Middle East

Clouds over 2022

Nuriel Rubini

Despite the downturn and turmoil of the new variant of COVID-19, 2021 turned out to be a relatively positive year for economies and markets in most parts of the world. After the severe recession of 2020, growth outweighed its potential and financial markets recovered strongly. This is especially the case in the United States, where the stock market is new, thanks to the very loose monetary policy of the US Federal Reserve (although central banks in other developed countries pursued their own radically accommodative policies). Reached a high price.

But 2022 may be more difficult. The pandemic isn’t over. Omicrons may not be as toxic as previous variants, especially in highly vaccinated developed countries, but they are much more contagious, meaning that hospitalizations and deaths remain high. The resulting uncertainties and risk aversion curb demand and exacerbate supply chain bottlenecks.

These bottlenecks fueled inflation in 2021, along with excessive savings, stagnant demand, and loose monetary and fiscal policies. Many central bankers who argued that the surge in inflation was temporary now admit that it will continue. The urgency varies, but we plan to phase out non-traditional monetary policies such as quantitative easing so that interest rates can begin to normalize.

The central bank’s determination will test whether raising the policy rate will shock bond, credit and stock markets. With such a large accumulation of private and public debt, the market may not be able to digest higher borrowing costs. If in trouble, the central bank will fall into a debt trap and will probably go backwards. It allows for an upward shift in inflation expectations, which makes inflation endemic.

The following year, geopolitical and systemic risk will also increase. On the geopolitical side, there are three major threats to note.
First, Russia is preparing to invade Ukraine, and it remains unclear whether negotiations on a new regional security regime can prevent the threat from spreading. US President Joe Biden has promised to increase military aid to Ukraine, threatening stricter sanctions against Russia, but also revealed that the US will not intervene directly to protect Ukraine from attacks. But such threats may not be able to discourage Russian President Vladimir Putin, as the Russian economy is more resilient to sanctions than before. After all, some western sanctions, such as a move to block the Nord Stream 2 gas pipeline, could further exacerbate Europe’s own energy shortages.

Second, the US-China Cold War is getting colder and colder. China is increasing military pressure on Taiwan and the South China Sea (where many territorial disputes are occurring), accelerating a wider separation between the Chinese and US economies. This development will have stagnant results over time.

Third, Iran is currently a threshold for nuclear powers. It was rapidly concentrating uranium to the weapons grade, and negotiations on a new or refurbished nuclear agreement went nowhere. As a result, Israel is openly considering a strike against Iran’s nuclear facilities. If that happens, the consequences of the stagnation can be worse than the oil-related geopolitical shocks of 1973 and 1979. The New Year also raises some systematic concerns.

In 2021, heat waves, fires, droughts, hurricanes, floods, typhoons and other disasters revealed the real-world impact of climate change. Most of the cheap talks were given at the COP26 Climate Summit in Glasgow, leaving the world suffering from the catastrophic warming of 3 degrees Celsius on track this century. Droughts have already caused dangerously high food prices, and the effects of climate change will continue to worsen.

To make matters worse, the aggressive push to decarbonize the economy has led to a lack of investment in fossil fuel capacity before a sufficient supply of renewable energy is available. This dynamics produces much higher energy prices over time. In addition, the influx of climate refugees will surge in the same way that the United States, Europe, and other developed countries are closing their borders.

Against this background, political dysfunction is increasing in both developed and emerging economies. The US midterm elections could provide a preview of a full-blown constitutional crisis, if not complete political violence, which could follow the 2024 presidential vote. This poses a serious systemic risk.

Even in regions like Latin America where populism has a dire history, populist parties (both on the far right and on the far left) are growing stronger around the world. Both Peru and Chile were elected radical left-wing leaders in 2021, Brazil and Colombia could follow in 2022, and Argentina and Venezuela will continue on the path to collapse. Normalization of interest rates by the federal government and other major central banks can cause financial shocks in these markets and other vulnerable emerging markets such as Turkey and Lebanon.

As 2021 approaches the end, financial markets remain bubbling, if not completely dead. Both public and private equity are expensive (above average price-earnings ratio). Real estate prices (both home and rent) are high in the United States and many other economies. And there is still enthusiasm around meme stocks, crypto assets, and SPACs (special purpose companies). Yields on government bonds are still very low, and with direct and indirect support from central banks, credit spreads on both high-yield and high-yield bonds have been squeezed.

As long as the central bank was in an unconventional policy mode, the party could continue. However, the asset and credit bubble could shrink in 2022, when policy normalization begins. In addition, inflation, slowing growth, geopolitical and systemic risks could create conditions for the 2022 market correction.

Nuriel Rubini
The CEO of Roubini Macro Associates is the co-founder of TheBoomBust.com.

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