The Biggest Risks of This Decade

Since the 2020 pandemic, many things have changed, but nothing more than geopolitics. Wars and clashes that used to be largely national have given way to more regional conflicts that threaten to upend the current world order. The Ukraine War and Israel-Iran conflicts have the potential to lead to world war.

The international arena once dominated by the United States has gradually changed into a more multipolar stage. China and India have grown in economic and military significance, and Russia and Iran have reasserted their influence. Rising world powers are increasingly challenging the over-extended leading power.

“The disintegration of the old order is visible everywhere…It is close to collapse.”

The Economist

Half of world’s nations feel that they are victims of economic and political inequality. A similar sentiment is found in the rising tide of populism—even in rich countries—because most people know that their economic situation has worsened in recent decades. At the core of both is the higher cost of energy and materials.

Figure 1 shows that oil price, inflation and interest rates rise and fall in tandem, and are considerably higher now than during the period before the Covid pandemic. The Ukraine War contributed to an energy shock that has moderated but oil prices have averaged nearly 60% higher after 2020 than they were in the six previous years. U.S. interest rates and inflation are more than three times higher.

French president Emmanuel Macron observed in 2022 that these changes are probably secular.

“What we are currently living through is a kind of major tipping point or a great upheaval … we are living the end of what could have seemed an era of abundance…the end of the abundance of products of technologies that seemed always available.”

Emmanuel Macron

The U.S. has coped with generally higher energy prices by borrowing. Debt has increased from about 62% of GDP in 1981 to 170% in 2023. It has risen 67% since the Great Financial Crisis.

Figure 3 shows how per-capita U.S. economic growth has fallen over the last 75 years. The simplest way to understand this is that excessive debt has limited new productive capacity. This and the previous two charts are specific to the U.S. but the problems of debt, inflation and interest rates are global, and are as great for emerging economies as for those that are more developed.

My friend Nate Hagens has identified the key interrelated risks for the coming decade: overshoot of the financial system, geopolitics and war, complexity and the six-continent supply chain, and rising popular discontent that makes governance more difficult. He calls these the four horsemen of the coming decade (Figure 4).

Recent geopolitical events in the Middle East create uncertainty about the crucial flow of oil, LNG and materials through the Red Sea-Suez Canal and the Persian Gulf-Strait of Hormuz.

“The biggest choke-point of course is the Strait of Hormuz where around 20 million barrels of the world’s oil is transported every day…If that were to be disrupted…that would cause major chaos in global financial, oil and delivery markets…We have a six-continent supply chain and it’s predicated on peace, and credit, and available, affordable oil. All those things are less certain going forward.”

Nate Hagens

Almost 9 million barrels of oil per day (mmb/d) pass through the Suez Canal and the Bab al-Mandab Strait. Houthi forces have disrupted shipping through those key passages to a greater extent than most experts thought possible. In the first week of April, the number of ships passing through the canal decreased by 66% compared to the same period last year. Crossings at the Bab-al Mandab, a crucial passage to and from the Red Sea, fell by 59% during the same period.

The Houthis recently expanded their range by successfully attacking shipping in the Indian Ocean. Now, they say that they can hit ships in the Eastern Mediterranean.

“Yemen’s Houthis say they can now hit the Eastern Mediterranean as well as the Indian Ocean and the Red Sea. If all three and Suez are out of bounds for Western shipping without naval escort, Operation ‘Prosperity Guardian’ [to protect Suez shipping] is an expensive bad joke.”

Michael Every, Global Strategist at Rabobank

The developments in the Red Sea demonstrate how the emergence of mobile missiles and drones is transforming naval warfare, much like aircraft carriers revolutionized it in the previous century. The significance cannot be overstated.

Ships are now forced to take the much longer route by the Cape of Good Hope to move oil and materials around the world. That adds an average of about 3500 miles, and more than $2.8 million per ship once fuel, operating costs and insurance are included. It is further projected to increase carbon emissions by 42% per ship for a standard Asia-North Europe voyage.

