Superpower


John Mauldin
 
May 20, 2015

Ian Bremmer’s new book on the future of the US and geopolitics, Superpower, just hit the streets yesterday, and it’s already creating quite a buzz. It draws on Bremmer’s remarkable understanding of politics, America, and the world. I first ran into Ian at a conference about four years ago, where he was the after-dinner keynote speaker. It was one of those dinners where I had to go (I had spoken earlier), and I confess I had no knowledge of Ian other than his official bio. A professor of geopolitics. From New Yawk.

So this Texas boy settled in while Ian walked on stage … and in three seconds I realized that this was an uber-nerd. Total geek. Seriously, when Hollywood wants to type cast a brilliant super-nerd, they should use Ian as the model. He hit all my stereotype buttons, and I of all people should know better.

Now I know, you’re saying it takes a nerd to know a nerd, and I do get that. But within five minutes, this nebbish professor was blowing me away. I was totally captivated. He took me on a trip through the geopolitical landscape as profound as any I had ever been on. I knew that I had to have him at my own conference, and he has been a featured speaker and crowd favorite there for the past three years.

Ian gave one of the most compelling presentations at our most recent Strategic Investment Conference. No fancy Powerpoint, just one machine-gun idea after another, strung together in what I now realize is his own carefully crafted style.

As I shared with you in Thoughts from the Frontline last week, Ian’s summary of the geopolitical situation and America’s role in managing it can be expressed in two words: it’s bad.

The US is not in decline, he asserts in today’s Outside the Box, citing “the strength of the dollar, US equity markets, employment levels and the economic rebound, the energy and food revolutions, and generation after generation of technological innovation”; but America’s foreign policy and international influence are most certainly in decline. Nevertheless, no other country can even come close to claiming superpower status, so the role the US chooses to play in the world remains of paramount importance.

For the past quarter-century, says Ian, our leaders have just been winging it:

From the fall of the Wall and Soviet collapse, US presidents of both parties have defined America’s mission in terms of tactics. US foreign policy has been reactive and improvisational for 25 years. And we can no longer identify a Democratic or Republican approach to foreign policy.

That’s where we, the American public, come in. We will have a national election in a year and a half, and our foreign policy needs to be front and center in the national conversation until then. To help us think about how we want to be in the world, in Superpower Ian offers three dramatically different foreign policy alternatives, which he outlines in today’s OTB. As I read Ian’s book, there was, I confess, an attraction to each elemental strategy.

I remember being at the Naval War College a few years ago, where Andrew Marshall of the Office of Net Assessment (the premier Defense Department think tank) assigned one group to split up intro three and adopt radically different views of what US strategy should be vis-à-vis China. These were serious thinkers from a wide variety of fields, and they spent over a week developing their arguments. Andy was kind enough to let me sit in on the final presentations and discussion at the end of the week. I found myself nodding as each presentation was rolled out, but at the conclusion I noticed that what I had thought was the most illogical position at the beginning (a nearly total military disengagement from Asia and a renewed focus on our borders and defense) made a great deal of sense. It gave me a great deal to think about.

That is the same feeling I had when I read Ian’s book. Each strategy will have its proponents, and all have their own logic; but that is why we need to have this national discussion. Rather than responding to events tactically, we need to have a national strategy. What is in the real interest of the world’s dominant power? Most of us can agree that the last 20 years has seen a mishmash of US actions that in hindsight we might want to change.

Which path forward does Ian prefer? He’s not going to tell us until the final chapter of the book, he says, but he makes as forceful a case as he can for each of the three choices, and he believes that each is viable. He adds, “I hope this book will help set the stage for a serious-minded, constructive debate among the candidates in 2016.”

Now, you can actually see this policy debate taking shape as the various candidates (on both sides) lay out their views of the future role of the US in the world.

I seriously urge you to get this book. Just like Ian’s speaking style, it is easy and mesmerizing. It is the opposite of nerdy. There is a reason that the company he founded, the Eurasia Group, is perhaps the largest geopolitical strategy think tank in the world and that his rather pricey service is subscribed to by Fortune 1000 companies and global funds. Ian is one of the most insider-connected guys I know. He literally got up from a dinner one night a few years ago with “the guys” in NYC, apologizing that he had to leave because Japanese President Abe was in town and wanted to see him. I am going to get together with him in a few weeks when I’m in NYC. I think I’ll ask who’s on his speed dial.

Get Superpower and read it. Click on the link if you are an online guy, or get to your bookstore. It will be there.

I am on yet another plane, flying from Raleigh to Atlanta to attend a board meeting for Galection Therapeutics (GALT) for the next day and a half before I head back to Dallas. I guess it’s geopolitical week for me, as my old friends George and Meredith Friedman will be over for dinner Friday night. George delivered his own power speech at my conference. I look forward to being able to get both George and Ian’s speeches up on the web for you as soon as possible.

I have spent four fabulous nights at the Umstead Hotel just outside of Raleigh. It’s one of the finest hotels I have been in anywhere. And even better was being with a group of friends and getting to have long serious conversations with Mark Yusko, Raoul Pal, and Kyle Bass and catching up with Dennis Gartman. Long days but really good ones.

And as I hit the send button – just so you’ll know that I don’t think being a nerd is a problem – let’s remember the answer to the old question: “What do you call a nerd after five years on the job?”

“Boss.”

And now, let’s enjoy Ian’s intro to his book that he sent to his clients this week.

