Historical events don’t always have to come out of a book, or be taught in colleges and universities. People around the world enjoy reliving history. Dressing and acting like people did from times long past no doubt make historical events come alive. Events from the past have provided copious inspiration for film, music and books based on true stories, and using historical fact to weave stories around. Two examples, before we enter this post. Jaws the film was an incredible success for director Stephen Spielberg. Jaws the book by Peter Benchley, was based on the Jersey Shore shark attacks of 1916. A panic stricken beach town caused by one shark attacking multiple people inspired one of the best known film stories of all time. I bet you didn’t know the book about Norman Bates called Psycho was later made into a film, but, the book was actually based on a real murderer called Ed Gein.
Historical events happen all the time, but, there as some monumental events happening right now. Not just Brexit, Donald Trump insulting another journalist, Vladamir Putin playing grand piano as he waits for the Chinese Premier Xi Jinping at the “One Belt, One Road summit”. Rather events that your children’s, children may study in the future but not from a school curriculum. This post will review big things happening in geopolitics, economics and how it’s going to affect financial markets.
In the lifetime of most people the United States of America has been a leading global superpower. Affecting our culture from everything from Breakfast cereals to Televisions shows, sorry television programmes, and children’s toys. Not to mention the functioning of politics, pensions plans and other financial institutions. The Hollywood film industry is (or rather the industry as a whole) is arguably one of the most powerful industries in the world, with the power to inspire and influence peoples ideas, lifestyle choices and emotional biases.
Could this be the beginning of the end of America being the worlds leading superpower?
American has provided security and stability to a lot of countries by providing intellectual and financial capital for financial systems, institutions and contributions to countless technological breakthroughs. Any big change to this will have big consequences for anyone thinking about where to place their bets for growing their wealth. Let’s take a look at the bigger picture.
Since the Bretton Woods Agreement after World War Two the United States Dollar has been the worlds dominant reserve currency. US Dollars where lent to countries damaged by war to build infrastructure again so that society would function properly. A good idea, which especially helped the United States, because it developed the world economy and promoted North Amercian economic and political values. Values which they gained originally from Europe (and the rest of the world before that). Great news for the World Economy as it developed a stable system allowing countries and individuals to trade and prosper. Part of the agreement stipulated oil had to be traded in Dollars. So if you need oil for industry or whatever you have to buy dollars to trade it. The reserve currency status also meant dollars where the preferred currency to trade goods and services in the global economy.
Soviet representatives attended the conference. They declined to sign off on the final details of the plan. Labeling the institutions created by the agreement to be branches of Wall Street. Which of course they are / where. Institutions created by the USA and United Kingdom where the International Monetary Fund and the World Bank.
The IMF’s Articles of Agreement state: the IMF is ” to promote international monetary co-operation, international trade, high employment, exchange-rate stability, sustainable economic growth, and making resources available to member countries in financial difficulty. ” All good things right? They hold a fund made up of Special Drawing Rights which consist of a basket of other currencies that can be used to help stabilise member nations using liquidity (cash injections).
Other things that came from the Bretton Woods Conference where the instigation of freely floating currencies and the idea that it’s better to reduce trade tariffs to promote trade. Relative to before Bretton Woods the world economy is almost a completely free trade system now with low tariffs being standard practice.
Agreements ratified at Bretton Woods encouraged many countries around the world to use dollars for trade. This financial model has worked well and allowed a lot of people to benefit who would not have if a plan had been signed off based on the principles of the Soviet era. Many advances in technology, medical sciences, welfare systems would not have happened had it not been for this system. For normal people, this means no more having a toilet in the shed in the back garden, hot water, a General Practitioner to help with your ailments, a pension, money if your your boss cuts you loose from your job as well as other welfare benefits and many more things like, iPhones, GPS so you don’t get lost, free online software, shops with almost anything you could want, and doctors with almost any drug required to help you live longer. Let’s not forget the option to travel almost anywhere in the world for a holiday or vacation. Of course the list goes on.
So what’s the big deal?
Events unfolding now could go down in history as those that marked the begging of the end of the United States of America being the world’s leading superpower. It’s a big deal for Global Economics and Geopolitics and the transition may not be smooth. Each time the world reserve currency has changed there’s been trouble. Various wars, revolutions and civil wars have accompanied these periods of transition overtime.
Portual to Spain in the 15th Century. At this time Portugal had substantial maritime trade routes. Advances in naval navigation technologies allowed them to create new trade routes to countries further away and later to avoid the growing Ottoman Empire. Trade was protected by establishing lots of military outposts along the way. Decline of the Empire started as they got overextended and succumbed to attacks from other countries (Holland, France and Great Britain). Portugal merged with Spain and to keep the dominant reserve currency going. The union broke down after wars and revolutions by the mid 17th Century.
Spain to the Netherlands in the 17th Century. Aided by the creation of the Dutch East India Company regarded as being the first multi national corporation trading spices from Asia and the pacific. With over 40 warships and a paramilitary of 10,000 they ruled world trade. Paying a dividend payment of 40% of the original investment to shareholders. An expensive Anglo Dutch war knocked the Dutch off the top table and gave way to other countries creating multinationals; French East India Company and English East India Company. Great Britain was practically broke due to fighting the Dutch so it was France who took on dominant reserve currency status.
