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The Fragmented Dislocation of the Global Rubik’s Cube

In recent weeks we have had the G7, the NATO summit, the BRICS summit, and the G20. All these meetings have had the merit of revealing more clearly a world in even greater fragmentation than just a few weeks ago. These are all the various facets of an increasingly fragmented rubik’s cube with an added dynamic of dislocation. This does not bode well at all.

Several facts are there to illustrate this fragmentation, but it is also a shift, and even a transition of power. We must even speak of a seesaw movement, where the countries of the South are asserting themselves with much more vigor.

The first fact is first of all what happened at the G7. Indeed, for the members of the G7 who therefore met in Germany, the question was whether they can really push back Vladimir Putin in Ukraine. However, after these few weeks, we can’t help but see that Westerners also seem to be lagging behind in the evolution of the planet.

The second highlight is also on the side of NATO, in a major meeting in Madrid, during which the members of the Alliance clearly reaffirmed their unity.

The third highlight is at the G20, the expanded format of the G7, that it must be found. Indonesia, which did not take into account the injunctions made to it not to invite Russia to the G20.

The fourth highlight is the BRICS meeting (Brazil, Russia, India, China, South Africa). Admittedly, it was a virtual meeting for health reasons. This BRICS summit, hosted by Beijing this year, is a major event in this shift in the world that we are witnessing. Because the BRICS group is now about to grow with the desire of Iran, Saudi Arabia, Indonesia, and Argentina to join this group, which in fact constitutes membership in the New Silk Roads project. This is not nothing, because among these four new members, there are no less than 3 members of the G20, including three major oil producers!

What we are experiencing is therefore not insignificant, but should not be a surprise. This turning point that we are living with force today, we have to go back several years to measure its historical significance. We are indeed witnessing a clear desire for emancipation on the part of the countries of the South, and the threats of sanctions no longer scare them.

Already in 2009, and in the years that followed, many countries of the South had expressed their desire to reform the international monetary system, after the financial crisis of 2007-2008. But in the trading rooms of London or New York, the concern was above all to get out of this trap as best they could, thanks to generous liquidity operations to save systemic institutions. “Too big to fail” they said. So that justified all the sacrifices and the public was going to end up benefiting from it, at least that’s what was promised to public opinions. Calls from the South to reform the monetary system were therefore received without too much attention, since what mattered was to save these systemic institutions. And year after year, the illusion set in. “Kick the can down the road…” was the motto on Wall Street and in asset management circles.

In the meantime, no one was listening to these suggestions for monetary reforms. They were very wise.

However, it would seem that we are gradually moving towards these reforms, and the seesaw movement we are witnessing could even contribute to this.

We are heading in that direction and it seems to be unavoidable this time.

First, because within the G7 alone, tensions are going to be untenable. For a reminder, 3 of the 7 members in the G7 are within the Euro area, a Euro area under extreme stress, with Germany, France and Italy facing a debt crisis which is putting them at odds against each other. How long will they be able to maintain a certain unity?  The Euro is already losing ground, and markets are noticing the challenge for the ECB of trying to square the circle of economies that are requiring completely divergent monetary policies. On the one hand Germany’s economy where rates should be hiked a lot more sharply, while for Italy and France, the next rounds of rate hikes could be devastating. The Euro is about to experience moments that could put its own existence at risk in the coming months.

The second reason, and not least important, that should lead us to a monetary shift of paradigm sooner than we think has to do with events in emerging countries. Sri Lanka appears to be the most obvious example. Here is a country brought to the brink of implosion. And it may not be alone in such a dire situation. The strength of the US$ itself is becoming a problem. With the key reserve currency of the world gaining strength, it will become increasingly difficult for countries whose debt is in US$ to continue to pay interest and principal of their debt properly.

We were warning about that a few months ago already. Whenever interest rates in US$ go up, it sends a shock wave to the rest of the world. It’s called the Triffin Dilemma and we talked about it a few weeks ago.

But we also talked about how the US$ is not about to lose that status that fast. It could continue to maintain its global currency reserve mantel regardless of the challenges we just highlighted. In that regard, we fully subscribe to Ray Dalio’s view which states that a reserve currency status lasts a lot longer than what the fundamentals dictate.

In the meantime, countries of the South, through the G20 and BRICS framework, will continue to look for alternatives that will alleviate their challenges.

But it may take a lot longer to settle and for each of us to see through the dust. Once the dust settles, it may have taken several years, if not decades.