Your proud of being a geek analyst,

John Mauldin, Editor
Outside the Box



Superpower

By Ian Bremmer

President Obama hosts a Gulf security summit, and most Arab leaders decide not to attend. Israeli Prime Minister Netanyahu comes to Washington to address Congress on Iran over protests from the president. Britain ignores pleas from the United States and becomes a founding member of the China-led Asian Infrastructure Investment Bank, a potential competitor for the World Bank. The Obama administration gripes that the Brits are pandering to the Chinese. Russia’s Putin, like Syria’s Assad, strides across American redlines with little consequence. Beijing and Moscow announce joint military exercises… in the Mediterranean. NATO ally Turkey turns to China for new defense equipment. The Dutch go to Huawei for internet security.

These are not random events. What’s going on?

America is not in decline. Look to the strength of the dollar, US equity markets, employment levels and the economic rebound, the energy and food revolutions, and generation after generation of technological innovation. But America’s foreign policy and its international influence most certainly is in decline. Superpower or not, too many countries now have the power and self-confidence to say no to US plans.

Globalization and an Americanization of the world once moved in lockstep. No longer. Globalization is accelerating; ideas, information, people, money, goods, and services cross borders at an unprecedented pace, but the Americanization of values, standards, political and economic systems, and international architecture is eroding.

I take this as the starting point for my new book (out tomorrow!). It’s called “Superpower: Three choices for America’s role in the world.” For this week’s update, I’d like to outline my key arguments for you.

Superpower


I called the book “Superpower” because, despite all the challenges facing American foreign policy—geopolitical creative destruction and the g-zero world—the United States  remains the world’s only superpower and will for the foreseeable future. That means that America is the only country with the political, economic, and military muscle to persuade governments in every region of the world to take actions they wouldn’t otherwise take. That’s a working definition for the global projection of power. Over the next decade, the absolute size of China’s economy will probably surpass America’s, but militarily, technologically, diplomatically, and culturally, China cannot compete with the Americans. No other country comes close.

But most Americans don’t want their government to project power as it has in past decades. A $3 trillion price tag for ill-conceived wars and occupations in Iraq and Afghanistan hasn’t helped. Revolutions in energy and food production ease both US dependence on imports and Washington’s need to partner with potentially unstable countries in unstable parts of the world. A hollowing out of the American middle class has helped persuade a growing contingent of Americans that their country doesn’t benefit from globalization. New tools of coercive diplomacy—cyber-surveillance and attack, drones, and the weaponization of finance—relieve US dependence on partnerships and alliances. US allies are losing leverage in their respective regions, and their governments are preoccupied on domestic challenges. America needs Europe less, most of Europe  feels the same about America, and the transatlantic relationship, the bedrock of the post-war order, is weaker than at any time in decades.

And so America faces an identity crisis. Americans—voters and leaders alike—know what they don’t want: they don’t want America to play global policeman; they don’t want to try to rebuild the Middle East; they don’t want to sacrifice troops and taxpayer dollars to make the world safe for democracy. But what do they want? What does America stand for? What’s all that superpower for? Americans don’t know. US allies and enemies don’t either. This has become the world’s biggest geopolitical question mark.

* * *

Enter the candidates. As the 2016 presidential election takes shape, foreign policy has re-entered the national conversation. The US economy is growing, sidelining a central political issue. Most Americans are tired of partisan hand-to-hand combat over healthcare. President Obama’s approval ratings are weakest on foreign policy. Hillary Clinton, the prohibitive favorite to win the Democratic nomination, is Obama’s former secretary of state. For both these reasons, republicans see Obama foreign policy as a promising political target. GOP candidates, from Jeb Bush to Marco Rubio and Chris Christie to Rand Paul—have lined up for a turn at bat.

But the lack of a coherent US foreign policy strategy didn’t begin with Barack Obama—though his second term struggles have made the problem more painfully obvious. From the fall of the Wall and Soviet collapse, US presidents of both parties have defined America’s mission in terms of tactics. US foreign policy has been reactive and improvisational for 25 years. And we can no longer identify a Democratic or Republican approach to foreign policy. There are now hawks, doves, and civil libertarians within both parties. Those hoping to understand their own policy preferences by falling back on party loyalty have some thinking to do.

In short, it’s high time to reconsider America’s role in the world. In “superpower,” I offer three dramatically different alternatives. And though I have a preference, which I argue for in the conclusion, I believe each is a conceivable option. What’s not workable is continuing to blunder forward reactively without a strategy. That’s the fourth option, and it’s by far the worst.

It’s foolish to think that the world’s only superpower has only one viable path forward. I’ve made as forceful a case as I can for each of the three choices to challenge the reader to decide, and I hope this book will help set the stage for a serious-minded, constructive debate among the candidates in 2016.

Here are the three choices. Each gets its own book chapter:

Indispensable America


This one will be the most familiar to readers. We live in a profoundly interconnected world. No, America shouldn’t play the global cop, but if America doesn’t lead, nobody else will either. International wildfires will burn out of control. More Middle East states will fail, and terrorism will metastasize. Russian revisionism will threaten Europe and beyond. China will use its growing economic influence to expand its political leverage, undermining structures and standards created by advanced industrial democracies to strengthen individual liberty and free market capitalism.

These values, which have benefitted both developed and developing nations, are increasingly under threat. The United States  must actively defend and promote those values. That means using every available tool of American power to bolster alliances with capable and like-minded partners. It means buttressing weakened international institutions. It means that in our interconnected world, America must develop and maintain a coherent and comprehensive global foreign policy strategy.

We can have no illusions that indispensable America will deliver quick and easy wins, that enemies will cower before American determination, or that longstanding allies will always follow America’s lead. Washington can’t topple every tyrant. But that’s all the more reason to take a stand. It’s not enough to undermine Syria’s Assad; America must help empower Syria’s citizens to build a stable and prosperous country. Answer Russian aggression and support Ukraine’s sovereignty to ensure that the Kremlin has no illusions that it can move onto NATO allies. Stand by traditional allies in the Middle East—Israel and the Gulf states—and don’t make any deal with Iran that depends on the honesty and good will of its leaders.

