The Consequences of Kabul

Blain’s Morning Porridge – August 16th 2021 –  The Consequences of Kabul

“When troubles come, they come not as single spies but in mighty battalions.”

This Morning – The shocking return of the Taliban dominates the headlines. It has critical implications for markets. Biden’s loss of credibility creates many hurdles and could drive the US towards isolationism – bruised by yet another flawed foreign adventure. Meanwhile, markets struggle with inflation and climate consequences.

The news-flow this morning is dominated by the speed of the Afghanistan collapse and the look of befuddled unravelling across President Biden’s face.

This time it is different. It’s not the same as Vietnam. It’s probably worse. The credibility of Biden’s foreign policy and his presidency went down in tatters over a shockingly fast timeframe – and that’s got massive consequences for the future path of the dollar, the USA’s monetary and economic dominance, diminishing the likelihood the US can undo the damage of the Trump years and patching up US Allies to join against China. The probability the political shock of Kabul’s collapse could cause the US to lurch back into protectionism and disengagement has increased dramatically. The US political and electoral calculus was trashed by the unfolding of events y’day in Kabul – and that’s something markets have to consider.

Consequences, consequences…

Troubles in mighty battalions come – we not only have a considerably weakened US to consider, but the growing global inflation conundrum, a new wave of climate threats as three tropical storms generate in the warm Atlantic south of Florida, Covid cases exploding exponentially in unvaxed nations, a global recovery that looks to be stalling, while the Chinese patiently watch and wait….

Afghanistan. What history books did the general staffs in Washington and Whitehall not read?

The Persians, Alexander the Great, The Mongols, The British (twice), the Russians and now the Americans have all fought long, bloody and utterly pointless stalemates for the hearts of minds of the Afghans. None of the invaders have ever come close to understanding what makes the tribes, the warlords, the Mujahideen and now the Taliban, tick. Anyone can successfully invade Afghanistan. Staying there and getting out is the problem – committed insurgency has trumped the best equipped and supplied armies every time.

This morning’s picture is Lady Butler’s “Remnants of an Army”. Back in 1843 Dr William Brydon was the only survivor of a 5000 strong British Army and 12,000 attached civilians to reach safety in Jalalabad. The rest were killed by the Afghan tribal troops as they retreated through the Khyber pass. He missed the dramatic last stand of the 44^th Foot at Gandamak – wiped out to a man by the tribes.

The story US House Speaker Nancy Pelosi wants to push forward on the US $1 trillion infrastructure bill this week is going to get nowhere as the noise around the collapse of Afghanistan will encourage the Republicans to kick back at Biden… They will no doubt recall it was Donald Trump who committed the US to the exit… but that’s not what history will record. It happened on Biden’s watch.

Inflation and the Bond Market

The market’s big debate remains all about inflation. Is it a real threat, an imaginary one, or can we rely on Central Banks to magik it away? The problem here is the bond market – the single most important market and number on the planet. Bonds never lie – they tell the truth…. or at least they did until central banks discovered how to manipulate and control them through asset purchases and QE. The result is we now have the most distorted bond markets in history – with all kinds of consequences, consequences…

In a sane and normal world declining bond yields would be telling us that inflation is under control while the steepness of the yield curve hinted at how long the accompanying economic slowdown would last.

Today the yield curve and yields tell us nothing – except perhaps that market participants:

• Believe central banks will continue to keep interest rates artificially lower for longer
• Believe central banks are trapped to keep interest rates lower for long to avoid market meltdown
• Believe central banks can’t risk the market instability higher rates could trigger.
• Believe lower for longer rates are now permanent.

Effectively these are all the same thing – rates won’t rise, because Central Banks think it’s too dangerous. In other words… should we trust central banks?

Inflation may always be a monetary phenomenon – the argument the inflation hawks are using is increasing money quantum (as has happened via QE and government spending) is bound to drive higher prices. That has happened – but only in financial assets; bonds and stocks. As it becomes increasingly clear stocks are overvalued in today’s increasingly uncertain world.. then inflation starts to cross from financial assets to the real economy. That is now happening.

It’s happening today in the price of takeover targets, in property and anything real. Factor that with supply side inflation – like chip prices, and the possibility of a bad harvest after what is likely to be the hottest year on record – and we could be facing a very different inflationary picture as suddenly as Biden was confronted by photos of a packed Kabul airport.

Haiti and Climate Change

Yet again Haiti has been hit by natural disaster – a devasting earthquake. The world’s least prepared nation seems to be hit repeatedly by whatever Mother Earth has to throw. Even as rescue efforts are underway, now the Island nation is threatened by a tropical cyclone – Storm Grace. It’s one of three storms currently brewing in the warmer-than-average Gulf, Caribbean and Atlantic waters.

Last year saw a record number of 30 Atlantic Storms – including storms occurring outside the usual hurricane season that runs from June 1 to Nov 30th. They also occurred further North and South, driven by warmer tropical waters. Earlier this season forecasters predicted a quieter 21 “named” storm season this year – still more active than usual..  They predicted 6-10 full on Hurricanes and 3-5 Major Hurricanes.

Add a powerful hurricane season to your list of reasons to panic about climate and sell insurance investments.

COVID

Instead of going sailing last week, I spent last week dealing with unavoidable family matters. I got back home to discover some of our best friends have come down with COVID after they came back from holiday. They are both double-vaxed. They have been in bed for over a week struggling, and tell us: “its far, far worse than a normal flu.” We’ve offered to take them round food, but they warned us to stay away.

Their experience is being repeated up and down the UK. People are not going into hospital and they are not dying – but it’s still a damn unpleasant illness for the 76% of the UK population that is double-vaxed – which includes my kids.

For the unvaxed – the numbers out the US highlight the rising damage in the Republican and southern states that discourage vaccination – versus states with higher uptake which are coping. The attempts of nations like Australia to lock the doors till the epidemic has past now look fatally flawed – the reality is Covid is the reality. No matter how unpalatable, we need to get used to it – fight it rather deny it.

Five Things To Read This Morning

Thunderer – China, The WHO and the power grab that fuelled a pandemic

FT – Tighter US Bond Market could dull pressure on Treasury prices from QE tapering

WSJ – China’s Corporate Crackdown Adds to Junk-Bond Distress

BBerg – Turmoil in Afghanistan Adds to Geopolitical Risks Facing Markets

BBerg – The World May Never Reach Herd Immunity Against Covid-19

Out of time, and back to the day job

Bill Blain

Strategist, Shard Capital