The Global Consequences of a Sino-American Cold War

What started as a trade war between the United States and China is quickly escalating into a death match for global economic, technological, and military dominance. If the two countries' leaders cannot manage the defining relationship of the twenty-first century responsibly, the entire world will bear the costs of their failure.

Nouriel Roubini

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NEW YORK – A few years ago, as part of a Western delegation to China, I met President Xi Jinping in Beijing’s Great Hall of the People. When addressing us, Xi argued that China’s rise would be peaceful, and that other countries – namely, the United States – need not worry about the “Thucydides Trap,” so named for the Greek historian who chronicled how Sparta’s fear of a rising Athens made war between the two inevitable. In his 2017 book Destined for War: Can America and China Escape Thucydides’s Trap?, Harvard University’s Graham Allison examines 16 earlier rivalries between an emerging and an established power, and finds that 12 of them led to war. No doubt, Xi wanted us to focus on the remaining four.

Despite the mutual awareness of the Thucydides Trap – and the recognition that history is not deterministic – China and the US seem to be falling into it anyway. Though a hot war between the world’s two major powers still seems far-fetched, a cold war is becoming more likely.

The US blames China for the current tensions. Since joining the World Trade Organization in 2001, China has reaped the benefits of the global trading and investment system, while failing to meet its obligations and free riding on its rules. According to the US, China has gained an unfair advantage through intellectual-property theft, forced technology transfers, subsidies for domestic firms, and other instruments of state capitalism. At the same time, its government is becoming increasingly authoritarian, transforming China into an Orwellian surveillance state.

For their part, the Chinese suspect that the US’s real goal is to prevent them from rising any further or projecting legitimate power and influence abroad. In their view, it is only reasonable that the world’s second-largest economy (by GDP) would seek to expand its presence on the world stage. And leaders would argue that their regime has improved the material welfare of 1.4 billion Chinese far more than the West’s gridlocked political systems ever could.

Regardless of which side has the stronger argument, the escalation of economic, trade, technological, and geopolitical tensions may have been inevitable. What started as a trade war now threatens to escalate into a permanent state of mutual animosity. This is reflected in the Trump administration’s National Security Strategy, which deems China a strategic “competitor” that should be contained on all fronts.

Accordingly, the US is sharply restricting Chinese foreign direct investment in sensitive sectors, and pursuing other actions to ensure Western dominance in strategic industries such as artificial intelligence and 5G. It is pressuring partners and allies not to participate in the Belt and Road Initiative, China’s massive program to build infrastructure projects across the Eurasian landmass. And it is increasing US Navy patrols in the East and South China Seas, where China has grown more aggressive in asserting its dubious territorial claims.

The global consequences of a Sino-American cold war would be even more severe than those of the Cold War between the US and the Soviet Union. Whereas the Soviet Union was a declining power with a failing economic model, China will soon become the world’s largest economy, and will continue to grow from there. Moreover, the US and the Soviet Union traded very little with each other, whereas China is fully integrated in the global trading and investment system, and deeply intertwined with the US, in particular.

A full-scale cold war thus could trigger a new stage of de-globalization, or at least a division of the global economy into two incompatible economic blocs. In either scenario, trade in goods, services, capital, labor, technology, and data would be severely restricted, and the digital realm would become a “splinternet,” wherein Western and Chinese nodes would not connect to one another. Now that the US has imposed sanctions on ZTE and Huawei, China will be scrambling to ensure that its tech giants can source essential inputs domestically, or at least from friendly trade partners that are not dependent on the US.

In this balkanized world, China and the US will both expect all other countries to pick a side, while most governments will try to thread the needle of maintaining good economic ties with both. After all, many US allies now do more business (in terms of trade and investment) with China than they do with America. Yet in a future economy where China and the US separately control access to crucial technologies such as AI and 5G, the middle ground will most likely become uninhabitable. Everyone will have to choose, and the world may well enter a long process of de-globalization.

Whatever happens, the Sino-American relationship will be the key geopolitical issue of this century. Some degree of rivalry is inevitable. But, ideally, both sides would manage it constructively, allowing for cooperation on some issues and healthy competition on others. In effect, China and the US would create a new international order, based on the recognition that the (inevitably) rising new power should be granted a role in shaping global rules and institutions.

If the relationship is mismanaged – with the US trying to derail China’s development and contain its rise, and China aggressively projecting its power in Asia and around the world – a full-scale cold war will ensue, and a hot one (or a series of proxy wars) cannot be ruled out. In the twenty-first century, the Thucydides Trap would swallow not just the US and China, but the entire world.

Nouriel Roubini, a professor at NYU’s Stern School of Business and CEO of Roubini Macro Associates, was Senior Economist for International Affairs in the White House's Council of Economic Advisers during the Clinton Administration. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.

Takeaways from the SIC

By John Mauldin


There are these two young fish swimming along, and they happen to meet an older fish swimming the other way, who nods at them and says, “Morning, boys, how’s the water?” And the two young fish swim on for a bit, and then eventually one of them looks over at the other and goes, “What the hell is water?”

—David Foster Wallace, This Is Water
Turning and turning in the widening gyre
The falcon cannot hear the falconer;

Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.

—William Butler Yeats, The Second Coming
I told the above fish story as we opened the Strategic Investment Conference this week. Most investors and fellow citizens have no idea what water we are swimming in. They swim in a pool of agreed-upon, commonly understood narratives. And that’s all well and good until the water changes.

It is very important to know your water and what to do when it changes.

