The week of July 18, 2022: Putin’s pipeline threat, inflation/recession, housing, the Fed, and much, much more.
The week of July 18, 2022: Putin’s pipeline threat, inflation/recession, housing, the Fed, and much, much more.
T he cat continues to play with the mice.
Bloomberg (July 21):
Russia began sending natural gas to Europe through the Nord Stream pipeline system after a pause, bringing relief to a continent whose economy is starting to wobble under the strain of reduced supplies.
Shipments returned to 40% of capacity, their level before flows were halted for 10 days of planned maintenance, data from the pipeline operator showed.
This was in line with an earlier prediction from Bloomberg’s Javier Blas, and his analysis, I reckon, still holds up well. I quoted from some of it here. In Blas’s view:
The market is right to reprice the gas curve; the only question is why it took so long. There’s further risk ahead: At some point, Moscow will completely turn off the tap, probably just before the winter, to try to bring the German economy to its knees . . .
Bloomberg:
The European Union is racing to stockpile natural gas ahead of the winter amid its worst energy crisis in decades. For now, the pipeline’s restart may alleviate concerns about a longer stoppage that could lead to massive economic damage.
I’ve written about just how much damage might be caused here and here.
Bloomberg:
Moscow has been curbing gas shipments to Europe for months, but the continent still relies on the little it’s getting to fill the retired salt caverns, aquifers and fuel depots that hold its fuel inventories. Without Russian gas, Europe is unlikely to have enough supply to warm homes and keep the lights on throughout the winter.
In Germany, the EU’s largest economy, gas-storage facilities are at about 65% capacity, well short of the government’s 90% target. Based on fill rates in the week before Nord Stream shut for maintenance, it would take more than two months to reach the level that would heat homes and keep factories running through the colder months.
A number of EU countries have already been encouraging users to cut back on consumption, with a view to making it easier to fill those depots. It is, shall we say, far from clear that they will reach that target. Putin, meanwhile, will continue to play games, as a none-too-subtle reminder of who is really calling the shots, or could be.
Bloomberg:
Putin has indicated that flows could fall to 20% as soon as next week. Only two turbines at a compressor station in Russia, which feeds the pipeline, are currently working, he said, and one of them needs to go for maintenance this month. Flows could drop unless a replacement component sent from Canada arrives in Russia soon, following sanctions-related delays, according to Putin.
But if this report from Reuters is correct, the games being played may also include Russia delaying the return of that turbine:
A missing turbine that Moscow says has caused the Nord Stream 1 pipeline to pump less gas to Europe is stuck in transit in Germany because Russia has so far not given the go-ahead to transport it back, two people familiar with the matter said.
And all this only helps Russia financially.
Bloomberg:
“Sending flows, but at capped levels, runs in Russia’s favor,” Tim Partridge, head of energy trading at DB Group Europe, said in a report on Wednesday. “It allows the Kremlin to continue to use the pipeline as a way of increasing volatility, while still reaping immense profits on inflated energy prices.”
Russia is awash with cash and when it judges the moment right, it can afford to turn off the tap. Bloomberg cites a new report from the IMF predicting a 5 percent fall in German GDP if that happens. That’s neither the highest nor the lowest estimate, but it should be remembered that if the gas is cut off, there will be effects across much of the EU and beyond. It is thus impossible to predict with any degree of certainty how much damage will be done once, economically, the dominoes start to tumble.
That said, according to this report from the Wall Street Journal, there are technical reasons (relating to pressure levels in the pipeline) why Nord Stream cannot transport volumes below 30 percent of its capacity. That means that at some point the decision will become binary: On or off.
The Wall Street Journal:
Germany and other European Union nations, which pledged to end purchases of Russian energy by 2024, are now working on two basic contingency plans.
The first envisages a status quo, with Nord Stream operating at around 40% of its capacity. Under that scenario, Germany, where gas storage units are currently 65% full, would have to significantly reduce consumption compared with the previous year to avoid a shortfall in the winter. Some regions, however, are expected to be more severely affected, possibly triggering local measures such as limited factory shutdowns and a cut in supply to some businesses.
Under this scenario, Germany would be unable to completely fill its reserves before year-end, leaving the country vulnerable to new supply cuts and keeping energy prices high.
This could be politically explosive for Berlin, with some 66% of Germans currently feeling that the government isn’t doing enough to tackle high energy prices, while 53% believe the sanctions are hurting Germany more than Russia, according to a Forsa poll published on Wednesday.