Politicians and editorial opinion writers like to blame economic problems on flawed government policies but this view ignores that inflation is a global phenomenon. Higher energy costs, disrupted supply chains, and wars act like a tax on consumers.

“Factors contributing to this inflation include increased fiscal spending [for wars] and geopolitical supply chain disruptions. Moreover, the slowdown in the pace of globalization, which previously served as a disinflationary force, adds another layer of cost friction.

Lyn Alden Investment Strategy

French farmers are upset because of higher costs for energy, fertilizer, and other essential supplies following the onset of war in Ukraine in 2022. In Germany, farm protests received support from the populist AfD party and saw participation from various other sectors, including craftsmen and small-business owners.

Another theme of these protests is the cost to workers of decarbonization programs that they feel governments forced on them. Climate-change measures were decided when interest rates were low and energy supplies appeared plentiful. As these new laws are now enacted, governments must navigate a more challenging economic and energy landscape. At the same time, conflicts in Ukraine and Gaza are prompting Western governments to increase defense spending.

In the US, UK, Canada, and Australia, rising housing costs are adding to inflation and popular discontent with government leaders, central banks, and their policies. In major US metropolitan areas, rents have increased at a rate approximately 1.5 times greater than wages over the past four years.

For many years, an influx of migrant workers helped nations such as Canada, Australia, and the UK counteract the demographic challenges posed by aging populations and declining birth rates. The post-pandemic surge of arrivals has resulted in a shortage of affordable housing.

“Thirteen economies across the developed world were in per-capita recessions at the end of last year…While there are other factors — such as the shift to less-productive service jobs and the fact that new arrivals typically earn less — housing shortages and associated cost-of-living strains are a common thread.”

Bloomberg

A decrease in cheap, foreign labor is compounded by the opposition to continued loose immigration policies by most conservative and right-wing movements.

Weaker economic growth, geopolitical tensions and pressure from populist parties has led to a shift towards trade protectionism. For example, the U.S. just announced a 100% tariff on Chinese electric vehicle imports this week.

Protectionism promises avoiding the supply-chain problems of the last several years by bringing manufacturing back home and providing more domestic jobs. It sounds great but it’s not very practical, and it’s inflationary.

“You say right, we’re going to have re-shoring, we’re going to have on-shoring, we’re going to have industrial policy…That process of trying to drag production and supply chains back from where we’ve moved them for the past forty years is inflationary. You’re having to basically redo everything from scratch.”

Michael Every, Global Strategist at Rabobank

But wait. Isn’t the consensus view that the U.S. economy is booming and that the global economy is improving?

“We’re talking about rates being higher for longer because growth is so good…Private sector activity in Europe—the highest level in a year. We’re seeing a reaccelerating of growth across the board…The bottom line, retail sales—smashing…You have unemployment still at very low levels. CPI surprise to the upside. Chinese manufacturing beginning to accelerate. Germany, Europe accelerating. And the list goes on. This is classic late-cycle expansion.”

Jeff Currie, Chief Strategy Officer of energy pathways at Carlyle Group

Other analysts see things somewhat differently.

“The global economy I would say is pretty flat…Even the mighty US economy which was growing over 3% last year, saw its GDP growth throttle back to 1.6% in the first quarter so things in the US are cooling off. Europe is actually surprisingly doing a little bit better…however the economy there is pretty stagnant. Japan—I would say again pretty stagnant. China seems right now to be printing a little bit better data however their economy is still really struggling under the lingering property and debt crisis…so you know you can pick and choose.”

David Rosenberg, Rosenberg Research

Some analysts are more pessimistic. Danielle DiMartino Booth does not believe that the US economy will have a soft landing. ​ She thinks it has entered a recession and that the downside risk has increased. ​ She also highlights indicators such as weak industrial production, increased layoffs, and negative revisions to personal income as evidence of a deep and prolonged downturn.

