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



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

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

 

Summary

 

- 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

 

 

Brent-WTI

 

 

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.

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



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.

"End of Days"

By Joel Bowman, Editorial Director, International Man


BUENOS AIRES, ARGENTINA – “End of Days.”

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.