Year 2022 made its mark as the inflection point where multi-decade, ultra-loose monetary policies of currency printing and declining interest rates were reversed to stricter monetary regime. The year 2022 is reminiscent of the era of the 1970s in which spiraling inflation gave sleepless nights to central bankers round the globe. The year was also reminiscent of the cold-war era of the 80s in which the Western Bloc had used the price of money, aka interest rate, to subvert the influence and aggression of the USSR by crushing oil, and the prices of industrial metals.
It proved to be a roller-coaster, not only from the geo-political perspective but also from the point of view of asset management and economics. The Russia-Ukraine war that bolstered commodities prices in the first half of the year saw prices stage a u-turn in the second half. Growth stocks, especially new age technology companies crashed like the Dot-Com bubbles of 2000-01. Value and defensive stocks of old economy sectors like energy, consumer staples, and health care replaced the growth stocks of consumer technology companies in investors’ portfolios. Index funds and passive managers, who were in vogue since the last two decades, faced quite a challenge from the active managers.
How is 2022 a game-changer?
After the pandemic in 2020, there was a massive bull run in commodities. The world expected enormous amounts of rebuilding after months of being in a state of inertia. The sudden action expected from a system that had atrophied during the pandemic created logistical bottlenecks and supply constraints.
Commodity prices soared on the back of such supply constraints coupled with easy fiscal and monetary policies. This created the mirage of a commodities super cycle. The so-called super cycle fizzled out in the second half of 2022, calling a stop to the bull-run within 2 years, and putting a question mark over the veracity of what was proclaimed as a commodity super cycle by market-pundits.
Furthering its assaults on conventional wisdom, the year 2022 has shattered the historical paradigm of monetary policies adopted by countries during war. Historically, countries relaxed their monetary conditions at the time of war, but in 2022, central banks around the globe are tightening their purse-strings. A decade old quantitative easing policies are giving way to quantitative tightening tools, even when one of the most powerful continents in the world is embroiled in warfare.
The rationale of the topsy-turvy turn of events that shattered the market predictions may not be found in the annals of financial and economic studies. What may baffle the financial pundits is easy to understand for an astute Statesman because 2022 was the year when geo-politics starkly stepped into the streets of capital-markets and started dictating terms.
Big story of 2022: War between currency vs commodities cartel
Commodities and currencies are pawns of the cold-war which is now being played at the speed of the internet driven economy. While, Russia has weaponised commodities, the US is weaponising the dollar hegemony.
After the Ukraine invasion, commodities producing nations primarily OPEC and Russia banded together and these nations started influencing prices based on supply squeeze and production curtailment.
This led to US-led Western bloc to induce demand destruction through tighter monetary policies. It was not a coincidence that after running loose monetary policies for many years and terming High Inflation as ‘Transient’ in nature, Federal Reserve, the US Central Bank raised interest rate in mid March just after 2 weeks of Russian invasion of Ukraine. The European Central Bank followed the Fed and hiked rates after a decade.
Since March, most of the nations in the Western hemisphere have hiked their interest rates with the prime objective of curtailing the demand for commodities.
Since global commodities trades are primarily done in dollar and euro thus commodities producing nations keep their earnings in Dollar and Euro backed assets and prior to War approx 80% of global forex reserves were invested in these two currencies. Threats of seizure of these investments have also subjugated the commodity bloc of nations to be at the mercy of the currency bloc of nations.
The Ukraine war forced the hands of policy makers in western nations to change their monetary and financial tactics as loose monetary policies were indirectly helping commodities producing nations like Russia.
Demand destruction through hiking rates is one of the major reasons for commodities dropping significantly in the second half of the year despite both OPEC+ bloc's attempts to influence prices through production cuts and the war.
What does it mean for India?
The casualty of cold-war between currency and commodity blocs is now affecting all parts of the globe, including India. The country's merchandise trade deficit for April-October 2022 has almost doubled to around $173 billion as against $94 billion in April-October 2021. Ballooning trade and current account deficit leads to depreciation of Indian rupee against the U.S. dollar. Higher global interest rates have proven detrimental to riskier investments like start-ups, new technology companies, and the Indian capital market. With the dramatic decrease of venture funding investments in India the start-up winter has already started creating job-losses on a huge scale. This high-value consumer class that now finds itself unemployed would reduce consumption significantly, thus exacerbating stagflation.
With the hiked rates of both commodities and the dollar, countries like India are in an even graver position. Widening current and fiscal deficits will make it difficult for the government to carry out social welfare projects and support subsidies without increasing taxes.
Akin to the parable of an Amazonian butterfly flapping its wings to cause hurricanes in China, the Indian citizens may as well expect getting taxed more and getting taxed through innovative schemes created by the government because Russia refused to tolerate NATO in its backyard.