Engage China, but contain its expansionist ambitions, including in the South China Sea. And do everything possible to empower China’s people to build irresistible momentum for political chang e inside their country.

If Americans learned nothing else from 9/11, it’s that Washington can’t afford to ignore emerging threats in faraway places. The world has become an increasingly dangerous place. There is important work to be done, and no one, not even the sole superpower can do it alone. But a volatile world needs leadership. For all its faults, who but America can lead?
 
Moneyball America

I take the idea of Moneyball America from Michael Lewis’s groundbreaking book on Oakland A’s general manager Billy Beane, who revolutionized the way in which winning baseball franchises are built. Without sentiment, he swept away old rules and conventional wisdom to focus on relentlessly rational results-oriented management. The A’s didn’t have the money of those damn Yankees, but by spending scarce capital only where it offered the most promising return, they found they didn’t need it. A champion of Moneyball America is less interested in promoting America’s values than in enhancing America’s value.

Don’t waste money and lives to sell ideas that leaders in China, Russia, and the Middle East are easily able to ignore.

The pivot to Asia—a true pivot, where turning to Asia means turning away from something else—offers a prime example of shrewd moneyball thinking. Build commercial and security ties in the heart of the world’s most economically dynamic region. Spend no time or political capital on selling a peace plan that Israelis and Palestinians don’t want, and balance traditional ties with Gulf Arabs with a more pragmatic relationship with Iran, a country and market that offer America future opportunities that others in the region can’t match. Share technology and information with allies, but let them assume greater responsibility for their own security. Never fight a war to defend a principle.

Where terrorism directly threatens American lives, fight to win.

The world is becoming a more challenging and competitive place. All the more reason to invest our human and material capital wisely. With a clear head and a sharp pencil, moneyball offers a path forward that all Americans can profit from.

Independent America


American values matter only if Americans live up to them at home. Washington can’t bribe, bully, or blackmail China (or other authoritarian states) into an embrace of liberal free-market democracy. Americans don’t have that kind of power. US allies and enemies know this, and both are banking on a more multipolar world—and a more balanced global economy. Many Americans now accept that a stronger will, deeper insight, and deeper pockets will not help Washington reshape the world as it would like.

No nation, not even the sole superpower, can consistently get what it wants in a world where so many other governments can shrug off US pressure.

Those who advocate independent America recognize that all those global challenges are far more dangerous and damaging for other countries than they are at home. Terrorism is a much greater threat for the Middle East, Europe , and Russia than for the United States . The conflict in Ukraine has little bearing onUS security or prosperity. Instability in energy-producing countries is less relevant for increasingly energy-rich America than at any time since the 1960s.

China’s expansion matters far more for China’s neighbors than for the United States . In fact, a more volatile world highlights the strength, stability, and resilience of US markets.

America must lead, but mainly by example. Its tremendous resource, demographic, and technological advantages—and the advantage of its position between Mexico, Canada, and two vast oceans—will be enhanced by committed investment in the nation’s crumbling infrastructure: bridges, railways (clearly), highways, ports, and schools. Leading by example also means open borders, welcoming more of the world’s growing number of refugees, and more trade.

An America that declares its independence from the responsibility to solve other people’s problems must ask allies to do more in exchange for continued US investment in global public goods. NATO can survive only if other members bear more of its costs and risks. Let Europe  manage relations with Russia as it chooses. Cut a deal with Iran that reduces US involvement in the region’s conflicts. Recognize that decisions made in Beijing, not in Washington, will determine whether China sinks or swims. Most importantly, invest the savings to build a secure, dynamic, and prosperous America that others want to emulate.

2016


The 2016 presidential season offers a crucial opportunity to force this debate.

Candidates are beginning to test these issues. Far from the 2012 Obama-Romney foreign policy debate, which spent way too much time on the Benghazi scandal and not nearly enough on anything else, we can hope for a more serious exchange this time around. No more bromides about how America must lead without explaining why, how, and to where—with attention to the all-important details.

As secretary of state, Hillary Clinton seemed to embrace the moneyball approach. Think of the Asia pivot, “economic statecraft,” support for the transpacific partnership, an end to war in Iraq and Afghanistan, and a reset with Russia—all while avoiding intractable issues like the Israeli-Palestinian peace process. These choices demonstrated a willingness to prioritize low-risk, high-reward projects over those that came with high costs, high risks, or the near-certainty of wasted time and political capital. But as a presidential candidate, her rhetoric has veered toward the more familiar campaign terrain of indispensable America. She has downplayed the Russia reset and distanced herself from the Iran deal and President Obama’s non-intervention in Syria.

She’s also incorporated an element of populism that leads to foreign policy incoherence, by refusing to take sides on TPP [Trans-Pacific Partnership].

On the other side of the spectrum, Senator Rand Paul has been the most overt advocate for independent America. His adamant opposition to the use of drones and cyber-surveillance, and his consistent rejection of costly military engagement in most places sets him apart in a crowded Republican field. But, hedging his bets, even Paul has, in recent speeches, been drifting toward moneyball.

Jeb Bush has been opaque, and he’s never held a national office that would give him a foreign policy voting record. He’s hit a few moneyball notes, but his determination to defend his brother’s foreign policy—and the decision to engage many of his brother’s advisors—clouds the issue. Marco Rubio has been the most thoughtful and articulate advocate for indispensable America. Chris Christie is also working to align with that position. Scott Walker doesn’t yet have a foreign policy, he acknowledges his lack of experience on these issues and the need to do some homework. That’s surely the case for others as well.