That’s what I wanted to share with you for the time being,

Let me know if you have questions and I look forward to hearing your thoughts. Feel free to comment.

The Fragmentation of the World

The fragmentation continues. Political fragmentation in France, societal fragmentation in the United States, monetary and financial fragmentation in the euro zone with this ongoing bond crisis.

In the United States, the Supreme Court’s decision to give states the right to decide for themselves on their own abortion policy seems to leave the door open to other decisions of the same nature.

In France, the political landscape also seems blocked after the legislative elections of last week, which delivered an extremely fragmented landscape.

At the same time, in the bond market and financial markets, corrections are giving way to an improvement, but all this seems only temporary.

However, it is also on a global scale that this fragmentation must also be observed. The BRICS who have come together on their own and have just completed a summit in virtual form. The BRICS (Brazil, Russia, India, China, South Africa).

This summit usually takes place in Beijing and represents the most visible form of the new structure put in place by China around the Asian Bank for International Investments and all the infrastructure projects, better known as the new Silk Road Initiative. The BRICS therefore held their virtual summit and it was an opportunity at the highest level, at the level of heads of state, to confirm their solidarity with Russia, each with more or less different degrees. But it is all the same a certain solidarity however this summit. But this BRICS summit is not just about these 5 countries. It is also all the countries which have subscribed to the AIIB and which are, directly or indirectly, involved in new silk road projects.

With the new international developments, it seems that this project is now crystallizing much more around emerging countries which continue to strengthen their adherence to this project.

On the other side, there is the G7 which is currently meeting. These two blocks, G7 and BRICS now seem to balance each other out in an explicit way. On the one hand, the BRICS much more inclined to take their destiny firmly in hand and on the other hand the G7, which is currently meeting.

This is therefore the state of the world, in the middle of the year 2022, with alliances and partnerships that are gradually being put in place, along commercial, societal and military lines. NATO will also bring together its 30 members in Madrid from June 28 to 30.

So that’s where we are; on the one hand, the United States is grappling with a societal crisis which does not seem to be over and which does not spare Europe either, since this decision of the Supreme Court of the United States on abortion raises fears of similar developments in other countries. These challenges will not stop there and seem to indicate new lines of fracture and fragmentation unsuspected until now.

The other political fragmentation in France is this internal challenge that President Macron encounters in forming a new government. If it is not resolved, we must not exclude a radical decision which could include the dissolution of this new National Assembly. However, this could only occur after multiple attempts by President Macron to form a government, trying to associate all goodwill as much as possible to form a new government. For the moment, we are not at that point, but it is not excluded, especially after many attempts on the part of President Macron.

And then, for the months to come, we must not ignore the current fragmentation in the financial markets in the euro zone. With the inflationary pressures manifesting themselves from one country to another, we are therefore witnessing a change in the position of the European Central Bank, with a tightening of monetary policy to come. However, there too, tensions are exacerbated within the area itself. To fight inflation, the European Central Bank will of course need to tighten its rates, just as all the other central banks have done, whether in industrialized or emerging countries.

The ECB will therefore have to fight inflation, but at the same time we can clearly see that this decision will come up against the need to remain vigilant to the needs of certain countries in the euro zone and in particular of countries whose debt ratio is extremely high, and who in this context of growth have no interest in seeing rates rise so quickly.

We therefore have for the first time in a very long time a divergence of interest between Germany and the countries of the North on the one hand, and those of the South whose indebtedness is reaching its climax. This tightening of monetary policy could be fatal to them. The European Central Bank is therefore faced with this divergence and this dilemma that is extremely difficult to resolve. This is a new element of this fragmentation which risks dealing a huge blow to the euro zone and to the European Union as a whole.

Moreover, such a divergence and such a crisis, such a rise in interest rate differentials between Germany and the other countries of the European Union, the last time this kind of crisis happened was in 1993. It was just at the time of the reunification of Germany. It was therefore during a period when the euro zone had not yet come into force. This was when the Maastricht Treaty was signed.

We haven’t seen such a rise in interest rate spreads since the early 1990s when Germany reunited, of course we also had 2008. Even if the rate level in absolute value is not as high, we are in a much more critical situation today than in the early 1990s and 2008.

This brings us back to the signing of the Maastricht Treaty.

The Maastricht Treaty, for those of you who were not there, was the decision to set up a monetary and economic union, provided that the member countries met a certain number of criteria in terms of budget deficit and debt ratio, these famous Maastricht criteria decided by François Mitterrand and Helmut Kohl; 3% of GDP for the budget deficit and 60% of GDP for debt ratios.

