeans have historically been at the forefront of cultural developments and experimentation, and the Eurozone’s energy politics are no different in that sense. In July 2021 the European Climate Foundation announced a new climate-focused policy initiative called Net-Zero 2050. This ambitious initiative comes at the heels of worthwhile considerations with regard to the impacts of carbon and methane emissions on the environment; however, the policies themselves failed to take into account the economic costs of such a rapid transition.
Richard S.J. Tol, professor of economics at the University of Sussex, concludes in his 2021 assessment of the initiative that:
“The total cost of greenhouse gas emission reduction could be 3% or more of GDP. The benefits would be only 0.3% of GDP, a benefit-cost ratio of one in ten… It is, therefore, safe to conclude that the benefits of the European Union’s climate policy do not outweigh its costs.”
Effects of higher levels of emissions (carbon dioxide and methane) are detrimental to the health of natural ecosystems — this is clear. What is also clear is that, despite a lack of political opposition to these policies, the policies had the potential to cause more immediate harm to the average European than intended.
Essentially, this issue comes down to Europe’s ability to be self-sufficient in its energy generation. Unfortunately for European bureaucrats, wishful thinking and rushed policy decisions have led to a litany of unintended consequences. First, consider the impacts of the ongoing geopolitical conflict between Ukraine and Russia: like it or not, Europeans depend on Russian gas imports (LNG) for a large portion of their commercial and residential energy needs. The Eurozone is aligned with NATO allies, specifically, by sanctioning and condemning the Russian invasion. Nothing out of the ordinary in this response, but what happens when Russia diverts gas supplies intended for Europe to, say, China or other Asian nations? What happens if Russia decides to increase prices, or cut off supply entirely?
On July 11th, the Nord Stream 1 pipeline — the Baltic Sea supply line connecting Germany and Russia — was shut down for its yearly maintenance. Ordinarily, maintenance of this sort lasts for roughly 10 days, but German Economy Minister Robert Habeck warned that EU countries should prepare for a case in which gas shipments to Europe from Russia do not resume. The dependence of Europe on imported crude oil derivatives is being exacerbated by the Net Zero 2050 agenda and global inflation. So much so, that many European countries are pausing their emissions targets and revitalizing their coal-fired power plants.
For all of their misguided policy objectives, European leaders are at least pragmatic enough to realize their predicament. They know that Putin is not above weaponizing his country’s natural resources, and so they are actively trying to reduce their country’s dependence on Russian gas products. Manufacturing giant Germany, along with Austria and the Netherlands, have dramatically walked back their restrictions on fossil fuel power generation facilities.
Stemming from the same emission-reducing agenda, farmers and citizens across Europe have taken to the streets to protest against the rapidly rising costs of food and energy. The situation in the Netherlands is a stark example of the unintended consequences of poorly researched policy decisions. In June 2022, the Dutch Parliament proposed legislation that sought to reduce the amount of livestock farming in the country by 30% — an amount that lawmakers deemed necessary to meet emissions targets. Environmental considerations are important, as Dutch Farmers do produce a lion’s share of nitrogen and ammonia emissions, but as it currently stands, the Netherlands is the second largest exporter of agricultural products in the world — trailing only the United States. The reality is that these proposed policies would cripple Europe’s ability to reliably produce enough food to meet its demand. Farmers from Germany, Poland, Italy, and Spain are standing in solidarity with the Dutch and embarking on protest campaigns in the hopes of dissuading similar “anti-farming” policies in their home countries.
Inflation and Chaos on The Global Stage
Under the surface of energy and agriculture policy disputes in Europe, the specter of inflation looms large. Official inflation data from June of 2022 shows an annual inflation rate of 8.6%, frankly, that number is “burying the lead,” as the saying goes. More notably, June’s YoY inflation in European energy prices was a whopping 41.9% — due in large part to the ongoing energy crisis covered in the previous section. On top of this, the Euro has experienced a precipitous decline in value (~20%) in recent months versus the USD. The ECB’s current deposit rate sits at -0.50% and has remained unchanged since September 2019. While rate changes are multifactorial decisions, one has to wonder whether the inaction of the European Central Bank is a large catalyst in the recent decline of the EUR.
Inflation is not just an American or European problem — countries around the world are dealing with the fallout of sharp price rises in essential goods and services. In Egypt, citizens are having to make painful concessions in order to sustain their household solvency: fruit and meat are now considered luxury items, purchased rarely — if at all. These tough choices are a consequence of the ongoing military conflict in Ukraine — in years past, Egyptians could reliably count on a healthy tourism industry supported by Russian and Ukrainian holiday-goers. Additionally, the decreased wheat exports from Ukraine have caused the prices of bread and cereals to skyrocket by nearly 200% in some cases.