Netherlands to France in the 18th Century. Louis XIV gained political dominance in Europe but ran up lots of debt that led to a debt crisis and civil war, giving way to the young general Napoleon Bonaparte, who carried on fighting over another decade. The Napoleonic empire was built on military presence in various countries. Napoleon was latter defeated by Great Britain after Britain had built substantial national wealth during an industrial revolution. Power in Europe balanced and peace was established, marked by the 1815 congress of Vienna. Peace lasted for the rest of the 19th Century.
France to Britain in the 19th Cenury. The British Empire held powers over one fifth of the worlds population made possible by the Royal Navy. At this time the modern concept of global reserve currency evolved due to the creation of national central banks, treasuries and an integrated global economy. Many countries at this time followed Great Britain and backed their currencies using a Gold Standard.
Britain to USA in the 20th Century. By the end of World War 2 Britain was bankrupt and they knew it, which gave way to the Bretton Woods agreement and the US Dollar becoming the new dominant reserve currency. The USA become the largest creditor nation at the time which brought them massive influence and power in the world.
In reality this story has been playing out for a long time already and it’s not an unusual event for a global reserve currency to change, as it happens every 100 years or so. Compared with the past the transition has not been as disastrous as before, so far. Possibly due to the advances of democracy, technology and evolution of intellectual capital. China has been making moves to side step the dollar for a while. Bilateral trade deals being it’s Modus Operandi to cut dollars and other countries out of the loop. These typically involve deals directly between governments and do not use hard currency for payment. One Grievance of other countries like China and Russia is that the dollar based trade system uses the SWIFT money transfer system. SWIFT allows the USA general oversight over every dollar based transaction. Good for keeping tabs on drug money, terrorist funds, and misappropriated aid given to African dictators. If like China you don’t want someone else looking in then it’s not so good. China set up Cross Border International Payments System or CIPS. Now they can bypass SWIFT and clear money transfers for trade using CIPS. A system they use with countries in their neighbourhood.
Despite information given to the contrary this pressure on the US Dollar to move-over and let something else take it’s place has played a major role in all foreign policy decisions at the top of US Government for some time.
What’s is causing the changes to happen now?
Too much debt. The Federal Reserve has stated they are going to unwind quantative easing by shrinking their balance sheet of US Treasuries and mortgage securities which where created to provide liquidity in the last financial crisis. Four trillion dollars of securities need to be sold without disrupting financial markets. The exact timing will depend on various economic and geopolitical factors. Who’s going to buy all these treasuries and mortgage backed securities?
The US Treasury will have billions and billions of dollars of US Treasury bonds to sell to fill this hole. Normally it’s central banks, pensions funds, and sovereign wealth funds that buys this stuff, but, they are looking for higher returns from better quality investments. Plus the volumes are too high.
Both China and Russia and various other groups have called for there to be an independent new currency to replace the US Dollar. As the story unfolds an increasingly wealthy China may push for the Yuan to replace the US Dollar. China and Russia have started to take matters into their own hands to get it’s voice heard.
China started to create institutions to rival those built by the US and UK 2013. The new institutions will help provide the infrastructure to allow the Yuan to be a global reserve currency. In part this is because they are looking for a better return on their investments than buying US Treasuries. The Aisan Infrastructure Investment Bank (AIIB) was created with money coming from lots of countries, including European countries and the United Kingdom, to help the Asia Pacific region develop it’s infrastructure. Projects so far include a $165 million loan for a Power Distribution System Upgrade and Expansion Project in Bangladesh, a $216.5 million loan for a National Slum Upgrading Project in Indonesia, a $27.5 million loan for the Dushanbe-Uzbekistan Border Road Improvement Project in Tajikistan, and a $100 million loan for the Shorkot-Khanewal Section of National Motorway M-4 in Pakistan. All of these, with the exception of the Bangladesh power project, are co-financed by other multilateral institutions.
China and Russia have expressed a wish to use gold more in the financial system and have said they would like to trade oil in gold instead of dollars. China’s new Shanghai Gold Bullion Exchange will allow them to do this. Both Chinese and Russian central banks have significantly increased gold reserves since 2009. World prices for Gold are currently set in London, called the London Fix. China wants a larger role in the pricing of Gold in the Asian Pacific region which is a step towards letting the Yuan become a global reserve currency (not the dominant one at this stage).
What is the proposed solution to this problem?
The bank of international settlements is helping to broke deals between nations on either side of the argument, notably The USA and China, to alleviate some of the grievances held by them. Grievances include that the international financial institutions in place have been set up to help the USA and allies more than those in the Asia Pacific region. An example of the measures to diffuse the problem include the IMF head hunting and employing the old head of the Peoples Bank of China to become number two at the IMF. A show of intent about cooperation to solve the problem.