Note that 53 percent.
The second contingency kicks in if Russia switches off the gas. At that point Berlin takes control of the gas supply, and rationing is introduced.
The Wall Street Journal:
Europe is also adjusting its gas infrastructure, which has so far been largely geared to receive supply from Russia. Belgium and Germany are working to expand the capacity of a pipeline connecting the two nations, while Austria and Italy are looking into improving their infrastructure to be able to channel more Norwegian gas into their storage.
The Netherlands, once among the world’s largest gas producers, is considering temporarily prolonging the life of a gas field scheduled for closure after mining work there caused numerous earthquakes.
Many governments are trying to secure gas from other suppliers, from Norway to Algeria, the U.S. and Qatar, which often comes in the form of liquefied natural gas transported by ship.
Germany is building several LNG terminals on its coast to receive shipments from faraway countries and has chartered five floating terminals that can handle those inflows in the short term. Increased LNG purchases by EU nations—Germany alone is investing over €15 billion—have caused a shortage on the global market, leaving countries such as Pakistan struggling to access supply.
Pakistan? The last thing that Pakistan needs at the moment is to have to pay up for LNG. The country’s currency has fallen some 7 percent this week (as of Thursday) and there is increasing talk that it may go into default. Dominoes . . .
The Wall Street Journal:
Berlin, meanwhile, has said it would review its decision to shut down its three remaining nuclear-power plants. It is already planning to increase use of coal to produce electricity this winter to save gas for heating.
The ironies created by Germany’s reckless Energiewende (spend billions on renewables, accelerate the phase-out of nuclear power and smooth the way with “cheap” Russian gas) never cease to impress.
Another aspect of Putin’s game plan is, doubtless, to increase divisions within the EU. There are some early signs that the gas squeeze will have that effect. A Brussels plan to confront the growing crisis has not been well received.
The plan (to oversimplify) was that all EU member-states should reduce natural-gas consumption by 15 percent over the next eight months. This would be voluntary, but, the Wall Street Journal reports, the EU Commission would like the scheme to become mandatory in the event that voluntary cutbacks are not enough to do the trick.
The proposal will be discussed next week. Assuming the EU Commission cannot force it through under its existing powers (probably not, but even the suggestion that it can has caused trouble), it will require the approval of at least 15 out of the EU’s 27 members, with those in favor accounting for at least 65 percent of the EU’s population. No one ever said that the EU’s voting rules were easy.
Securing that majority might not be straightforward. As was noted in the Wall Street Journal, the Spanish and the Portuguese are not thrilled. Not coincidentally, both have the facilities to import large quantities of LNG, facilities that Germany currently lacks. Also highlighted in the Journal’s report is Hungary, which has its own, uh, transactional relationship with Russia, and which also distrusts any initiatives that, whether voted on or not, would pass more power to Brussels.
Also, there’s this (via Reuters):
Hungary is in talks with Russia about redirecting all of its gas shipments under a long-term supply deal to the Turkstream pipeline that brings gas to Hungary via Serbia, Foreign Minister Peter Szijjarto said on Monday.
This is needed to ensure security of supply as the levels of gas shipments from Austria into Hungary are lowered by insecurity in Western Europe’s pipeline system, Szijjarto said.
“We are receiving on a daily basis a steady volume of 32-33 million cubic meters of gas, we get half of this amount via Turkstream via Serbia every day — this shows that the southern shipping route is the most stable, predictable and secure,” he said in a video posted on Facebook . . . .
Szijjarto said Hungary was receiving about one-third of the contracted amount from Russia on the Austrian pipeline and 100% via Serbia, which means that overall, Russia is delivering 88% of the contracted daily volumes under Hungary’s long-term deal.
Meanwhile, the New York Times has reported that Greece, a country with a traditionally close relationship with Russia, is also objecting, but the Times’ report adds an interesting — and credible — twist:
Many Europeans already think Germany, the bloc’s largest economy, is a wealthy neighbor that is not always eager to help weaker countries. That characteristic was most recently highlighted by the country’s attitude toward helping Greece, Spain and other countries that use the euro when they were struggling financially about a decade ago.
Now, some of those very same countries are signaling that they are unwilling to make their businesses and people endure more suffering when energy prices are soaring to help bail Germany out of its dependence on Russia.