“The US economy had entered recession in October of 2023 given the revisions that we have on hand given how very weak industrial production has been given what the revisions say to personal income minus government transfers…The labor market is softening, and there is an increase in layoffs, particularly in retail and technology sectors..Now these are things that take a very long time to pan out.“

Daniel diMartino Booth, CEO & Chief Strategist for QI Research LLC

Lyn Alden believes that the U.S. economy is in a state of stagflation in which some sectors are experiencing a recession while others continue to perform well. She suggests that inflation will continue because of continued high levels of fiscal spending and geopolitical supply chain disruptions. The shift towards a stagflationary environment resembles patterns observed in emerging markets during economic downturns.

“It’s very sector specific. If you’re in commercial real estate, it’s catastrophic. If you’re Coca Cola, you’re fine…When you get rising wealth concentration, then you start to get rising populism where people know something’s wrong but they can’t quite say what it is.”

Lyn Alden Investment Strategy

Jeff Snider is unequivocal.

“No soft landing. Consumers are strapped and higher energy costs are being reflected in GDP. The US economy is going to decelerate going forward”

Jeff Snider, Eurodollar University

It seems fair to say that downside risks appear to far outweigh those to the upside for the economy.

Those risks are compounded by the highest global debt levels in eighty years (Figure 5). Ray Dalio provides a credible framework suggesting that world orders change when debt cycles approach their end. That’s because systems collapse when energy and capital demand exceed supply.

Energy is the economy and debt is a lien on energy. The global financial and credit system is supported by trust that productivity will continue to outpace the cost of debt service. That trust is based on relatively cheap and abundant energy to sustain productivity. If that wavers, credit and growth will contract.

“We cannot solve a credit crisis using more credit. Recall that debt is a lien on energy. If we are ever to honor our current debts, the amount of energy required will be immense. If the energy is not available, at cheap prices, those debts will never be repaid.”

Nate Hagens

Unfortunately, energy has become more expensive and less abundant.

Figure 6 shows that oil prices have been twice as high for the last twenty years as they were for the previous twenty in March 2024-adjusted dollars. That is because there has been a relative supply scarcity since 2003 that was interrupted for about five years by lower, more abundant supply from U.S. shale plays between 2015 through 2020. That pulse of cheaper supply is ending.

The last time that real oil prices were this high was during the period of oil shocks from 1973 through 1986. Those high prices resulted in three U.S. recessions in 1973-1975, 1979-1980, and 1981-1982. It was far worse for the developing world that experienced a depression for much of the 1980s.

Luke Grommen summarizes the situation concisely.

“We need sustained oil inflation to drive the oil production increases needed to support economic growth [and] record western sovereign debt. But the record amounts of western sovereign debt cannot absorb the needed inflation without becoming dysfunctional and having rates rise to levels that threaten western sovereign solvency or force Central Bank intervention…Inflation is HIGHLY unlikely to be “transitory”, failing a productivity miracle.”

Luke Grommen

High oil prices are inflationary. Spending to increase oil supply in order to lower prices is inflationary. Wars are inflationary. Protectionism is inflationary. Investment in renewable energy is inflationary. Stagflation is just a variant on inflation in which there is no economic growth and higher unemployment.

Energy and materials drive society. Since money is a claim on energy, debt becomes a claim on future energy. Money is a derivative of the energy and materials which back its value.

That’s not how most of our leaders, and the economists who advise them, see things. Governments and their central banks have focused on tinkering with money and credit in order to sustain growth. Energy is largely ignored as an exponent in the economists’ production equation. That misalignment explains a great deal about how we have arrived at our present predicament.

Nate Hagens’ Four Horsemen of the Coming Decade provides a useful way to understand the present state of things. Finance, geopolitics, supply chains and governance are connected by energy abundance or scarcity and its resulting cost. Add the social and fiscal pressure of managing the environment and climate change, and it’s a bit overwhelming.

That’s why there’s so much risk that one of the four horsemen might go down.