Currently, the narrative says that central banks and governments “have our backs” and will do “whatever it takes” to make everything, including the water, go on as usual. Call it kicking the can down the road or whatever metaphor you like, but most investors extrapolate the recent past into the far future.
And that’s usually the right move. The cautious optimist usually wins, which in our current social and political circumstances means that the one most important thing to know is:
What could change the narrative?
That was the SIC theme this year. I chose almost every speaker specifically for their ability to help us “think the unthinkable.”

I think most thinking investors, whether professional or managing their own portfolios, sense a shift in the zeitgeist, what Ben Hunt calls the “widening gyre,” referring to the Yeats poem. As an artist and a poet, Yeats presaged the 1920s and 1930s trauma that led to World War II.

We understand that things are changing, but the question we should ask ourselves is, “Change to what?” We know that whatever happens won’t be rainbows and unicorns. Yet if you are truly aware of what’s going on in the world, you have to be optimistic about humanity, about the potential explosion of creativity in the midst of turmoil.

Opportunity and crisis both beckon, and I believe both will happen at the same time. This will require a particularly delicate balance in both our lives and our portfolios.

The conference itself?

First, recognize that I am writing stream-of-consciousness late on Thursday night at the end of the conference. I am emotionally overwhelmed, intellectually sated, and trying to assimilate probably the most stimulating and overpowering of 16 annual events. Dear gods, I love it when a plan comes together.
There were speakers that discussed the next 6–12 months and others who looked out over the horizon. Both were equally important. David Rosenberg was his usual brilliant self, with scores of slides making his case for recession and bear market. He has been my opening speaker for 10 years and I joked that I am going to keep inviting him back until he gets it right.

His slide decks are simply brilliant.
Rosie focused on the Fed overshooting the neutral rate, actually tightening as we go into recession with a combination of balance sheet reduction and interest rate increases (something I’ve also been ranting about). His deck was worth the price of admission.

I’ll give you one more chart with staggering implications on a topic other speakers also mentioned. Corporations are using record profits to increasingly borrow cheap debt and buy back their own shares. This increases the P/E ratio and creates the appearance of strength and growth even when neither is actually happening. It is, as Dr. Woody Brock told us later, a bastardized form (his words) of capitalism that Adam Smith would not recognize.
If Rosie was a shotgun, Mark Yusko was a high-velocity machine gun with 100+ slides in his deck. It reminded me of The Joker who, on seeing one of Batman’s miraculous escapes, asked the world, “Where does he get all those cool toys?” Where does Mark get all those cool charts?

More than one speaker pointed out how the US dollar could go higher, but not necessarily for good reasons and not for ones that we would like—at least those of us in the US. But it comes with the territory when yours is the world’s reserve currency. Again, a common theme was that the dollar’s reserve status is by default, as there is no other realistic option. It’s the cleanest dirty shirt in the laundry.
Carmen Reinhart was a revelation. Arguably the world’s leading expert on government debt, she co-authored (with Ken Rogoff) the definitive book on government debt and debt crises, This Time Is Different. Now, with a different set of collaborators and what must be a battalion of grad students, she is studying every government debt issue since the Battle of Waterloo. It turns out there are similar characteristics between emerging market government debt, with all its write-downs and defaults, and high-yield corporate debt. There are ways to make a significant premium over the risk-free rate.

In the Q&A, I mischievously asked her, “How has the fact that you arrived in the United States in 1966 at 10 years old with your mother and father and three suitcases from Cuba affected your outlook and analysis?” Her answer (paraphrasing)…
“I talk with my students and colleagues about crises. But there are various degrees of crises. There are times when the crises are cataclysmic. And we need to understand the difference. At 10 years old I watched them take truckloads of men to be executed by firing squad. That was a cataclysmic crisis.”
The audience reacted viscerally to Carmen’s thoughts. The only question I had for myself was, “Why did it take 16 years for me to get her to my conference?”

Lacy Hunt gave his best presentation ever. That was not just my analysis but that of many long-term conference attendees. He presented two theorems. First, federal debt acceleration leads to lower, not higher interest rates. This is because the economic stimulus effectiveness ends quickly, but the debt overhang causes weaker business conditions that reduce loan demand.

Similarly, monetary easing eventually leads to lower, not higher interest rates. Debt productivity falls, making the velocity of money decline so monetary policy becomes asymmetric and inefficient.

These are not intuitive to most people, so Lacy walked through algebraic proof of both theorems. He also showed empirical evidence, comparing government debt to interest rates in the US, UK, eurozone and Japan since 2007. All the graphs looked almost identical.

These theorems are ominous if true, because they show it is almost impossible for higher savings to both absorb the debt load and sustain consumer spending and business investment. The only solution is prolonged austerity. But the slightly good news is that in this scenario the US will likely stay the world's strongest economy, simply because it has the best combination of debt productivity and demographics. Somewhat analogous to the cleanest dirty shirt in the laundry.

I was actually blown away that Bill White, the former chief economist for the Bank of International Settlements, had never met Lacy. They were both fans of each other. When Lacy finished, I had Bill come on the stage and they engaged in a vigorous conversation about Lacy’s analysis. It was one of the intellectual highlights of not only that conference but my life. I can only say 47 wows.

Bill gave his own presentation on Thursday, along with Carmen Reinhart and the inimitable Howard Marks of Oaktree Capital. The final panel really was the fitting ending to a soaring conference.

I could go on and on about the other speakers. The panels on China and Europe were simply amazing. Housing? Emerging markets? Lots of China? Louis Gave was his usual brilliant self. George Friedman forced us to step back and look at the bigger picture. Real estate? People were begging for more after that session.

