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DisInflation, Nuclear Power for Data Centers & Treasury Stability
Europe's Aim to be a Superpower
Here is what we will be getting into today:
Modular Reactors for Data Centers
Treasury Stability Solution
Europe Wants To Be 3rd Superpower.
Let's Dive In!
Recent CPI Data Shows Cooling Inflation in the US
The recent CPI data suggests that inflation in the US is showing signs of improvement, with energy prices falling for the first time since January 2021. The stabilization of supply chains has also led to a stabilization in prices for core manufactured goods, with used car prices offsetting rises in other goods. Food inflation is also cooling, with prices for at-home food items declining for the first time since November 2020. Inflation in core services, which are most influenced by monetary policy, is also showing positive signs. Annual core services inflation declined for the first time since August 2021 thanks in large part to a cooler print from housing prices. Inflation in core services ex-housing, which the Federal Reserve believes best reflects labor-cost-driven price pressures, remains high but may start cooling as declining wage growth passes through to prices.
The recent decline in inflation has represented the fading of idiosyncratic shocks to aggregate supply, with core goods inflation cooling as supply chains improve, energy prices declining as oil market dislocations fade, and food prices stabilizing after the Russian invasion of Ukraine. Monthly headline inflation was essentially entirely propped up by rising prices for housing and other services, for which there has been relatively little relief for most of the last 12 months. This month's CPI report showed some long-awaited signs of improvement in core services inflation.
Year-on-year housing inflation appears to be at or near peak levels, and growth in new lease prices peaked around this time in 2022. If that continues, year-on-year growth in headline and core inflation can meaningfully decline over the next few months. Non-housing services inflation is also cooling off thanks in large part to how the CPI measures medical care services prices. Energy prices, which at peak were more than enough to push inflation above the Fed's 2% target on their own, are now pulling inflation downwards for the first time in years. Gasoline prices have fallen 12% over the last twelve months and crude oil prices have fallen 15% as the initial impacts of Russia's invasion of Ukraine on oil markets fade. Prices for used motor vehicles also continued to decline as the effects of supply-chain improvements passed through to the auto market.
Overall, while there is still progress to be made, the effects of tighter monetary policy on inflation are finally being felt in a big way. Markets remain confident that the Fed will be able to reign in price growth, even if the disinflationary process will still take some time.
Small Modular Reactors: The Solution to Data Center Energy Woes
Data centers are essential to our modern civilization, but they consume enormous amounts of electricity 24/7, which is becoming a problem. Power transmission bottlenecks in Northern Virginia could delay new data center development into 2026, and data center developers across the pond are facing the same problem. Concerns about greenhouse gas emissions, water usage, noise pollution, and the overall sustainability of data centers are fueling local opposition that is constraining where or even whether data centers get built. Tech giants like Google, Amazon, Microsoft, and Facebook have responded to the demand for clean energy by investing heavily in wind and solar projects. But wind and solar alone can't solve the problem as they can't deliver the uptime that data centers need. A power source reliable enough to provide uptime round-the-clock at low cost and with zero emissions is needed. Small modular reactors (SMRs) supply between 10 and 300 MW of power 24/7. A data center supplied by an SMR would face no more competition for power with local communities. No more waiting for new transmission lines or power plants to be built. And no more emissions. SMRs differ from large conventional nuclear plants as much as modern smartphones differ from old rotary phones. Conventional plants are large and complicated, and cumbersome US and European regulations make them expensive to build. Two units currently being built in the US state of Georgia have cost upwards of $30 billion. SMRs are simpler and much less expensive to construct. Off-the-shelf components and factory prefabrication bring construction costs as low as $60 million. SMRs have a small footprint, about two acres for the smallest reactors, which is less than 0.5% of the land used by traditional reactors. Most don't use water for cooling and therefore don't have to be sited near a lake, river, or ocean. They can be installed on site or at a nearby location in under a year, and developers needn't put capital at risk as some SMR companies offer power purchase agreements (PPAs). SMRs promise data centers what they're looking for: a reliable, low-cost, carbon-free energy source that yields round-the-clock uptime. Data centers of all sorts can use SMRs to secure the energy independence they need to overcome bottlenecks in the grid and to avoid competition for energy with local communities.