We are very far from it today since we are now at a debt and budget deficit rate for France which is now double what it was at the beginning of the 90s. The stock of the debt is therefore gigantic and any rise in rates means that debt service cannot be covered by the income generated by sluggish growth. The situation will be even more dramatic if we find ourselves in stagflation. And this observation does not only apply to France. It is also valid for practically half of the Euro zone. The European Central Bank is therefore faced with a lethal fragmentation and an insoluble dilemma.

So that is the state of this fragmentation. It doesn’t show anything really promising.

That’s what I wanted to share with you for the time being,

Let me know if you have questions and I look forward to hearing your thoughts. Feel free to comment.

 

 

 

France: Fragmentation at the National Assembly

I was telling you about fragmentation yesterday, in the global economy and in financial markets. Tonight in France, we are witnessing a manifestation of that fragmentation in the political sphere.

We already knew that the newly reelected French President Emmanuel Macron would have trouble achieving an absolute majority. The real results are a lot worse than expected.

At the time of this post, president Macron’s coalition, ENSEMBLE! barely reached 234 (compared to 336 previously, a decline of 102 seats). The left wing NUPES reached 141 (60 previously, an increase of 81 seats). The traditional Right Wing Les Républicains/Other Various Right got 75 (119 previously, a decline of 44 seats), Rassemblement National 90 seats (8 previously, an increase of 82 seats).

Clearly, we are in that second scenario that I told you about few days ago. However, a lot worse scenario than what I described. 

Ensemble! Macron’s coalition did win a relative majority, but way below the threshold of 289 seats. President Macron will now have to rely on the Right Wing Les Républicains, but that’s not even guaranteed. He can also extend himself to the left wing and pull some occasional support from some of the left wing partners within the NUPES coalition or from the left wing parties that have not joined the NUPES. It will still be possible for Macron to expedite his reforms but on a case by case basis and probably on a much harder line than in the previous scenario.

However, at the same time the left wing NUPES will also rely on its large number of seats (141) to create opposition and harden the debate. 

The much better than expected result from the far right Rassemblement National will also create further undercurrents of turbulence. Despite Macron’s ability to rely on the right wing Les Républicains, expect very hard debates, leading to a tense social climate, that some already call the “Fourth Round”.

Overall, this new National Assembly appears very difficult to lead in the foreseeable future.  

Should President Macron find it impossible to gather the support he needs, he may have to call for new general elections to reshuffle the parliament, but only after one year.

In the meantime, expect some heavy turbulence, especially on any topics related to France’s commitment to European treaties.  Indeed, if you take the number of seats of parties that are openly eurosceptic, we end up with 30% of the parliament. That’s enough to create tense debates in the coming legislature.

That’s what I wanted to share with you for the time being,

Let me know if you have questions and I look forward to hearing your thoughts. Feel free to comment.

 

 

 

Fragmentation, From One Crisis to Another

“Fragmentation”, that’s the new word we keep hearing more and more. From the IMF which is warning us about the fragmentation of the financial markets, of the global trading systems, of the supply chains.

We heard it again this week from the European Central Bank which is now concerned about the fragmentation of the government bond market within the Eurozone.

We hear it increasingly from commentators and analysts who want to express their worries about a world that is coming apart at an increasing speed.

Fragmentation is indeed the opposite of integration. And for sure, since COVID, value chains, supply chains and political coordinations are falling apart. The war in Ukraine is only pushing it to a new plateau of chaotic dislocation.

And that new plateau appears to have been reached when the IMF warned, on May 23, 2022 at Davos, that the world economy is going to hit the biggest financial headwinds since world war II.

So when I heard that, and when I saw that the ECB convened an emergency gathering of its governing body this week, it just felt like a perfect storm was just about to hit the world.

For sure, we already knew that the FED was getting ready to hike rates by a large magnitude – it had told us already and it ended up pushing key rates by 75 bp, the largest since 1994.

So all of a sudden, all this ruffle and shuffle on financial markets pushed me back into the past. I started seeing all these crises that I have witnessed in my life back into my mind. It always helps to remember those moments. Reading about them in books and technical notes does not provide any additional flavor and learning. The reminiscence of such events, the very process of getting yourself back to those moments is where the learning happens.

And for those of you who are too young to remember, I highly recommend you to read about these moments by feeling how it would have been for you in person.