In Pakistan, blackouts this summer and beyond are becoming more probable. Normally, Pakistan would be able to import LNG from global markets at affordable rates. But this year, because of Europe’s increased demand for gas and other crude oil derivatives, the price of LNG has increased to such a level that developing nations like Pakistan can no longer afford to meet their domestic demand. Valerie Chow, head of Asia Pacific Gas and LNG research at Wood Mackenzie summarized the situation as follows “The European gas crisis is sucking the world dry of LNG… emerging markets in Asia have borne the brunt of this and there is no end in sight.”
Blackouts are bad, but sovereign nations completely collapsing is worse. The nation of Sri Lanka is in the midst of what can be described as absolute chaos — inflation is up over 50% YoY, with the cost of food up over 80% (as of June). Along with a reduction in revenues from tourism, the biggest driver of Sri Lanka’s current crisis are the green energy policies adopted by western allies. In April 2021, the Sri Lankan government moved to ban chemical fertilizers. Without getting into a discussion regarding the merits of chemical fertilizers versus regenerative practices, note that Sri Lanka was self-sufficient in rice production before the policies. Over 90% of Sri Lankan farmers used chemical fertilizers, and only months after the ban was enacted, the price of rice increased by 50%, while the prices of carrots and tomatoes increased fivefold. The situation, at the time of writing this piece, has continued to deteriorate: in May, Sri Lanka defaulted on its foreign debt obligations, and country-wide protests have become increasingly destructive. Angry citizens have breached the walls of the homes of the President and Prime Minister — both of whom have fled the country for fear of violent retribution.
Elsewhere, in Turkey, inflation figures are similarly ominous. An old saying in Turkey is playing itself out in real-time amid nationwide price increases: “There is no government that cannot be brought down by an empty cooking pot.” Prescient, given that incumbent and long-serving president Recep Tayyip Erdoğan is up for election in 2023. With his country currently embroiled in an inflationary period, which officially stands at 80% YoY, conventional wisdom would be to increase central bank lending rates in order to curb inflation. Unfortunately for Turkish citizens, that does not appear to be an option their president is considering. So, much like their Egyptian neighbors to the south, the Turkish people are drastically cutting back on once-ordinary food items, like fruit.
Conclusions and Silver Linings
This piece was meant to be broad: we attempted to touch on as many impactful current events in the macroeconomic landscape as possible. Frankly, it is not pretty out there, there is no sugar-coating that. However, while it is important to consider the reality of situations as they currently exist, fixating on negativity is unproductive. To conclude this piece, we will provide some silver linings — potential positive outcomes — and finish out with the team’s top factors to track.
Real-World Use Cases for Cryptocurrency
Speaking as an American, very often we hear the argument that cryptocurrencies like bitcoin and Ethereum cannot function as a currency due to the associated short-term volatility. But if one considers that in countries where inflation is unfathomably high — Lebanon (211%), Sudan and Zimbabwe (192%), Venezuela (167%), and previously mentioned Turkey (80%) — simply holding one’s native currency destroys one’s purchasing power year over year. In these countries, would it not make more sense to store wealth in assets that have demonstrated the tendency to appreciate over time? Or, in a case where short-term volatility is unpalatable, would it be worth considering storing one’s wealth in USD-denominated stablecoins, such as USDC, USDT, and others?
We will not examine the challenges of exiting a collapsing country with all of one’s savings intact, but suffice to say that it is tricky. However, if one’s or one’s family’s wealth is saved in a cryptocurrency, that store of value can be transported across borders on a mobile phone, a USB-sized device, a slip of paper, or even stored in one’s memory (bitcoin seed words). Beyond the legitimate use cases mentioned above, consider Europeans’ position: those who were invested in stablecoins for the past few months or weeks could stand to realize a 20% profit on that position due to the weakening of the Euro. This should not be glossed over — cryptocurrencies and digital assets, generally speaking, are actively revealing themselves as a legitimate means of preserving purchasing power in countries where inflation is running hot.
Do not fight the Fed
Forgive the American-centric perspective, but from where this analyst is sitting (in the United States), the decisions made by the American central bank are crucial to pay attention to. Rhetoric from Jerome Powell and other members of the Fed has been hawkish — central bankers know that they need to tame inflation, but they also know that their tool in affecting change (interest rate manipulation) is akin to a chainsaw, where a scalpel would be better suited for the job. That said, readers, keep your eyes and ears open especially during the last week of July when both the Fed and ECB have meetings scheduled to discuss interest rate strategies.
As stated earlier in the piece, if rates are increased too aggressively, there could be catastrophic consequences — particularly in Europe and Japan — but, if a Quantitative Easing campaign is enacted in haste, inflation in the United States could explode. Tough choices will need to be made soon.
Final thoughts: the macroeconomic landscape looks bleak at the moment, but we must not center ourselves on negativity. Humanity (and markets) have passed through these cycles before, and there is no doubt that humans will pass through this storm stronger than we were previously. In the meantime, our vision and goals at VegaX are unchanged: we will continue to provide educational content highlighting cryptocurrency use cases and create quality investment products for those who believe in the potential of blockchain technology to revolutionize the way we think of ‘money’ in the future.
Thank you for reading, we sincerely hope you found this content useful in some way.
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