Relaxing the Supplemental Leverage Ratio: A Solution for Stability in the Treasury Market
The Office of Financial Research (OFR) has published a paper titled "Fragility in Safe Asset Markets," which revisits the US Treasury market's fragility in March 2020. The paper explains how strategic investor behavior can create market fragility in a model with investors valuing safety, investors valuing liquidity, and constrained dealers. The authors developed a simplified theoretical model of a market with three distinct types of players: investors that value safety above all, investors that value liquidity above all, and intermediating dealers that face balance sheet constraints. They found that most of the time, including at times of stress, these players interact symbiotically with offsetting trades, but in really acute times of turmoil, liquidity-oriented investors can start to anticipate worse prices and seek to sell preemptively, leading to self-fulfilling market runs that are like traditional bank runs in some respects.
The Supplemental Leverage Ratio (SLR) is a regulation that was introduced after the global financial crisis to prevent banks from taking on too much risk. During times of stress, the SLR can hinder the ability of banks to provide liquidity in safe asset markets, such as the Treasury market. To prevent future stresses in the Treasury market, some experts suggest that the temporary relaxation of the SLR should become a more regular feature. By relaxing the SLR during times of stress, banks would have more flexibility to provide liquidity without taking on excessive risk. This could help improve market stability while still maintaining the intended benefits of the regulation.
A possible solution to address the issue of financial markets becoming unstable when the economy is under stress is to enable all interested parties to directly trade in the market for government bonds with each other. This can prevent situations where people suddenly want to sell off their investments, causing a panic and making it harder for everyone to access cash.
During times of stress, the people who are worried about losing their money often want to invest in safer options, like government bonds. This can actually make the problem worse, because it raises bond prices and makes it harder for banks to hold onto them. If people who care a lot about having access to cash are convinced that the situation is bad enough, they may start selling their bonds, which can make other people panic and try to sell their bonds too. Even though the Federal Reserve has tried to prevent these problems by offering to buy government bonds, it hasn't always worked. This is because the banks that help people trade these bonds are still worried about running afoul of regulations that limit the amount of debt they can hold.
During times of market stress, banks with limited resources on their balance sheets can cause prices to become very unstable, particularly in safe asset markets. To address this issue, the Fed made changes to its policies, including outright purchases of Treasury securities and exemptions for Treasuries and Fed reserves from the supplemental leverage ratio. This helped to restore market stability. If these changes had been made earlier, fewer purchases would have been necessary to maintain stability. The temporary exclusions for Treasuries from the supplemental leverage ratio calculations ended in March 2021.
Europe's Ambition to Become a Third Superpower in a Multipolar World
French President Macron's recent declaration that Europe should become a third superpower, with strategic autonomy from the United States, has sparked controversy in Europe. While some agree with Macron's vision, others are enraged. Having said that, a multipolar world is inevitable, and having a second pole committed to democracy and human rights, rather than having these notions inextricably associated with American power, would be a good thing. The truth is that Europe is simply not prepared to become anything resembling a superpower.
Europe is politically disunited, and its constituent states are not quite independent, but the whole is not quite a superstate either. Europe also appears incapable of keeping its main military threat at bay without massive American assistance. Russia spends over 4% of its GDP on its military, while the core European states of France and Germany spend much less. Even in terms of total armed forces personnel, all of Europe combined had only about 30% more than Russia before the war. As long as Europe doesn't have the ability to hold a weakened, dysfunctional Russia at bay without massive American help, all Macron's talk of European sovereignty will continue to ring hollow.
Europe's weakness isn't just military; it's economic and technological. A region that once dominated the global economy is now falling behind in almost every important area of industry and in economic importance as a whole. The EU's GDP was equal to America's in the early 1980s, but since then, it has grown considerably more slowly. As for China, its economy eclipsed Europe's in size as of 2020. Europe appears to be turning its back on the technologies of the future, viewing them either as threats to be regulated away or as consumption goods to be imported from China. If Europe wants to be a superpower, mastery of cutting-edge technology leads to both economic and military power; the EU will not be able to substitute regulatory power or moral power in their place.
For more in depth analysis of these topics, check out these articles:
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