As an alternative to cutting the Dollar out of the game completely by using Gold or Yuan (or a mixture of the two) the USA is promoting using Special Drawing Rights (SDRs) to a much larger extent. SDRs are currently what the IMF uses and comprise a basket of currencies which are freely exchangeable with the host nation. SDRs are one step closer to an independent global currency. With the backing of US military power and agencies like the Central Intelligence Agency (CIA) this is the path that the global community is following. To solve the problem mentioned at the start of this article; who’s going to buy all those treasuries that the US Treasury will be selling? The answer is the IMF will provide liquidity using SDRs which will basically allow major trading countries around the world to provide some of the money to maintain the financial system. Let’s face it, it’s a lot of money to ask of other countries to do this, so the IMF will probably print SDRs. Importantly there will be some changes made to how SDRs are set up which will impact where to place your bets on investments going forwards.
What are the changes to SDRs and what will the affects be?
- Chinese Yuan will be included in the calculation for the first time. This may encourage central banks around the world to hold more Yuan. Also organisations linked to the World Bank use SDRs which will require that more Yuan are bought. There will probably be a trend of more international organisations using SDRs. This may increase the value of Yuan and hurt China’s export trade because Chinese goods will become more expensive. Something they will not want as the country still gains most of its national income from exports.
- 25% of national currencies that are participants in the SDR are to be backed by the commodities they produce. This will cause competition for resources, like oil, gas, water, and food.
- 25% of national currencies used in the SDR are to be priced by the foreign reserves a country holds. Currently USA does not hold significant reserves of foreign currencies because it has been the dominant reserve currency. They’ve not needed anything other than King Dollar. When this change is enforced they will need to sell dollars to buy other currencies. All the Dollars that currently reside outside of the USA will find their way home because other nations will not need as many. When other nations sell dollars, coupled with the US Fed having to hold more foreign reserves it will lead to a step-wise devaluation of the US Dollar.
The image shows where US Dollar are and where they may be going in the future.
What may call the dollar valuation to fall?
Plans by the US Federal reserve to start unwinding their balance sheet and for the US Treasury to sell bonds are predicted to start at the end of 2017. The resulting money printing by the IMF in the form of SDRs to provide liquidity would reduce the value of the dollar. As would the points mentioned above about the changes to the SDR. In response China may devalue the Yuan in order to maintain their competitiveness in global trade. This may trigger a sharp fall in stock market valuations similar to those at the end of 2015.
A sub plot to this story is the negotiations happening between China and the IMF about the Yuan gaining reserve currency status, which it would have to do to become a Dominant Global reserve currency. Conditions of this deal include China having to reduce it’s control over the currency. This and the changes to the SDR could cause volatility in the short term and cause China to devalue their currency in the near future, which would cause sharp drops in world stock markets.
Reduced demand for US Dollars in the global financial system will cause the value of the dollar to decline. The speed with which this happens depends on Geopolitics and who has the biggest aircraft carriers in the region. By using the SDR dollar demand should decline slowly as long as Russia and China do not side step the dollar significantly leading to other nations to do the same, but rather do it in a controlled away. Either way more dollars are going to be sold than bought over time and will be finding their way back to the USA. President Trump’s economic pledges include getting epic US corporations like Apple Inc to repatriate the cash hoards they hold overseas. This fits in with part of the play book and may help protect the value of the dollar as other currencies will be sold to buy dollars before they are transferred back to the USA, which increases dollar demand.
More Dollars finding their way back to the United States will increase money in the system and cause inflation. This will manifest itself as rising prices for good and services, growing stock market valuations, and increasing gold prices. Another affect should be that US wages start to rise which would keep the electorate happy.
Repatriated Dollars by US Corporations should get spent on the infrastructure required for some of the major technological advances which are in the pipeline. Coupled with the planned tax cuts by the Trump administration this would be positive for US economy and stock market prices. This would also help cause inflation in wages and increasing prices of goods and services.
Companies getting commodities out of the ground will become increasingly important. The USA has used technological advances in oil and gas drilling to massively increase their oil and gas reserves, which conveniently coincides with the changes to the SDR. The IMF has signaled that gold may be used in the SDR calculation as per China and Russia’s wishes. This would increase the gold price and increase the share price of many gold mining companies. Times of inflation are good for the gold price and other commodities in limited supply like platinum. Platinum is an industrial metal used in among other things in catalytic converters. Defense sector companies should also benefit because they are helping the US armed forces underwrite the system.
What will trigger positives moves in the stock market?
- Trump administration tax cuts and infrastructure spending starting in 2019.
- Massive infrastructure projects funded by China and G20 nations starting int 2020.
- A devaluing dollar would help import deflation at a time when inflation and interest rates would normally be higher.
- Repatriation of cash held by corporate America should increase investment and capital expenditure in the USA.
Possible strategies to ride the crest of this wave of changes include; using pound cost averaging to take a position in resource related stocks like gold miners, industry metal miners and oil companies. Expecting to get big positive movements in share prices starting in 2019/2020; Being ready to use cash sitting on the sidelines to invest after a stock market correction of over 10%. If there is a recession investors would want to get into the retail sector after it has bottomed, and get into growth stocks linked to the economic cycle, ready for the recovery.
Place your bets!