I moderated a conversation between Neil Howe and George Friedman on the political outlook for 2020 and beyond. I know both of their underlying cyclical arguments so I expected some fireworks. I didn’t realize they would both describe (for different reasons) the same kind of social tension in our near future. On realizing this, I just sat there stunned for a second. I literally was speechless, and I guess it showed on my face as the audience laughed.

I genuinely try not to be surprised on stage, as I do a lot of prep work with each speaker. They still left me reeling. I can guarantee you that I’m going to review Neil Howe’s slide deck and George’s speech more than a few times trying to assimilate it into my outlook.

I don’t want you to think the conference was more bearish than it was. There were actually numerous positive investment themes and opportunities. Attendee reaction was the most positive any of us from Mauldin Economics can remember. Every year, long-time attendees (and more than a few have been there 10+ times) say that it is the best conference ever. But 2019 seems to have set a new high bar.

I can guarantee you that you will see the impact of this SIC in my writing. I also know I will read every transcript at least once and probably several times. Some of the presentations were so insightful that you need a few passes to be able to really absorb the information.

At the end of one panel, which did not mention cryptocurrencies, the implications of what they said hit me so hard that I quipped, “Almost thou persuadest me to buy bitcoin.” That was just one of a dozen portfolio-changing takeaways that I gleaned.

I will confess, as I write this late Thursday night, I’m a little tired after a week of intense presentations and meetings. I plan to sleep late for the next few mornings before Shane and I return to Puerto Rico on Saturday. I’m particularly pleased that more than 60% of the attendees at this conference were repeat. They are now old friends and all say it’s the best conference they attend every year. Many, many people told me they’ll be back next year. Talk about high bars…

I know, I am raving. But it was just that damn good. I’ve been to three hog callings and two county fairs, and no event in my life has ever touched this one. Nothing but A-list speakers. Nobody pays to get on my stage. My speaker budget would choke a horse. Or at least it chokes me. But you can’t argue with the results.

Now, I know you wish you could’ve been there. I wish you had been there too. Your personal presence would have made it even better. But the next best thing is a Virtual Pass. Every attendee this year got a free Virtual Pass as part of their admission price. Most of them have told me they’re going to be going back and listening to their favorite speakers. Click here to order your Virtual Pass.

My friend Simon Hunt, one of my go-to China insiders, said that it was the single-best conference he has ever attended in his life. And both of us have lived a long time, and done hundreds of conferences.

I have to admit that I take a deep personal satisfaction that many SIC speakers don’t just fly in and fly out. They stay for the experience, both to meet other speakers and meet our attendees who are without a doubt some of the world’s most interesting people. And the speakers who couldn’t stay very long all wanted a Virtual Pass as part of their fee.

Personal confession: I really don’t watch speeches on the internet very often. I read faster than people can talk. Which is why I insisted that our Virtual Pass be not just video, but audio and full transcripts and slides.

Depending on the speed at which you read, you could “attend” this conference in a day, but some of the presentations simply must be seen to be grasped. The nuances just don’t come out in print.

At Mauldin Economics, I am talent, not management. I don’t set prices or do the marketing. And I certainly don’t run a conference. Shannon Staton and her team are simply the best. I thank them for all their hard work. They made this happen.

And with that I will hit the send button. It is almost midnight and I’m sitting in a hotel room dictating into the computer, while my poor suffering wife Shane kibitzes on my wording and wishes I would finish so she can go to sleep. Because she has an early day and I do not. Then again, she is the Energizer Bunny and I am not.

I have had one of the most awesome weeks of my life. Next week will be great, too, as I spend time relaxing and pondering this one. I hope you have a great week, too. Take some time to think about the coming changes to our world and our own personal lives. I believe it will be more glorious and at the same time more upsetting than anything we have experienced so far. But we will do more than Muddle Through. The 2020s are going to be awesome. So much potential, so much possibility.

Sure, if you project the recent past into the future, you are not going to be happy. But if you think about it and put a plan into action, what an incredible future we are going to experience.

Your friends don’t let friends buy-and-hold analyst,
John Mauldin
Chairman, Mauldin Economics

We have reached the end of the Franco-German love-in

The interests of the two countries and their leaders are diverging

Wolfgang Münchau

France and Germany have deeper bilateral relations than any other two EU countries, dating back to the days of Konrad Adenauer and Charles de Gaulle © Getty

Last week’s European Council was dominated by Brexit. But it may be remembered for the visible cracks in the Franco-German relationship.

Emmanuel Macron’s refusal to accept the German-led majority view to agree to a long Brexit extension is perhaps the most clear sign of an end to the love-in between the two countries. The French president’s uncompromising stance caught most German political observers off-guard. Some members of Angela Merkel’s entourage in Brussels expressed unbridled fury at Mr Macron’s insurrection. How dare he?

What the debate in Germany misses is that Mr Macron owes little to the German chancellor. She managed to fend off most of his eurozone reforms. What is left — a small structural spending facility in the EU budget — is now being challenged by the Netherlands.

In the early days of his presidential campaign, Mr Macron surrounded himself with advisers who had close German connections. These are some of the most pro-German people to be found in France. Many are fluent German speakers and they forged many personal relationships across the border.

The German Social Democratic party under its former leader, Martin Schulz, would have been the ideal partner for Mr Macron. But Mr Schulz, a former president of the European Parliament, did not survive the snakepit of German domestic politics for long. After a disappointing election result, he left the front line. Germany is slowly reverting to its political norms.