The Spanish energy minister, Teresa Ribera, said on Thursday that her country would encourage but not require its citizens to cut gas use. “Unlike other countries, we Spaniards have not lived beyond our means from an energy point of view,” she told El País newspaper, echoing the description some German ministers used during the eurozone crisis.
The Greek government has also pushed back against the European Union’s call for a 15 percent cut in gas use. Although Greece relies on Russia to meet 40 percent of its gas needs, its supplies have not been cut.
The euro just keeps giving. Indeed, the history of the EU’s vampire currency clearly helps explain the response of the Italians (another nation that found itself on the wrong side of Angela Merkel during the euro zone crisis) to the commission’s proposal. The Daily Telegraph’s Ambrose Evans-Pritchard notes that:
The Italian press says this is really about Germany coming “cap in hand” as a result of its own improvidence and its Faustian pact with Putin. Italy has secured extra supplies from Algeria and has the biggest strategic gas reserve in Europe.
Oh yes, Poland doesn’t seem too keen on the EU’s plan either. About half of its gas has traditionally come from Russia (which has now cut Poland off). Gas has accounted for about 17 percent of primary-energy consumption, but unlike Germany, Poland has for years been building the infrastructure that should replace Russian gas within a few months. Poles know a thing or two about Russia, and they also know that the Germans knew (or should have known) quite a bit too, and yet . . .
The Daily Telegraph’s Joe Barnes quoted this comment from an unnamed Polish official:
“While coordination in the spirit of solidarity in the EU is indispensable as a complement to the efforts of the member states, it cannot be used as a tool for ‘mutualising the consequences’ of prolonged, systemic over-dependence of some countries on Russian gas and the lack of investment in diversification”.
Ten days ago, I wrote that, when it came to natural gas and Europe, Putin was in the catbird seat. That hasn’t changed. The gas may be flowing again, albeit in smaller quantities, to Germany, but, as noted above, Russia could switch it off at any time, threatening to plunge the EU, where the economy is already looking fragile, into a severe recession and an energy crisis, two distinct, yet connected, sources of misery. The result, almost certainly, will be political upheaval. The consequences are unlikely to be helpful for Ukraine.
In the meantime, Putin can, with menacing comments, dark hints, and, doubtless, the tactical deployment of “technical problems,” repeatedly remind the EU, and most particularly Germany, about the threat that is hanging over them, a threat that empowers and enriches Putin and risks dividing Europe.
It’s not the brightest of prospects.
The Capital Record
We released the latest of our series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which appears weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and NRI trustee David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.
In the 76th episode David is joined by Sachin Khajuria, author of the brand new book, Two and Twenty, and long-time partner at private-equity behemoth, Apollo Group. They discuss the state of the private-equity industry, the true differentiating factors of the cultures at the best firms, and ultimately, what this all means for the economy. Private equity and innovation in financial markets are under attack. If you listen to this whole podcast, you may decide the righteous fight is with the masters of the universe.
The Capital Matters week that was . . .
Inflation
Throughout 2020, Powell’s mantra was that the Fed would do everything in its power to support the economic recovery. In early 2021, Powell repeatedly stated that the Fed would give “ample warning” before any changes in policy. By fall, however, Fed officials realized that high inflation was more persistent than they had previously expected. The FOMC raised its inflation projections and stopped describing inflation as “transitory.” Since committing to a stable policy, the data had changed.
At this point, Powell had to choose: Would he encourage the FOMC to move quickly to raise interest rates and stave off inflation, or would he stick to his commitment to move slowly and provide ample warning of changes in policy? Powell chose to move slowly and allow higher inflation, although he probably underestimated how high it would actually get . . .
Energy
The writers of the Journal piece (Bojan Pancevski and Jenny Strasburg) also note the hub role played by Germany in the European gas market. That’s one problem, but so is the effect that a complete shutdown of Russian gas supplies to Germany may have on industrial production in that country, and by extension, on production elsewhere on the continent. A fresh round of supply-chain disruptions may be on the horizon . . .
The U.K.’s own Energiewende has, in many ways like its even more disastrous German equivalent, been a massive, reckless, and rushed exercise in malinvestment. It is nothing the Tories can be proud of.
Quite how this transition will create “millions of jobs” remains a mystery, particularly if those millions are calculated — as they should be — on a net basis, after accounting for the jobs that will be lost.
Doubtless Mordaunt will be able to explain.
