The Riskiest Macroeconomic Environment of the 21st Century


Corporate Finance columnist Les Nemethy believes the macro environment is riskier than before the Dotcom Bubble and before the Great Financial Bubble. Why? A nasty cocktail of factors that may reinforce each other.

Chair of the Federal Reserve Jerome Powell declared he wants to see a trend of lower consumer price index (CPI) data before the Fed takes the foot off the monetary tightening pedal. The Fed calling itself “data dependent” is like driving using the rearview mirror. The Fed intends to continue to raise interest rates until data, which by definition lags, shows a favorable CPI trend.

What if raising interest rates kills demand but not inflation? Then the Fed continues to tighten, literally until something breaks. At the same time, consumer expenditures are falling off a cliff.

Both bond and equity markets have had their worst half year since the Great Depression. Powell seems to think he can “do a Volcker” and tame inflation. But the world is a very different place than under his predecessor Paul Volcker, the 12th chair of the Fed. U.S. government debt is at 120% of GDP, compared to 40% under Volcker, making the U.S. government far less able to withstand high interest rates. Individual, corporate, and government debt have seen similar increases the globe over, making the world ever-so-fragile.

The number of emerging market countries experiencing crisis is increasing by the month. High U.S. interest rates are sucking money out of emerging markets into the States. This is because much of the emerging market debt is denominated in USD, making it harder to service given higher U.S. interest rates and a higher U.S. dollar.

While oil and many other commodity prices have dipped a bit, prices remain very high by historical standards. In addition, underinvestment in energy and commodities has been so severe that it has created capacity constraints.

Potential for Price Surges

It will take many years to bring on new supplies. Tight supply conditions will continue to buoy prices, with the potential for price surges upon disruption. In the meantime, wholesale electricity prices in Europe are going through the roof.

High electricity and gas prices (the latter at quadruple the U.S. prices) due to the war in Ukraine are contributing to Germany’s loss of competitiveness, which means it cannot fuel its export machine. Indeed, for the first time in more than 30 years, Germany had a trade deficit. Its economic model is based on cheap Russian energy; Germany willingly threw away the option of atomic diversification, shutting its nuclear power plants.

Total disruption of Russian hydrocarbon supplies to Europe is now a very real scenario and would make matters worse.

Inventory shortages and supply-side disruptions in the fertilizer and food sectors risk creating famine, further price spirals, and political unrest. Inventories of critical commodities like wheat are extremely low.

Despite Quantitative Tightening (QT) in the United States already having caused so much pain, real interest rates in America and Europe remain high; in the case of Europe, the trend is frightening.

The European Central Bank is in a “damned if you do, damned if you don’t” dilemma. It desperately needs to raise interest rates. However, raising interest rates would put a strain on the periphery (in other words, Italy) and further dampen GDP growth.

Consequences and Uncertainties

On top of all this, we have the consequences and uncertainties of the COVID-19 pandemic and the Ukraine War. Epidemiologists are again raising concerns about the newest variants, while Russia’s President Vladimir Putin just keeps escalating.

The above list is far from exhaustive. There are many other vulnerabilities. Certain European banks have equity to asset ratios below 3%. Demonstrations are going on by deposit holders in China who have been unable to withdraw deposits since April. Meanwhile, Evergrande’s default on more than USD 300 billion of debt continues to work its way through the system.

Much is already breaking. The economy is rapidly decelerating. In the United States, Q1 2022 came in at -1.6% growth; the Atlanta Fed estimates Q2 growth at -2.1%. (two negative growth quarters are the definition of a technical recession). Danger signals, such as inversions of yield curves and reverse repos at new records, are flashing.

The trillion-dollar question is when the U.S. Fed will pivot from Quantitative Tightening to Quantitative Easing. It is the high levels of debt that could make the next crash the most dramatic of this century.

Powell seems to think that there is the economic equivalent of a feedback loop, whereby high interest rates are enough to drive down inflation. But what if other things (increased money supply, supply bottlenecks, inflation expectations, etc.) keep inflation from responding? The economy may crash before inflation comes down.

Think of a dry forest with an accumulation of flammable undergrowth. There may never be a forest fire, but one tiny spark has the potential to cause a conflagration.

Les Nemethy is CEO of Euro-Phoenix Financial Advisers Ltd. (, a Central European corporate finance firm. He is a former World Banker, author of Business Exit Planning (, and a previous president of the American Chamber of Commerce in Hungary.

This article was first published in the Budapest Business Journal print issue of July 15, 2022.

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