This realisation has taken some time in Paris. But the recent publication of proposals on the EU’s future by Annegret Kramp-Karrenbauer, who succeeds Ms Merkel as leader of the Christian Democrats in December has alerted them. AKK, as she is known in Germany, managed to shock the French political establishment with the essay.

She called on France to give up its permanent seat at the UN Security Council and build a joint aircraft carrier. These proposals lack rhyme or reason, especially given Germany’s low defence spending. She also called on France to relinquish Strasbourg as one of the two seats of the European Parliament. AKK is a domestically focused political operator, agnostic about Europe. So the problem, from the French perspective, is not Ms Merkel. It is what comes next.

France and Germany have deeper bilateral relations than any other EU countries, dating back to Konrad Adenauer and Charles de Gaulle. Recently, Ms Merkel and Mr Macron renewed their vows in the Treaty of Aachen. But the relationship undergoes periodic crises. I fear we are heading into one.

If US president Donald Trump were to impose high tariffs on European cars and other goods, as he periodically threatens, Germany would push the EU towards a free-trade deal. Mr Macron would resist. French agriculture would suffer if the EU opened its markets to American food imports as the US asks. On trade, the interests of France and Germany are diametrically opposed.

Another foreseeable cause of conflict is Mr Macron’s likely opposition to Manfred Weber, the German candidate for the presidency of the European Commission. Mr Weber, the official choice of the centre-right European People’s Party, is tainted by his longstanding support of Viktor Orban, Hungary’s openly anti-Semitic prime minister.

But the single biggest test would be another eurozone crisis. Had it not been for extreme measures by the European Central Bank, the eurozone might not have survived the last sovereign debt crisis. With short-term interest rates at minus 0.4 per cent and a lack of appetite for further quantitative easing, the ECB’s room for manoeuvre in monetary policy is more constrained today. As the International Monetary Fund noted in its latest Global Financial Stability Report, the doom loop between banks and sovereign borrowers lives on. The banking union has made no difference.

The return of the crisis is no distant threat. The synchronised economic slowdown of the global economy may be all it takes. French corporations are heavily indebted. Italy’s fiscal policies are once again out of control. The probability of an Italian sovereign debt restructuring is rising.

France is more exposed to Italy than Germany. The eurozone badly needs a capital markets union with a joint sovereign debt instrument as a financial stabiliser. It also needs revised fiscal rules to encourage investment. Both are taboos in Germany. Mr Macron, or his successor, will eventually have to confront Germany with a choice between reform or the risk of disintegration.

France and Germany do not disagree on the principle of European political integration, but they are at loggerheads on the most important details. We are headed into a period in which the interests of the two countries and their leaders are diverging. These will be difficult years for the EU.

The Physical Oil Market Is Saying We Are About To See The Largest Crude Storage Draw Since 2011

by: HFIR
- Oil prices are down slightly today. We attribute the weakness to speculators dumping long exposures to wait on the sidelines ahead of the OPEC+ JMMC meeting.

- Physical timespreads continue to improve, which contradicts the financial price sell-off.

- Crack spreads continue to improve, albeit falling slightly today. US refinery throughput is about to ramp materially in the coming weeks.

- As the physical oil market begs for more supplies, we expect that things will only get tighter as global refineries start ramping up throughput just as global oil-on-water is at the lowest in 3 years.

- The steep backwardation in the Brent timespreads tells us we are about to witness the largest crude drawdown since 2011.

Oil prices are pulling back slightly today with Brent underperforming WTI and narrowing the Brent-WTI spread. The move today appears to be speculators dumping long positions going into the OPEC+ JMMC meeting. In the case of surprises, speculators are taking the cautionary stance of being on the sidelines. While, on the macro front, it appears the China/US trade war is heating up leading to lower risk appetite for those betting on oil prices.
But, on the physical market, the divergence continues with the Brent 1-2 timespread moving up, while Brent 2-3 is flat on the day despite the sell-off. WTI timespreads are also improving, which might indicate that storage draws are coming, although the spreads are still in contango, which is still an illustration that the US crude market remains oversupplied.
Brent 1-2
Brent 2-3
WTI 1-2
WTI 2-3
321 Crack Spreads vs WTI
Source: CME, HFI Research
321 Crack Spreads vs Brent


Source: CME, HFI Research
As you can see from the charts above, the physical oil market remains healthy despite headline macro concerns. Whatever financial speculators are doing today, the physical oil traders are completely ignoring. For the US market, we know that unplanned outages continue to dampen US refinery throughput which has led to crude builds over the last month. But this is going to change within the next few weeks as high 321 crack spreads indicate higher refinery runs.
Global oil-on-water
In addition, another metric we track closely is the global oil-on-water, which has reached the lowest level over the last 3 years. The decline since the start of May comes from a steep dropoff in Iranian crude exports which tanker tracking services are pegging at ~500k b/d. Logistical issues in the near term are capping Iranian exports, but we don't expect this to sustain going forward.
But this confirms the physical oil market's appetite for crude as a lack of oil-on-water just means less supplies globally. As global refineries ramp up into the summer, the physical oil market situation will only get tighter and tighter, which will eventually translate into higher financial oil prices. Our view is that the algos, along with energy investors, are staying on the sidelines until they see evidence of storage draws, but especially in the US. Once US storage starts to drop, that's when the fund flows will return.
For our UWT trade, we remain long and holding till $69 to $70/bbl target. The steep backwardation in the Brent timespreads tells us we are about to witness the largest crude drawdown since 2011.
Source: IEA

Emerging market currencies suffer worst week since 2018 lira crisis

China’s offshore renminbi has weakened to its lowest level in five months

Philip Georgiadis in London

© AP

China’s offshore renminbi has weakened to its lowest level since November on escalated trade tensions, in the worst week for emerging market currencies since the Turkish lira crisis last summer.