As Barnard points out, “Belgium’s Green Party did an about-face to extend the life of the country’s remaining two reactors by a decade,” “Poland is building its first plant,” the Czech Republic is planning to build “several reactors,” France is “now doubling down on nuclear energy, including next-generation designs,” and “the Dutch government is moving toward construction of two new plants in response to war-induced energy shortages.”
The one important point to add is that — even amid the potential European nuclear-energy renaissance that Barnard details — the U.S. is trailing behind.
Not content with the Jones Act only harming our fossil-fuel industry, Congress now wants it to harm our renewable-energy industry as well. The House passed a crew-mandate bill that would apply to the ships used for offshore energy projects, including wind farms.
The new mandate was included in a defense authorization bill, and it would require the crews that work on offshore wind and oil projects to be citizens or permanent residents of the U.S. or be from the same country as the vessel’s flag. Foreign-flagged vessels are rarely crewed solely by people from the same country, so the bill has the effect of extending the Jones Act’s provisions to offshore energy projects . . .
With gas prices running at nearly $4.50 a gallon — almost $2 a gallon higher than when President Trump left office — soaring electric-utility costs for homeowners and businesses, and the threat of blackouts and brownouts in as many as a dozen states, the last thing America needs is a green zealot running the federal agency overseeing American energy policy. But in tapping Richard Glick for a second term to head the Federal Energy Regulatory Commission (FERC), President Biden has doubled down on his crusade to eliminate oil, gas, and coal from America’s energy supply . . .
Pharmaceutical Pricing
Senator Joe Manchin has reportedly told Democrat leaders he will not support the economic package they are seeking to pass through reconciliation, which requires only a simple majority in the Senate. But Manchin has indicated he will support a bill that imposes price controls on Medicare drugs.
Say it ain’t so, Joe. The proposal is unnecessary, and it will harm Americans by decreasing access to innovative new drugs and decreasing life expectancy . . .
Education
In most states, where you live determines where you can go to school. This method of residential assignment intertwines property wealth and schooling because high-ranking public schools are often located in more expensive neighborhoods.
Open enrollment, however, can break down the barriers that prevent families from accessing public schools other than their residentially assigned one. This form of school choice allows families to enroll in any public school if there are open seats, thus weakening the connection between housing and schooling. Research from Texas and Florida shows that families in states with strong open-enrollment laws use the policy to find better educational opportunities for their children . . .
The Pandemic
But New York City has never seen its Pret Index exceed 0.8 since the pandemic began. In downtown Manhattan, the Pret Index is only 0.38, and in midtown, it’s 0.45. The authors note that the “bounceback hasn’t materialized” in New York as it has in London. The highest reading for New York was a 0.72 for midtown in November 2021. Downtown has been consistently below 0.6.
It could be the case that people just aren’t eating at Pret A Manger as much as they used to in New York. But other data show the same trend. MTA ridership numbers remain well below pre-pandemic levels. This past work week, average subway ridership was 58 percent of pre-pandemic levels and average commuter-rail ridership (LIRR and Metro-North) was at 60 percent.
Weekend ridership, on the other hand, is doing much better . . .
Housing
There is, however, an argument, based on historical data, that housing is a decent hedge against inflation. Housing passed that test in the inflationary 1970s, when it was one of the better performing assets. On the basis of that precedent, if inflation is back, housing should be fine. On the other hand, housing’s ability to keep pace with prices during the disco era can be seen as a continuation of the pattern from the mid-1950s onwards during which inflation and home prices moved (very roughly) in tandem. The problem now is that that link snapped at some point from in the late 1990s. After then, housing outpaced inflation, at least as generally understood, a divergence that resumed after the crash that accompanied the financial crisis thanks to ultra-low rates and, eventually, the pandemic effect. To be sure, the old link with inflation may be restored, but will it take a sell-off in home prices before it is?
As mentioned above, no one (well, there will always be someone) seems to be expecting the sort of collapse in prices that we saw during the financial crisis, but if we have left the era of ultra-low rates behind us for good it would not be entirely surprising if there is some relatively heavy sledding ahead . . .
Put all these things together, and they reinforce the impression that home prices look fairly likely to ease, rather than merely remain stagnant. Whether “ease” turns out to be a euphemism remains to be seen, but the combination of a record (median) home price and falling sales does not seem to be one that can endure for long . . .