America needs this debate. Without a coherent foreign policy strategy, the next botched response to a bolt-from-the-blue crisis—a next generation 9/11, a cyber fight with Russia, or an economic flareup with the Chinese—will prove much more costly, for Americans and for others. The terrorist attacks on 9/11 came when American foreign policy influence was at its height; the next geopolitical convulsion will come in a dramatically different context.

***

That’s the argument in a nutshell. Which choice comes closest to my own view?

I won’t tip my hand here, but I hope you’ll do some serious thinking about which one you would choose. After all, I wrote the book to challenge readers to reach their own conclusions. My goal is not to persuade you that my opinion is right but to provoke a debate that can benefit all of us—Americans and everyone else. I honestly didn’t know which option I would favor until I’d finished writing all three.

It’s a tough decision, and one that I think everyone should consider with an open mind.


Global Insight

May 17, 2015 5:52 pm

World’s central bankers braced for big divergence

Ferdinando Giugliano, Economics Correspondent

A U.S. flag flies on top of the Marriner S. Eccles Federal Reserve building at sunrise in Washington, D.C., U.S., on Tuesday, Oct. 28, 2014. The Federal Open Market Committee meets today and tomorrow after six weeks of volatility in global financial markets. Since the FOMC met in mid-September, oil prices have tumbled 14 percent, and the Standard & Poor's 500 Index of stocks dropped as much as 7.4 percent from a record close. Photographer: Andrew Harrer/Bloomberg©Bloomberg
The Federal Reserve


Since the global financial crisis, mankind has learnt to live with a third certainty along with death and taxes — monetary loosening.

Central banks have slashed interest rates to record lows and embarked upon unprecedented programmes of asset purchases in an attempt to raise inflation and restart economic growth.

The common path on which monetary policy makers have strolled, however, is expected to diverge this year. The timing of the partition and the way in which its side effects are managed hold big implications for financial stability and the global recovery.

After years of respectable growth and sizeable falls in unemployment, the US Federal Reserve and the Bank of England have ceased to expand their quantitative easing programmes and are eyeing a first rise in interest rates in nearly 10 years.

The European Central Bank, conversely, is in full loosening mode, having launched a €1.1tn scheme of asset purchases. In Asia, the Bank of Japan is busy with its own bond-buying programme, while the People’s Bank of China has just cut interest rates three times in six months.
 
The immediate danger facing the world economy lies in when exactly the US’s rate lift-off will take place. Growth has disappointed in the first quarter, with weak retail sales and industrial production figures last week showing that the US slowdown may be more than a seasonal dip.
 
Economists fear that the damage arising from a premature tightening by the Fed would go well beyond the US: a new recession in the world’s most important economy would hurt exporters across all continents, as well as hitting confidence and investment.

Even with a well-timed rate rise, however, the global economy is far from safe. José Viñals, the director of the International Monetary Fund’s monetary and capital markets department, warned last month that as higher rates in the US lure back investors from abroad, emerging markets face the risk of increased volatility and sudden stops of liquidity.
 
Some fear a so-called “super taper tantrum” could surpass the market turmoil unleashed by former Fed chairman Ben Bernanke in 2013 when he hinted at the tapering of the Fed’s QE programme. They are calling for greater co-ordination of monetary policy across the world.
 
But central bank watchers warn that this may not be legal. Monetary authorities, including the Fed and the ECB, have a domestic mandate, and so cannot make decisions on the basis of the spillovers they might cause abroad.

Collaborating to manage exchange rates — another possibility — would also be problematic. As Charles Engel, an economist at the University of Wisconsin-Madison, notes, there is no agreed model upon which to determine the relative value of currencies. Add to that the immense political pressure that policy makers would face upon entering such negotiations.

What most analysts agree is that policy makers — and the Fed, in particular — can be clearer about their future steps than was the case in 2013. Indeed, some central bankers in emerging markets appear more concerned about the risks of excessive dithering by the Fed over a rate increase than about the decision itself.

As they brace themselves for the big divergence, some economists are also urging countries to find ways to share the risks arising from financial spillovers. “There needs to be an international insurance mechanism for emerging markets,” said Eswar Prasad, professor of trade policy at Cornell University.

The IMF is one buffer. It offers assistance ranging from a full lending programme — rife with conditions on structural reforms and budgetary policy — to more flexible credit lines.

But while Christine Lagarde, managing director, can preside over a multibillion dollar loan facility, many economists believe this could be expanded. Changes agreed in 2010 would see a marginal strengthening of the IMF’s lending capacity, but they have been held up by the US Congress which has refused to ratify the capital increase.
 
As long as the US economy gathers enough steam, monetary divergence is inescapable. But policy makers have the means to ensure the transition to this new phase will be merely turbulent, rather than tempestuous.

Economic Beat

Cash Might Be Dethroned, but It Hasn’t Gone Away

Immense amounts of U.S. currency are sloshing around the globe, but no one can say precisely where.

By Gene Epstein

May 15, 2015 10:38 p.m. ET

 
Is cash still king? Based on data from the Federal Reserve Board, you might think so. The Fed routinely tracks M1, which covers cash plus checking deposits. In March, the cash component of M1 had a face value of $1.3 trillion, a record high (see chart).
                 
cat
About $1 trillion of that $1.3 trillion is in $100 bills. Another $300 million is in denominations of $500, $1,000, $5,000 and even a gasp-provoking $10,000. (These bills haven’t been produced in decades, but remain in circulation.) The rest, nearly $300 billion—also a record high—is in denominations of less than $100, with workhorse $20 bills accounting for most of that value.

Where is all this currency? The Fed can only tell you with certainty where it is not. It’s “outside” the U.S. Treasury or any of the Federal Reserve Banks, and outside the vaults of commercial banks and all other depository institutions. It must therefore be currency in circulation.