Emerging market bond and equity funds have also experienced significant outflows this week, as talks between the US and China have stalled. Washington has accused Beijing of reneging on trade commitments, while China on Monday announced it would impose tariffs on $60bn of US imports starting on June 1, knocking investor sentiment further.

China’s offshore renminbi, which is widely traded in London, stood 0.1 per cent weaker at Rmb6.9400 per dollar around the start of full European trade. It has weakened nearly 3 per cent over the past two weeks as economic hostility between the world’s two largest economies have weighed on the currency.

The offshore renminbi is the “focal point” for trade tensions, analysts at ING said. “Were it to hit 7.00, alarm bells would ring even louder around the world.”

MSCI’s broad index of emerging market currencies has fallen 0.9 per cent since Friday, its biggest weekly fall since August last year when Turkey’s currency was in free fall, and fifth consecutive week of declines. It slipped 0.4 per cent to 1614.22 on Friday morning in London.

The uncertainty is also spreading through many of Asia’s trade-sensitive economies. The Singapore dollar has suffered its worst week since October, as the island state’s economy has shown signs of weakening, while the New Taiwan dollar has notched its biggest one-week declines since the same time.

Amid the risk-off sentiment, emerging market bond funds recorded their largest outflows since June 2018 in the week to May 15, according to Barclays. Passive funds largely drove the moves, but active funds also saw outflows for the first time since February.

“The resilience of inflows by institutional investors into EM bond funds may be tested over the next weeks,” the bank’s strategists said.

Overall, flows into dedicated bond and equity emerging market funds fell around $5bn, Barclays said.

Aside from the trade tensions, “the aggregate growth picture in emerging markets has not been particularly positive,” said Paul Fage senior emerging markets strategist at TD Securities, pointing to recent data including weakening industrial production.

“Probably the most important thing for emerging markets whether they can generate in aggregate a decent pick-up in growth to the developed markets and particularly the US, that has been one of the weaknesses coming into this year,” he said.

The dollar will dominate for a while yet

And when a challenge to its supremacy comes, it might be from an unexpected quarter

Gillian Tett

Will it be cryptocurrencies that eventually supersede the dollar, not the renminbi? © Reuters

This week, a frisson passed through Treasury markets when it emerged that China has been selling US government bonds. These sales were not huge — a mere $20.5bn in March — nor were they made with accompanying public threats. But in the current protectionist climate, the news left investors pondering two unnerving questions. Could the current trade war turn into a capital and currency war? And if so, might that undermine the dominance of the US dollar?

The answer to the first question is, “one hopes not”. And to the second, “almost certainly no”.

The reasons for this were neatly laid out at a meeting of central bankers earlier this week in Zurich, organised by the IMF and Swiss National Bank. This started with a paper from Barry Eichengreen, the American economist, outlining a split among academics in the US about the way the dollar has in effect anchored the international monetary system (it accounts for about 60 per cent of foreign exchange reserves, foreign currency liabilities and bank deposits).

Prof Eichengreen noted that at the University of California, Berkeley, where he teaches, economists tend to assume that dollar dominance will eventually end. Other currencies (or metals) have been dominant in the past — sterling in the 19th century, say. However, a little-noticed feature of these earlier eras was that dominance almost always occurred within a multipolar global system.

The Berkeley economists assume that the world will eventually become multipolar again, particularly as the current status quo does not serve anybody well. Most notably, emerging markets are laden with alarmingly large levels of dollar-denominated debt. And while US leaders like the political status and power associated with the dollar’s dominant role, it has some negative consequences for America’s domestic economy too. It fosters an excessively strong currency and artificially low levels of market interest rates.

But “eventually” is the keyword here. Even Prof Eichengreen does not predict that the dollar will lose its dominance in the near future. Meanwhile, on the other side of the US at Harvard University, a group of economists, including Gita Gopinath (now chief economist at the IMF), have recently developed some powerful empirical arguments for why dollar supremacy is “sticky”.

Currently, the dollar is the dominant currency for trade invoices (if you exclude euro-denominated payments inside the eurozone) and that encourages debt issuance in dollars too. Taken together, these factors create an overwhelming dollar tilt that is difficult to shift, particularly since the Chinese currency is not yet liberalised and markets in the eurozone remain disunited.

The case of Russia demonstrates this “stickiness”. At first glance, Moscow seems to be trying to escape the dollar yoke. At the IMF-SNB meeting Elvira Nabiullina, Russia’s central bank governor, revealed that between July 2017 and July 2018 Russia cut the dollar proportion of its foreign exchange reserves from 46.3 per cent to 21.9 per cent, replacing these with euros and some Chinese renminbi.

That might seem to make sense given Russia’s trading patterns: commerce with America accounts for a measly 1.5 per cent of Russian gross domestic product, whereas trade with the EU and China is a whopping 24.3 per cent of GDP. But here is the catch: measured overall, 55 per cent of Russia’s trade is still invoiced in dollars, Ms Nabiullina noted. And since Russian companies (sensibly) try to match liabilities and revenues, 54 per cent of Russian debt is dollar-denominated too.