Religion and Free Enterprise
Defenders of a free-enterprise system have too often had a disappointing relationship with the faith community. Christian theology provides the basic anthropology that both reveals and promotes the tenets of market economy (human creativity, justice in exchange, individuality, division of labor, etc.), and yet the modern church (in both Catholic and Protestant traditions) often sounds more like a woke-progressive bumper sticker than it does a prophet of biblical truth and teaching . . .
The Budget
This growing pressure on the federal budget is causing lawmakers to focus new attention on trimming wasteful spending. House appropriators recently called on the comptroller general and the nonpartisan Government Accountability Office (GAO) to identify ways that Congress can save money by leveraging the watchdog agency’s nonpartisan oversight.
In its report accompanying the FY2023 funding bill for the legislative branch, the House Appropriations Committee included reporting requirements that will identify opportunities to trim hundreds of billions of dollars of waste from the budget . . .
China
TikTok’s parent company has an extensive, well-documented history of cooperation with China’s security state, including the bureaus responsible for the Uyghur genocide. TikTok, as it happens, is also rapidly displacing Google as the premier option for Internet searches among Gen Z . . .
I, for one, am not entirely convinced that accepting the installation of one of these committees, the representatives, effectively, of a genocidal authoritarian regime, is entirely compatible with good governance. I’m not sure how it fits in with the “S” (social) of ESG, either . . .
Supply Chains
Since the Supreme Court declined to hear a challenge to AB5, it’s up to the California state government to rectify the situation. California has already exempted numerous professions from the requirements of AB5 because of the economic damage the requirements would cause. At the very least, trucking should be included in the exemption list, and California lawmakers should make that clear as soon as possible.
These protests and the resulting economic damage are an unforced error by California’s progressive, Democratic state government. Seeking to please organized labor, lawmakers have managed to create a situation in which nonunion truckers are pursuing effective labor action and workers from one of the state’s most powerful unions are siding with those nonunion truckers against the law.
Corporatism
In May 2020, CMA CGM got a $1.1 billion loan, 70 percent guaranteed by the French government. The initial government stance on Covid was that transportation companies would need to be bailed out because they were vital to the economy and would go under without government help.
That turned out to be wrong, as ocean shipping became more important than ever before, and carriers were operating at maximum capacity month after month. Excessive demand drove prices up all around the world, and carriers, for basically the first time, made huge profits. These profits were not due to lack of competition, and carriers are investing in new ships and better technology. CMA CGM made a profit in the first quarter of 2020, before it got the $1.1 billion loan, and it hasn’t looked back.
Now, after propping up the company for years, the French government wants to portray CMA CGM as a robber baron . . .
The Fed
Jerome Powell risks going down in history as the Federal Reserve’s worst chairman since Arthur Burns, who brought us runaway inflation in the 1970s.
He risks doing so by first having kept monetary policy too loose for too long as he waited for clear signs of inflation to actually show up in the data. He thereby lost control over inflation and added to an asset-price bubble. He now risks allowing the same data-driven approach to cause him to slam on the monetary-policy brakes too hard to regain control over inflation even at the likely cost of a deep recession . . .
Tax
Jonathan Williams and Nick Stark:
In 2022, a new record of four states — Iowa, Mississippi, Georgia, and Arizona — have made the leap from a progressive tax on personal income to a flat tax. In early March, several hours before giving her rebuttal to President Biden’s State of the Union address, Iowa governor Kim Reynolds signed into law aggressive tax cuts, which consolidated Iowa’s nine personal-income brackets into a single rate and lowered the rate from 8.53 percent to 3.9 percent. These historic changes will result in a $2 billion tax cut for Iowans.
In Mississippi, lawmakers passed a plan in early April to lower and flatten the state’s personal-income tax. Mississippi speaker of the house Philip Gunn, a true champion for real tax reform, called the plan “a huge win” for the state of Mississippi. The $525 million tax cut, the largest in the state’s history, lowers the top marginal rate from 5.00 percent to 4.00 percent by 2026 and eliminates the bottom two brackets . . .
The Economy
So inflation has likely peaked, but history suggests that inflation spikes (such as this one) take a long time to work out of the system. While inflation will likely start to head south, it is very unlikely that it will be close to the Fed’s 2 percent target before the next president is inaugurated.
But as the prices drop, we will see White House repeat what it said this week, probably all the way through midterm election. First, deny that we are in a recession. Second, there will be an absurd attempt to claim credit for the reduction in inflation: “Gasoline prices are down because President Biden took bold action to release oil from the strategic reserve! Other prices are down because he fixed the supply chain problems!”
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