At $1.3 trillion, currency in circulation has grown faster than nominal gross domestic product, and noticeably faster than the U.S. population. Divide that $1.3 trillion by all U.S. households, and you get a record high of $11,000 per household, up from $7,000 per household as recently as 2008.

But, of course, such a ludicrously large stash of cash can only be held by a fringe group, especially since debit cards, credit cards, and electronic transfers have almost obliterated our need for currency.

As a Barron’s cover story has pointed out (“The End of Cash?” Dec. 31, 2012), the dethronement of the greenback has been nearly total, at least in the above-ground economy tracked by the tax collector.

SO WHERE’S ALL THE CASH? That mystery will not be unraveled here, for the simple reason that no one seems to know for sure. But the main patterns seem fairly clear.

To begin with, while illegal transactions with virtual currencies like Bitcoin have prompted concern, the gangster’s true friend surely remains Uncle Sam, ever willing to print C-notes by the bale to facilitate untraceable payoffs. A million dollars’ worth of $100 bills can fit into a mere briefcase. Ironically, the Treasury’s ongoing efforts to print C-notes whose design characteristics stay one step ahead of the counterfeiters is one way the drug lords can be confident that their money will be purer than the heroin they buy and sell with it. We don’t know what share of U.S. currency is used by criminals, both foreign and domestic, but it cannot be insignificant.

Then there is the immense amount held abroad. “Dollarized” economies, in which the dominant medium of exchange is the greenback, include Panama, El Salvador, East Timor, and the British Virgin Islands, along with others that actively use the dollar, including Iraq, Lebanon, Bermuda, and Zimbabwe.

According to a November 2012 Fed study on currency at home and abroad, foreign demand for U.S. money generally tends to rise with an increase in financial turmoil. Immediately following the fall of the Berlin Wall in 1989, the resulting financial turmoil prompted a foreign flight into U.S. currency, which abated by the early-2000s. But demand for greenbacks has heated up again in the wake of the 2008-09 financial crisis.

As the Fed study makes clear, however, the amount of cash that actually leaves the country, by plane or by boat, is impossible to track.

FINALLY, A LOT PROBABLY NEVER LEAVES the country, but is used in the “informal” sector of the domestic economy—non-criminal, except for evading the tax collector. An August 2011 Urban Institute study estimated this sector at 5% to 10% of gross domestic product. There are at least two reasons to believe the informal sector has grown disproportionately over the past decade: the surge in recipients under 60 of Social Security disability benefits, for whom benefits would be threatened if they reported earnings from work; and the surge in recipients of conventional Social Security checks, whose income would be taxed if they reported earnings.

As noted, however, most of the above consists of semi-educated guesses. The best guess is that, far from going away, cash will probably be with us for quite a while longer.


Why Most Gold Bugs Are Dead Wrong

By Jim Rickards, editor, Jim Rickards’ Strategic Intelligence

May 16, 2015




One of the most persistent story lines among gold bugs and market participants who foresee the collapse of the dollar goes something like this:

China and many emerging markets including the other BRICS are looking for a way out of the global fiat currency system.

That system is dominated today by the U.S. dollar. This dollar dominance allows the U.S. to force certain kinds of behavior in foreign policy and energy markets.

Countries that don’t comply with U.S. wishes find themselves frozen out of global payment systems and find their banks unable to transact in dollars for needed imports or to get paid for their exports. Russia, Iran, and Syria have all been subjected to this treatment recently.

China does not like this system any more than Russia or Iran but is unwilling to confront the U.S. head-on.

Instead, China is quietly accumulating massive amounts of gold and building alternative financial institutions such as the Asia Infrastructure Investment Bank, AIIB, and the BRICS-sponsored New Development Bank, NDB.

When the time is right, China will suddenly announce its actual gold holdings to the world and simultaneously turn its back on the Bretton Woods institutions such as the IMF and World Bank.

China will back its currency with its own gold and use the AIIB and NDB and other institutions to lead a new global financial order.

Russia and others will be invited to join the Chinese in this new international monetary system.

As a result, the dollar will collapse, the price of gold will skyrocket, and China will be the new global financial hegemon. The gold bugs will live happily ever after.

The only problem with this story is that the most important parts of it are wrong. As usual, the truth is much more intriguing than the popular version.

Here’s what’s really going on.

As with most myths, parts of the story are true. China is secretly acquiring thousands of tons of gold. China is creating new multilateral lending institutions. No doubt, China will announce an upward revision in its official gold holdings sometime in the next year or so.

In fact, Bloomberg News reported on April 20, 2015, under the headline “The Mystery of China’s Gold Stash May Soon Be Solved,” that “China may be preparing to update its disclosed holdings…”

But the reasons for the acquisition of gold and the updated disclosures, if they happen, are not the ones the blogosphere believes. China is not trying to destroy the old boys’ club — they are trying to join it.

China understands that despite the strong growth and huge size of its economy, the yuan is not ready to be a true reserve currency and will not be ready for years to come.

It is true that usage of the yuan is increasing in international transactions. But it is still used for less than 2% of global payments, compared with over 40% for the U.S. dollar.

Usage in payments is only one indicium of a true reserve currency, and not the most important one. The key to being a reserve currency is not payments but investments. There needs to be a deep, liquid bond market denominated in the reserve currency. That way, when countries earn the target currency in trade, they have someplace to invest their surplus.

Right now, if you earn yuan trading with China, all you can do with the money is leave it in a bank deposit or spend it in China. There is no large yuan-denominated bond market to invest in.

In addition to a bond market, you need the “plumbing” of a bond market. This includes a network of primary dealers; hedging tools such as futures and options; financing tools such as repurchase agreements, derivatives, clearance, and settlement channels; and a good rule of law to settle disputes, secure creditors, and deal with bankruptcies.