Now, a critic of America might point out that Russia is an extreme case — it is highly dependent on commodity exports, which tend to be priced in dollars. But the global pattern is clear. And what was striking about the IMF/SNB event was that while almost all the central bank governors from emerging market countries fretted about the pain the dollar yoke creates, none predicted it was about to vanish.

However, there was also an interesting caveat. This, the ninth such meeting, was the first to include representatives of fintech companies, who boldly predicted that technologies such as blockchain and cryptocurrencies are poised to overturn global finance. Unsurprisingly, the central bankers were not convinced, but they did not dismiss the fintech claims out of hand.

So if you want to see what might eventually challenge dollar supremacy, look to Silicon Valley as much as China. Just don’t expect that change too soon, even amid a trade war.

Central Banks Soften Us Up For Higher Inflation

There was a time when “price stability” – that is, money that buys the same amount of stuff every year – was considered a good thing. But as debts began to pile up around the world, it became clear to policymakers that managing that debt required money that got a little less valuable over time, say 2%, to allow debtors to pay interest in cheaper currency and employers to placate workers with “cost of living” raises.

This delayed the reckoning on the old debt but at the cost of soaring new debt, as pretty much everyone figured out that it’s smart to borrow depreciating currency.

In the decade since the trough of the Great Recession, nearly every sector of every major economy took on historically unprecedented amounts of new debt. And now the old “optimal” inflation rate of 2% isn’t enough to make interest payable for a growing number of borrowers.

The solution? Higher inflation of course. The old 2% target was arbitrary to in any event. And as with so many other things in life, if a little was good, a little more must be better, right?

So the question becomes how to phrase the transition to faster currency depreciation in a way that shapes the behavior of buyers, sellers, borrowers and lenders in the best possible way.

China got the ball rolling back in December, with fuzzy words designed to reassure while avoiding specifics:
China’s top policy makers confirmed that more monetary and fiscal support will be rolled out in 2019, as the world’s second-largest economy grapples with a slowdown that’s yet to show signs of ending. 
“Significant” cuts to taxes and fees will be enacted in 2019 and while monetary policy will remain “prudent,” officials will strike an “appropriate” balance between tightening and loosening, according to a statement published after the annual Economic Work Conference that concluded in Beijing Friday.

Very comforting: “Significant” is actually “prudent and appropriate.”

Thus reassured, Chinese banks and their customers went on a lending/borrowing spree for the record books. From Doug Noland’s Credit Bubble Bulletin:
China’s Aggregate Financing (approximately system Credit growth less government borrowings) jumped 2.860 trillion yuan, or $427 billion – during the 31 days of March ($13.8bn/day or $5.0 TN annualized). This was 55% above estimates and a full 80% ahead of March 2018. A big March placed Q1 growth of Aggregate Financing at $1.224 TN – surely the strongest three-month Credit expansion in history. First quarter growth in Aggregate Financing was 40% above that from Q1 2018.

While China was setting records, QE pioneer Bank of Japan conflated “powerful” and “patient”:
Bank of Japan Governor Haruhiko Kuroda on Tuesday vowed to “patiently continue” the central bank’s “powerful” monetary easing as it was taking longer than previously thought to accelerate inflation to its 2 percent target.

Japan offers a glimpse of the future as its population ages and its debts soar. The further it travels down this path, the more difficult the math becomes. Which means hitting the BoJ’s 2% target will just set the stage for even more “patient but powerful” easing.

Now it’s the Fed’s turn. US core inflation handily exceeded 2% last year, but has since trended down a bit.


Still, the recent average is close to 2.5%, which you’d think would be fine if 2% is still sufficient to manage our debts. But it’s not, and the Fed is now sending its talking heads out to break this news:
The U.S. Federal Reserve should embrace inflation above its target half the time and consider cutting rates if prices do not rise as fast as expected, a top policymaker at the central bank said on Monday. 
“While policy has been successful in achieving our maximum employment mandate, it has been less successful with regard to our inflation objective,” Federal Reserve Bank of Chicago President Charles Evans said in New York. 
“To fix this problem, I think the Fed must be willing to embrace inflation modestly above 2 percent 50 percent of the time. Indeed, I would communicate comfort with core inflation rates of 2-1/2 percent, as long as there is no obvious upward momentum and the path back toward 2 percent can be well managed.”

Again, lots of focus-grouped soft, comforting words: “modestly … no obvious upward movement … well managed.”

But the truth is less comforting: Rising inflation, by in effect putting money on sale, encourages borrowers to borrow more, which sends aggregate debt higher at a rate that (see China) exceeds the rate of inflation, thus making the problem worse at an accelerating rate.

The only solution to too much debt is a borrower die-off. And those are by definition the opposite of “well managed.”

The Brexit Impossibility Triangle

As the United Kingdom's chaotic quest to leave the European Union drags on, the country's leaders need to accept that the primary objectives of Brexit are, and always have been, mutually incompatible. Sadly, their refusal to acknowledge this is indicative of the kind of leadership that led to the current impasse.

Emily Jones , Calum Miller

ejones2_ Leon NealGetty Images_theresa may

OXFORD – With the European Union’s latest extension of the United Kingdom’s membership in the bloc, onlookers around the world are right to wonder why the Brexit process has proved so intractable. The short answer is that the UK’s government and parliament are trying to achieve three incompatible goals: preserving the country’s territorial integrity, preventing the return of a hard border between Northern Ireland and the Republic of Ireland, and enabling the UK to strike its own trade deals.