You see, there is always that sense that we already know what happened from the history books, that it is old stuff and that it’s just a waste of time. But I beg to disagree and here is why.

The crises I have been privileged to witness personally, either as a market participant, or on the sideline are the following:

August 12, 1982 Mexico – I was just a student in business school

August 17, 1998 Russia – I was a market analyst on Wall Street

September 15, 2008 Lehman Bros – I was working on a corporate social responsibility project

October 20, 2009 Greece – I was working on a corporate social responsibility project

And now 2022

Behind every single climax, there was a silent web of interconnected waves bubbling silently under the surface.

Indeed, the Mexican Crisis of 1982 was a distant aftershock of President Nixon’s decision to suspend the US$ convertibility into gold and the demonetization of gold that followed at the Jamaica conference of 1976. Indeed, once all currencies became floating against each other, without any safety net, then anything that happened with the dominant reserve currency, i.e the US$, would send tremors of instability to the rest of the world. Mexico, one of the US closest economic partners, felt the heat immediately, as soon as the Federal Reserve hiked rates without any restraint at the beginning of the 80’s.

I will go back to each one of these climaxes by telling you more about the feelings and experiential conditions that prevailed for me personally.

Everytime I do that exercise, it connects me closer to an economic theory that a prominent economist provided at the beginning of the 60’s. Every time I examine those successive crises, they become even more clearer thanks to that theory. I am talking about the famous Triffin dilemma. It becomes even more real the more I feel these crises through real and experiential circumstances. I highly advise you to do that for yourself.

Yet, notice also how these climaxes seem to favor August, September and October. Just a notice…Nothing more.

And then, whatever came after that were aftershocks, after effects of a larger dilemma. The dilemma of reserve currencies.

That’s what I wanted to share with you for the time being,

Let me know if you have questions and I look forward to hearing your thoughts. Feel free to comment.

France: Further Thoughts on the Rubik’s Cube of French Politics

We are still few days away from the second round and the key highlight of the first round was abstention at a record 52.5%. At the presidential election, we saw the emergence of 3 blocks, while at the current parliamentary election, we see 2 blocs (Listen further here).

At this point, several possible scenarios:

  • Ensemble! Macron’s coalition wins a majority above the required 289 seats at the National Assembly. Macron’s government will rely on the kind of vote called “playmobile”. Macron can rely on it to expedite reforms on pensions, fiscal commitments to the European treaties in order to bring the budget deficit back to 3%. “Playmobile” is a term used in French politics in reference to the readymade regulations and laws that can be quickly expedited. It’s a derogatory term mainly used by the opposition, whichever side of the spectrum it comes from, to describe how debates on specific laws are not really happening. Yet, with the Front National gaining the ability to form a parliamentary group projected within a range of 23 to 45 seats and the newly found power of the NUPES (projections of 161 to 210 seats), expect a lot of hardening in the debates. These two groups will use whatever opportunity they can to disrupt that “playmobile” process that characterized Macron’s first presidential mandate.
  • Ensemble! Macron’s coalition wins a relative majority or even a thin majority: Macron will then have to rely on Right Wing Les Républicains. It will still be possible for Macron to expedite his reforms but on a case by case basis and probably on a much harder line than in the previous scenario. However, the left wing NUPES will also rely on its large number of seats (161-210) to create opposition and harden the debate. Despite Macron’s ability to rely on the right wing Les Républicains, expect very hard debates, leading to a tense social climate, that some already call the “Fourth Round”.
  • Left Wing NUPES wins a relative majority or Left Wing NUPES wins a majority above the required 289 seats at the National Assembly. In that case, it’s a whole new political universe that could have wider implications for European bond markets. We will talk about it further in the coming days.

So these are the possible scenarios. But they are still based on assumptions that remain irrelevant. So much can still happen. Such projections do not mean anything at this point. These are 577 single elections.

In any case, the probability that France will be difficult to govern with a grid-locked National Assembly looms high on the horizon. Pension reforms, spending cuts, to just name a few, will be very difficult to pass.

Between now and Sunday, there are several variables that can still play a role:

  • The abstention; it was the highest among the younger generations (60% to 70%). Should they decide to go back to the voting booth, they will benefit Mélenchon’s NUPES.
  • The reserve of votes; They are more favorable to Ensemble! which can better rely on the right wing voters whose candidates could not pass the first round.

That’s what I wanted to share with you,

Let me know if you have questions and I look forward to hearing your thoughts. Feel free to comment.