China has none of these things on the needed scale or level of maturity. When it comes to true reserve currency status, the yuan is not ready for prime time.

China is also not ready to launch a gold-backed currency. Even if it has 10,000 tons of gold – far more than it currently admits, the market value of that gold is only about $385 billion. China’s M1 money supply as of April 2015 is about $5.4 trillion. In other words, even on assumptions highly favorable to China, their gold is worth only about 7% of their money supply.

Historically, countries that want to run a successful gold standard need 20–40% of the money supply in gold in order to stand up to bank runs in the market. China could reduce its money supply to get to the 20% level, but this would be extremely deflationary and throw the Chinese economy into a depression that would trigger political instability. So that won’t happen.

In short, China can’t have a reserve currency because it does not have a bond market, and it can’t have a gold-backed currency because it has nowhere near enough gold.

So what is China’s plan?

China wants to do what the U.S. has done, which is to remain on a paper currency standard but make that currency important enough in world finance and trade to give China leverage over the behavior of other countries.

The best way to do that is to increase its voting power at the IMF and have the yuan included in the IMF basket for determining the value of the special drawing right. Getting those two things requires the approval of the United States because the U.S. has veto power over important changes at the IMF. The U.S. can stand in the way of Chinese ambitions.






The result is a kind of grand bargain in which China will get the IMF status it wants, but the U.S. will force China to be on its best behavior in return. This means that China must keep the yuan pegged to the dollar at or near the current level. It also means that China can have gold but can’t talk about it. In order to “join the club,” China must play by club rules.

The rules of the game say you need a lot of gold to play, but you don’t recognize the gold or discuss it publicly. Above all, you do not treat gold as money, even though gold has always been money.

The members of the club keep their gold handy just in case, but otherwise, they publicly disparage it and pretend it has no role in the international monetary system. China will be expected to do the same. It’s important to note that China will not act in the best interests of gold investors; it will act in the best interests of China.

Moreover, just because the grand bargain is in sight does not mean it will be easy to realize. Both sides are jockeying for leverage.

Beijing launched its own development bank to put pressure on the IMF. The U.S. Treasury blames the tea party for delays in approving China’s new votes at the IMF. Meanwhile, the White House does nothing to break the logjam in Congress. The White House is happy to let China twist in the wind while the game goes on behind closed doors.

Meanwhile, China will probably announce its increased gold holdings later this year. But don’t expect fireworks. China has three accounts where it keeps gold – the People’s Bank of China, PBOC; the State Administration of Foreign Exchange, SAFE; and the China Investment Corp., CIC.

China can move enough gold to PBOC when it is ready and report that to the IMF for purposes of allowing the yuan in the SDR. Meanwhile, it can still hide gold in SAFE and CIC until it needs it in the future.

China will also probably be admitted into the SDR basket later this year. Far from launching its own gold-backed currency, China will be acknowledging that the SDR is the true world money as far as the major powers are concerned.

Why would China want to give up on fiat money any more than the Fed or the European Central Bank? All central banks prefer paper money to gold because they can print the paper kind. Why give up on that monopoly of power?

Gold is still the safest asset, and every investor should have some in his portfolio. The price of gold will go significantly higher in the years ahead. But contrary to what you read in the blogs, gold won’t go higher because China is confronting the U.S. or launching a gold-backed currency.

It will go higher when all central banks, China’s and the U.S.’s included, confront the next global liquidity crisis, worse than the one in 2008, and individual citizens stampede into gold to preserve wealth in a world that has lost confidence in all central banks.

When that happens, physical gold may not be available at all. The time to build your personal gold reserve is now.

Inspiring Economic Growth

Robert J. Shiller

MAY 18, 2015 .reading paper

NEW HAVEN – In his First Inaugural Address, during the depths of the Great Depression, US President Franklin Delano Roosevelt famously told Americans that, “The only thing we have to fear is fear itself.” Invoking the Book of Exodus, he went on to say that, “We are stricken by no plague of locusts.” Nothing tangible was causing the depression; the problem, in March 1933, was in people’s minds.
 
The same could be said today, seven years after the 2008 global financial crisis, about the world economy’s many remaining weak spots. Fear causes individuals to restrain their spending and firms to withhold investments; as a result, the economy weakens, confirming their fear and leading them to restrain spending further. The downturn deepens, and a vicious circle of despair takes hold. Though the 2008 financial crisis has passed, we remain stuck in the emotional cycle that it set in motion.
 
It is a bit like stage fright. Dwelling on performance anxiety may cause hesitation or a loss of inspiration. As fear turns into fact, the anxiety worsens – and so does the performance. Once such a cycle starts, it can be very difficult to stop.
 
According to Google Ngrams, it was during the Great Depression – around the late 1930s – that the term “feedback loop” began to appear frequently in books, often in relation to electronics.
 
If a microphone is placed in front of a loudspeaker, eventually some disturbance will cause the system to produce a painful wail as sound loops from the loudspeaker to the microphone and back, over and over. Then, in 1948, the great sociologist Robert K. Merton popularized the phrase “self-fulfilling prophecy” in an essay with that title. Merton’s prime example was the Great Depression.
 
But the memory of the Great Depression is fading today, and many people probably do not imagine that such a thing could be happening now. Surely, they think, economic weakness must be due to something more tangible than a feedback loop. But it is not, and the most direct evidence of this is that, despite rock-bottom interest rates, investment is not booming.
 
In fact, real (inflation-adjusted) interest rates are hovering around zero throughout much of the world, and have been for more than five years. This is especially true for government borrowing, but corporate interest rates, too, are at record lows.
 