The British are finally confronting the fact that only two of these objectives can be met at any one time. This implies that there are three basic scenarios for moving ahead with Brexit.

The first scenario centers on a “free-trade union,” which would grant Britain autonomy over trade policy and territorial integrity in exchange for the return of a hard border in Ireland. Trade-policy autonomy requires that the UK leave both the EU customs union and the single market. In either case, customs and regulatory checks would have to be established at the border between Northern Ireland and the Republic of Ireland. Though some have suggested that new technologies could obviate the need for physical border checkpoints, no such technologies exist. Hence, a major risk in this scenario is that the return of a hard border would jeopardize the 1998 Good Friday Agreement, which ended decades of violence in Northern Ireland.

The second scenario would offer an answer to the Irish question. The UK could enjoy trade-policy autonomy without a hard border in Ireland by sacrificing territorial integrity. This would involve keeping Northern Ireland in the EU customs union and single market while establishing a border in the Irish Sea – that is, between Northern Ireland and Great Britain.

The problem with this arrangement is that different parts of the UK would have different trade rules and regulations. Not only would Unionists in Northern Ireland object to being separated from the rest of the UK – again, raising the risk of renewed conflict – but Scotland would probably demand its own closer relationship with the EU. And if the Scots decided to pursue another independence referendum, the entire UK could be at risk.

Under the third scenario, the UK could avoid the Irish question and preserve its territorial integrity, but would have to abandon the vision of “Global Britain” by remaining in both the customs union and single market. Under this scenario, there would be no meaningful autonomy over trade policy. This is the essence of the “Common Market 2.0” proposal that has been put before the House of Commons.

Following Norway, the UK could opt out of the Common Agricultural Policy and the Common Fisheries Policy, thereby reducing its EU budget contributions. But it would still have to permit significant migration from the EU – a key red line of the “Leave” camp. Likewise, Britain would still fall under the jurisdiction of the European Court of Justice, albeit indirectly.

Moreover, even a simple customs union with the EU – the option that has so far come closest to commanding a parliamentary majority – doesn’t resolve the Brexit trilemma. While it would grant the UK control over immigration, it would require new regulatory checks between Britain and the EU. It also means that Britain would be locked out of the single market in services, which constituted around 40% of British exports to the EU in 2017, accounting for a surplus of £28 billion ($36 billion).

The Brexit impossibility triangle makes clear why UK Prime Minister Theresa May’s withdrawal deal has been rejected by the House of Commons multiple times. As an exit treaty, it leaves open the details of the UK’s future relations with the European Union, but it does include a legally binding commitment (the “backstop”) to prevent the return of a hard border in Ireland. In the terms of the Brexit trilemma, May’s deal rules out the first scenario of a “free-trade union,” but leaves the inevitable choice between trade-policy autonomy and territorial integrity for the next stage of the Brexit negotiations. It is this ambiguity that worries many MPs.

For their part, hardline Brexiteers are determined to secure autonomy over trade policy, which means they would accept a border through the Irish Sea. But then Scotland would demand its own special arrangement vis-à-vis the EU, putting the UK on track for a major constitutional shakeup, and possibly dissolution. Avoiding this scenario means sacrificing autonomy over trade policy for the sake of the Good Friday Agreement and territorial integrity. But this would upset hardline Brexiteers and could split the Conservative Party, a risk Theresa May has been unwilling to take.

British leaders need to acknowledge that all Brexit scenarios involve tradeoffs, and the country urgently needs to hold a national debate to rank the electorate’s preferences. The choice is between one of the three Brexit scenarios and suspending the Brexit process altogether. Without a mature and frank discussion, the UK will continue to bear the costs of interminable uncertainty and indecisiveness.

But, of course, a proper debate requires effective leadership that highlights the choices and creates space for compromise. If the wounds of Brexit are ever to heal, voters will have to move past transactional, tribal politics and embrace leaders who are willing to reach out to the other side and speak honestly about policy tradeoffs. Only by working together will the UK arrive at an outcome that all can respect and live with.

Emily Jones is Associate Professor in Public Policy at the Blavatnik School of Government, University of Oxford.

Calum Miller is Associate Dean and Chief Operating Officer at the Blavatnik School of Government, University of Oxford.

martes, mayo 21, 2019



"End of Days"

By Joel Bowman, Editorial Director, International Man


The caption loomed over a friend’s photo of the grand Notre Dame Cathedral in Paris, as it stood engulfed in flames.

The picture was eerie… apocalyptic, even. So too were the videos of solemn onlookers, singing Ave Maria on the banks of the Seine as the embers rose into the air around them.

At over 850 years old (and 200 years in the making) the burning building reminds us that nothing lasts forever… at least not in the same form.

Political empires... their monies and their militaries... the hearts and minds of men.

We are always and in every moment changed, constantly transformed by our experience. So too does the world around us groan and morph into something new.

Many will read the great fire on the Île de la Cité – especially at the beginning of La Semaine sainte – as some kind of omen.

The beginning of the fall of Europe… a sign the continent is breaking apart… the end of an era… or of the world itself.

But let us not be too hasty in immanentizing the eschaton.

There is much in this world to celebrate yet… even if it has to be turned upside down from time to time.

Here in the “Paris of the South,” where politicians are constantly upending the Argentine economy, there is plenty of silver lining to frame the brooding clouds.

Yes, the peso lost roughly half its value in the last year... and yes, inflation is running somewhere in the mid double digits… and yes, the coming presidential election might see a return of the Kirchner regime…

But there is opportunity in crisis… if one knows where to look.

