Edge Newsletter #16 - A brief economic outlook on the world

What I’m Reading

I’m rereading The Changing World Order by Ray Dalio. It’s my favourite economics book. Have you heard the term ‘if in doubt, zoom out’? The book takes this principle to the extreme by looking at the past 500 years. The premise is that while these significant events we’re seeing unfold (pandemics, the rising of a new world power, extreme wealth gaps) may not have happened before in our lifetimes, they have occurred many times in history. By studying these, we can learn to navigate the future.

Resource of the Week

I’ve been using Keepa (Chrome extension) for several years now. I simply cannot use Amazon without it, and it’s saved me so much money. This chrome extension overlays a chart directly in Amazon that displays the historical prices of a product so you can tell whether you’re getting a good deal.

Quote

“It is not death that a man should fear, but he should fear never beginning to live.”

Marcus Aurelius

Thoughts

Without delving into the politics, watching the situation unfolding in Russia provides a fascinating case study as to the mechanisms behind modern-day capital wars. Much has been written about the wave after wave of sanctions the West has imposed on Russia. In the meantime, the pound has declined close to the 30-year low against the dollar in the currency markets. Investors have low confidence in the UK market and are deploying their capital elsewhere.

In the meantime, what do you think the strongest performing currency has been this year (against the dollar)? The Ruble. Yes, it is a strange situation and not very much reported.

It’s impossible to go through all the reasons behind it, but there are a few major forces at play:

• Record high oil prices.
• Aggressive currency defence by Russia, initially doubling interest rates.

Despite the sanctions, reducing reliance on Russian oil takes time. At current prices, oil revenue Russia is generating from the EU has so far eclipsed the aid sent to Ukraine. Russia has demanded payment for oil using Rubles which has contributed to the currency's strength.

To prevent soaring inflation, Russia more than doubled their interest rate from 9.5% to 20% before bringing it back to 11%.

Now all of this doesn’t necessarily reflect the strength of their economy. In a way, the sanctions have artificially strengthened their currency. With almost no Western countries doing business with them, they haven’t been unable to utilise much of their foreign currency reserves. Meaning there are little to no imports while still benefitting from significant export revenue.

Unemployment in Russia is rising, expected to hit 7% (almost double the UK currently). The exit of Western companies has led many to lose their jobs and caused poverty to rise. The rise in interest rates will undoubtedly cause their economy to slow down. Of course, the longer the war drags on, the more it’ll continue to deplete capital.

Not to mention the social issues caused by how polarising the war is among Russian citizens.

However, we in the UK have challenges of our own. We’re facing a cost of living crisis. Also, not to exaggerate, I believe we are facing the most precarious economic outlook of our generation. We have an extremely high debt burden (far higher than Russia) as a country. Real growth is set to stagnate. Normally in this type of situation, the Bank of England and the government have two tools they turn to 1) lowering of interest rates to stimulate the economy and 2) debt monetisation or printing money. Number one is out. As before COVID interest rates were already at historic lows following the 2008 crisis. The second option has already been used to an extreme level to pull us out of the COVID recession and we’re struggling to contain the subsequent inflation. So option 2 is a no go as printing more money would worsen the inflation situation. We have some tough times ahead.

During wars, we all suffer. Throughout history, wars are almost always more terrible and last longer than people think. There’s a high risk of a further recession on the horizon. In these situations, being financially literate and diversifying is as crucial as ever. The risk of capital being eroded via inflation is abnormally high.

The goal isn’t even to strive for exceptional returns but to protect your savings. My investment philosophy going forward is defensive. I still believe property is currently a strong investment. The markers are there: availability of credit (banks easing lending criteria) and sustained demand.

One of the biggest misconceptions I hear from people is equating a recession to falling property prices. In recessions, when inflationary measures are put in place (money printing and lowering of interest rates), it leads to increased asset prices, less profitable to hold debt assets and reduced purchasing power for those holding and earning money in pounds. This is why wealth gaps almost always widen during and after recessions.

In addition to property, I’ll be looking to index funds and watching the crypto market very closely in the coming months. As I think if prices ease more, diversifying out will be a much lower risk than holding pounds and dollars.

Hit reply if you have any questions or feedback. Have a good week!