In such circumstances, governments considering a proposal to build, say, a new highway, should regard this as an ideal time. If the highway will cost $1 billion, last indefinitely with regular maintenance and repairs, and yield projected annual net benefits to society of $20 million, a long-term real interest rate of 3% would make it nonviable: the interest cost would exceed the benefit. But if the long-term real interest rate is 1%, the government should borrow the money and build it. That is just sound investing.
 
In fact, the 30-year inflation-indexed US government bond yield as of May 4 was only 0.86%, compared with more than 4% in the year 2000. Such rates are similarly low today in many countries.
 
Our need for better highways cannot have declined; on the contrary, given population growth, the need for investment can only have become more pronounced. So why are we not well into a highway-construction boom?
 
People’s weak appetite for economic risk may not be the result of pure fear, at least not in the sense of an anxiety like stage fright. It may stem from a perception that others are afraid, or that something is inexplicably wrong with the business environment, or a lack of inspiration (which can help overcome background fears).
 
It is worth noting that the US experienced its fastest economic growth since 1929 in the 1950s and 1960s, a time of high government expenditure on the Interstate Highway System, which was launched in 1956. As the system was completed, one could cross the country and reach its commercial hubs on high-speed expressways at 75 miles (120 kilometers) an hour.
 
Maybe the national highway system was more inspirational than the kinds of things that Roosevelt tried to stimulate the US out of the Great Depression. With his Civilian Conservation Corps, for example, young men were enlisted to clean up the wilderness and plant trees. That sounded like a pleasant experience – maybe a learning experience – for young men who would otherwise be idle and unemployed. But it was not a great inspiration for the future, which may help to explain why Roosevelt’s New Deal was unable to end America’s economic malaise.
 
By contrast, the apparent relative strength of the US economy today may reflect some highly visible recent inspirations. The fracking revolution, widely viewed as originating in the US, has helped to lower energy prices and has eliminated America’s dependency on foreign oil.

Likewise, much of the rapid advance in communications in recent years reflects innovations – smartphone and tablet hardware and software, for example – that has been indigenous to the US.
 
Higher government spending could stimulate the economy further, assuming that it generates a level of inspiration like that of the Interstate Highway System. It is not true that governments are inherently unable to stimulate people’s imagination. What is called for is not little patches here and there, but something big and revolutionary.
 
Government-funded space-exploration programs around the world have been profound inspirations. Of course, it was scientists, not government bureaucrat, who led the charge. But such programs, whether publicly funded or not, have been psychologically transforming. People see in them a vision for a greater future. And with inspiration comes a decline in fear, which now, as in Roosevelt’s time, is the main obstacle to economic progress.
 
 


Markets Insight

May 18, 2015 5:25 am

Reforms needed to combat threat of Asian deflation

Frederic Neumann

Trend is not temporary and should not be ignored High quality global journalism requires investment.

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It is easy to shrug off tumbling inflation across Asia as merely representing the collapse in oil prices.
 
But that is to ignore deeper and more pernicious reasons. Growth across the region continues to slow and traditional measures to stave off a slide into outright deflation appear to be losing their punch.

Yet two misconceptions hold sway. The first is that tumbling inflation readings are a temporary phenomenon. Steadying, or even slightly rising, crude prices, the reasoning goes, will push up inflation gauges by the second half of the year.
 
In fact, the two are allegedly connected: the fall in the cost of oil over the past nine months represents a windfall for Asia, which imports most of its energy. So headline inflation may fall for a while, but this should eventually be offset by a boost to growth and a consequent pick-up in broader price pressures.
 
The trouble is there are no signs that growth is benefiting from lower oil prices. By now, demand should have started to strengthen. Instead, the first quarter probably represented a new low in the region’s growth since the global financial crisis.

The real question should be: how much weaker would growth have been if oil prices had remained unchanged? The answer: a lot lower, possibly by up to half a percentage point in Korea, India and Thailand, where spending tends to respond more to changes in energy costs than elsewhere.

This hints at broader, structural factors weighing on Asia’s growth. After all, not only has headline inflation slowed sharply but core price pressures, which strip out energy costs, have declined as well.
 
Central banks have cut interest rates and injected extra liquidity into financial markets. Yet investment has failed to bounce back and consumers continue to curtail their purchases. Equity markets have rallied, but that in itself will not cure Asia’s growth malaise.

The second misconception is that the latest tilt towards deflation does not matter. The Bank for International Settlements in a recent paper noted that deflation is rarely associated with economic weakness. Since the second world war, the authors find, falling prices have often occurred during periods of robust growth. This has reinforced the impression among many that the region’s bout of declining price pressures can be safely ignored.

Far from it. As the BIS authors concede, if deflation coincides with a bursting asset bubble the effects on financial stability and economic growth can be highly destructive. And it is on this score that Asia looks a lot more vulnerable: not only has debt increased sharply in recent years, exposing borrowers that are counting on rising revenues and incomes to service their obligations, but property prices have had a spectacular run, often underpinned by speculative borrowing. Prolonged deflation, therefore, is bound to exert a drag on growth and, if asset prices take a tumble, could lead to escalating financial challenges.

In depth

Emerging markets in retreat
Currency wars
Emerging markets are taking a battering as investors withdraw at the prospect of higher global interest rates 

 
At the heart of the debate is the distinction between “positive” and “negative” deflation. The former is associated with leaps in productivity that preserve profit margins of companies even as prices decline. The latter is reflective of a drop in demand, thus harming company profits. In Asia, it is difficult to argue that a positive deflation shock is under way. True, falling commodity prices are good for profits, but these in large part reflect slowing demand.

Productivity growth, meanwhile, has slowed in recent years.
 
What, then, is to be done? It is tempting to think that further monetary easing will do the trick.

Alas, this has lost its punch amid already high levels of debt. Other measures need to be taken.