A few days ago, your editor broke bread with the original international man, Doug Casey, and our good friend, Robert Marstrand. That is to say, we three feasted on Patagonian lamb and thick cut bife de chorizo, accompanied by papas fritas and strong Malbec wine… all washed down with pistachio ice cream and limoncello digestivos.

We ate and drank like civilized men, in other words, even as civilization itself threatens to turn itself inside out.

And, as anyone who knows the company would assume, we mused on the state of the world.

Topics of conversation included money, old and new – from the recent bump in cryptos (some were up 85% in the preceding week) to the increasing mission creep of the state when it comes to individuals transporting gold and silver coins across borders.

We spoke about investing – how to grab rock solid Russian stocks on the cheap (while avoiding the political risk of being frozen out of the market, should the West impose further sanctions.)

And we waxed about political correctness – and the dire need for an irreverent outlet that really spoke truth to power, consequences be damned (watch this space…)

We'll have more from the Fin del Mundo in future issues...

In the meantime, we invite you to enjoy Mr. Marstrand’s take on the madness that is Modern Monetary Theory… and how it could end in a flaming pile of fiat scrip for those not properly prepared.

Money for Nothing

By Robert Marstrand

“That ain’t working, that’s the way to do it
Money for nothin’ and your chicks for free.”

~ Money for Nothing, by Dire Straits (1985)

“Modern Monetary Theory”, or MMT, keeps popping up in financial commentaries. It’s a theory that appears to be gaining ground among academic economists, in monetary policy circles, and... of course... among deficit-spending politicians.

MMT involves central banks creating new money to directly fund government budget deficits. It’s practically the same as quantitative easing (QE)... at least when QE money is used to buy government bonds.

But MMT removes some of the smoke and mirrors. Instead of laundering the money through the bond market, it’s handed straight to finance ministries to spend as they please.

There’s nothing at all “modern” about this. Places like Argentina have been doing it for decades. In fact, the Argentine central bank only stopped doing it last year (most recently), as the country battles to reduce high inflation. Last year, consumer prices rose around 50%. This year, most people are expecting 30-40%.

This funding of government budget deficits by central banks tends to have two results. First, deficits get even bigger, as politicians are let off the fiscal leash. Second, due to the inflation in the money supply, the currency is devalued and prices of goods and services take off like a rocket.

Here’s a chart that shows the size of Argentine budget deficits since 1961. The only time there was a surplus was in the early 2000s. That was shortly after a massive currency devaluation and during a huge commodity price boom. (It was also an opportunity that was squandered by the government, and the budget and trade deficits soon returned.)

Right now, we have very high inflation in Argentina. But the country also suffered from hyperinflation in the past. Between 1975 and 1990, the average inflation rate was 300% a year.

The guy who cuts my hair told me that, in the late 1980s, he would work in the morning. Even during hyperinflations, people still need a haircut. Then he’d go straight out after lunch to buy his daily groceries and other necessities, before prices went up. Any spare cash was converted into US dollars at the first opportunity.

This is the very definition of hyperinflation: wholesale currency dumping. The collapsing currency is like a hot potato that no one wants to hold on to. (Although that’s unfair to hot potatoes, which at least have nutritional value.)

Consider this. I’ve lived in Argentina for over ten years. When I arrived, one US dollar bought 3.2 Argentine pesos. Today, one dollar will buy 43.4 pesos. Put another way, relative to the dollar, the peso has lost a staggering 93% of its value in a decade. And the dollar has also lost purchasing power over that time.

(My kids, now aged 13 and 12, have learnt about this stuff early. They already know that they need to convert their peso savings - garnered from birthday gifts and unspent pocket money - into US dollars or British pounds.)

Ironically, the cost of living in Buenos Aires is now the cheapest it’s been since I’ve lived here, in US dollar terms. That follows last year’s currency collapse, when the peso was cut in half. That’s good news for people with dollar incomes, or for foreign visitors.

But, in the past couple of years, a great many local people’s peso wages have fallen way behind peso price increases. Life is tough right now for many Argentines.

(I always mentally price things in dollars here. Peso prices change so rapidly that you can’t keep up. A lunch at a decent restaurant 18 months ago could have cost the equivalent of US$40. Now, the same lunch is more likely to be US$20.)

In this world of QE and MMT, it pays to know something about what money really is, and how it’s created by banks (of either the central or commercial varieties). For example, many people seem to think that banks “look after their money” when they make a bank “deposit”. But, in reality, a deposit is just a loan to the bank. That’s why banks report customer deposits as liabilities on their balance sheets.

This progressive edging of developed countries towards a monetary cliff is a good reason to own some physical gold. With the dollar (and euro, pound, and yen) under increasing threat from trendy new-old theories, gold is the go-to inflation hedge. It’s a better alternative to the sanctuary that Argentines find in US dollars.

Argentines have placed their faith in dollars for decades. After all, the paper bills (which are VERY popular here) do bear a comforting message - “In God we trust”.

But trust in the almighty may not be enough to protect the dollar in the future. The Fed’s already got away with printing trillions under QE. When it started, everyone thought the policy was insane. It was only ever meant to be a temporary, emergency measure. But now it’s an accepted (and permanent) practice. Now that they’ve warmed everyone up with the foreplay of QE, how long until they go the whole way with MMT?

Of course, currencies may not collapse immediately. Most likely, nothing much will happen for years. But then bad things could happen quickly. As more and more politicians and central bankers believe they can print money for nothing, they’re edging closer and closer to dire straits.