In the short term, extra fiscal easing would help. In addition, financial reforms are needed that allocate capital to more efficient uses.

In China, the crackdown on shadow banking has reduced risks but also left smaller companies, the engine of job creation, with little recourse to borrowing. In India, overburdened banks have been reluctant to pass on rate cuts to their customers.

Regulatory changes may be needed to allow financial institutions to at least temporarily shoulder more risk. That also means, however, that opportunities for private companies will need to be expanded, primarily by pruning the privileges of state-owned enterprises and opening more sectors to foreign investors.

A tall order indeed. But without such reforms, Asia risks sliding deeper into deflation and the dire consequences this entails.


Frederic Neumann is co-head of Asia economics research


IMF Estimates Trillions in Hidden Fossil-Fuel Costs

Use of coal in China and India surpasses savings as governments slash traditional energy subsidies

By Ian Talley

Updated May 18, 2015 10:20 a.m. ET

A power plant in Changchun, northeast China's Jilin province. The IMF released a report on Monday about the hidden health and environmental costs of fossil fuel use. Photo: Agence France-Presse/Getty Images


WASHINGTON—Consumers should be paying a whopping $5 trillion more a year for energy to cover the hidden health and environmental costs of using fossil fuels, the International Monetary Fund said Monday.

Vitor Gaspar, head of the IMF’s fiscal affairs department, which produced the report, called the estimates shocking and “one of the largest negative externalities ever estimated,” referring to costs that aren’t factored into prices.

The fund said policy makers must start capturing those costs—valued at roughly 6% of global gross domestic product—in fuel prices now to curb the damaging effects, encourage greater energy efficiency and prevent a mounting toll on human health.

The report said the costs—largely fueled by the ballooning use of coal in China and India—far surpassed the savings gleaned in the past year as governments cut traditional energy subsidies.

Falling oil prices have given governments including India and Angola an opportunity to raise energy prices closer to their market values.

Cutting subsidies relieves a burden on state budgets and allows a government to channel revenue elsewhere, such as social services, health care or growth-spurring investments.

But the IMF said the uncounted costs of pollution from coal, oil and natural gas also should be considered subsidies because economies are burdened with mounting costs resulting from their use.

Based in part on new World Health Organization data, the fund estimates those “post-tax subsidies” will hit $5.3 trillion this year alone.

Around a quarter of that covers the theoretical cost of mitigating greenhouse-gas emissions.

The rest is from the health effects of local pollution as well as from traffic congestion, accidents and road damage.

“It is important to put in perspective just how many health problems are linked to energy consumption and air quality,” said Benedict Clements, a division chief in the IMF’s fiscal affairs department.

For example, the WHO estimates more than one million premature deaths a year occur because of outdoor air pollution caused largely by burning coal, he said.

IMF economists acknowledge the figures are disputable, but say they provide some indication of hidden costs that should provoke debate.

They also accept that eliminating subsides by raising energy taxes would be costly for consumers, and so it recommends a gradual increase.

“Moving to efficient energy pricing in one step would require very large increases in consumer energy prices, in particular for coal, with a global average price increase of more than 200 percent,” the IMF warned.


New Military Spending Bill Expands Empire But Forbids Debate on War

By: Ron Paul

Sunday, May 17, 2015


On Friday the House passed a massive National Defense Authorization for 2016 that will guarantee US involvement in more wars and overseas interventions for years to come. The Republican majority resorted to trickery to evade the meager spending limitations imposed by the 2011 budget control act - limitations that did not, as often reported, cut military spending but only slowed its growth.


But not even slower growth is enough when you have an empire to maintain worldwide, so the House majority slipped into the military spending bill an extra $89 billion for an emergency war fund. Such "emergency" spending is not addressed in the growth caps placed on the military under the 2011 budget control act. It is a loophole filled by Congress with Fed-printed money.

Ironically, a good deal of this "emergency" money will go to President Obama's war on ISIS even though neither the House nor the Senate has debated - let alone authorized - that war!

Although House leadership allowed 135 amendments to the defense bill - with many on minor issues like regulations on fire hoses - an effort by a small group of Representatives to introduce an amendment to debate the current US war in Iraq and Syria was rejected.

While squashing debate on ongoing but unauthorized wars, the bill also pushed the administration toward new conflicts. Despite the president's unwise decision to send hundreds of US military trainers to Ukraine, a move that threatens the current shaky ceasefire, Congress wants even more US involvement in Ukraine's internal affairs. The military spending bill included $300 million to directly arm the Ukrainian government even as Ukrainian leaders threaten to again attack the breakaway regions in the east. Does Congress really think US-supplied weapons killing ethnic Russians in eastern Ukraine is a good idea?

The defense authorization bill also seeks to send yet more weapons into Iraq. This time the House wants to send weapons directly to the Kurds in northern Iraq without the approval of the Iraqi government. Although these weapons are supposed to be used to fight ISIS, we know from too many prior examples that they often find their way into the hands of the very people we are fighting. Also, arming an ethnic group seeking to break away from Baghdad and form a new state is an unwise infringement of the sovereignty of Iraq. It is one thing to endorse the idea of secession as a way to reduce the possibility of violence, but it is quite something else to arm one side and implicitly back its demands.

While the neocons keep pushing the lie that the military budget is shrinking under the Obama Administration, the opposite is true. As the CATO Institute pointed out recently, President George W. Bush's average defense budget was $601 billion, while during the Obama administration the average has been $687 billion. This bill is just another example of this unhealthy trend.

Next year's military spending plan keeps the US on track toward destruction of its economy at home while provoking new resentment over US interventionism overseas. It is a recipe for disaster. Let's hope for either a presidential veto, or that on final passage Congress rejects this bad bill.