by Ben G | Jul 30, 2022 | Economics of Connectedness, Technology
With the current digital transformation initiatives across the globe, we are currently dreaming of a world where artificial intelligence will eventually create a world self organized around the goals of efficiency and greater productivity.
And we are engaged on this path while committing to remain in the +2 degrees climate scenario. We are putting our entire faith and soul on technology hoping that our innovative technological marvel will save us like a Deus ex machina, out of nowhere. Mind you, that’s how all of us have been formatted, in our schools and leadership programs, truly convinced that some hidden free market deities will intervene and reward us.
But what if this does not happen at all? What if these beliefs in an almighty technology are pure fantasy?
After all, when you look at the requirements needed for this digital transformation and the energy transition, you start to see that all the resources needed to convert the analog world to the digital world are mind boggling. To build all these new electrical vehicles, all these new electrical networks, all these sensors and servers, all these digital infrastructures embedded in new bridges and roads, all these initiatives to convert older polluting technologies to sustainable and clean digital technology, all this will require a staggering amount of resources. Mining experts estimate that within a constrained scenario of +2 degrees for climate change, the new technological and energy transition will require the following consumption within the next 3 decades; 90% of copper known reserves, 87% of known reserves of beauxite, 83% of known reserves of cobalt, 60% for nickel, 30% for lithium.
That is staggering isn’t it? Some of the same experts are now concerned; the very efforts we are initiating to mitigate the very causes that lead to climate change, are actually leading to even greater damaging effects than the ones we are trying to avoid.
Which leads me back to Dune. In that novel, we are placed somewhere in the future, thousands of years ahead. And civilizations seem to have transcended technology. They seem to have taken what they needed from it and even imposed boundaries with it. We may want to examine this relationship that we have with technology while it’s still time. Because using between 30% to 90% of reserves of the most essential resources in such a short amount of time does not seem that sustainable to me.
And we might even discover, sooner than we think, that the very countries that have been able to preserve and protect their environment are the ones that are going to be the best prepared to handle the challenges of climate change.
So what if we each prepared individually for a world where less of these reserves are going to be needed? We may even have to reintroduce some elements of analog technology in our daily lives. This may sound far fetched, but it may have to come much sooner than we think.
Feel free to comment and share your thoughts.
by Ben G | Jul 29, 2022 | Economics of Connectedness
So in my last post, I left you with these increased risks of foreign exchange controls, imposition of restrictions on the flow of capital or on investment, possibly higher taxes on savings. And I was telling you that these risks cannot be ignored. It’s not so outlandish to think about them.
We’ve seen it in the past and we cannot exclude the same thing from coming back.
However one of the things to watch very carefully in this crisis as it unfolds is also the relationship between the euro and the US dollar. That relationship is crucial because for the past 60 years, it has been at the heart of trade flows and investment between North America and Europe. In fact, it is the unique and sole guiding star that all investment professionals have been watching extremely carefully for the last decades. It has always acted as a beacon for decision making between North America and Europe, and in fact the world.
As a preliminary and to get a better sense of our coming discussion, I invite you to do a very simple search on Google. Plug in the Euro US$ parity and click on the chart that Google will give you. If you had trouble with it and for the sake of saving you time, here the link to the chart we will be commenting on in the minutes to come, Click here . Make sure you ask for the maximum of history. The chart will show you a Euro / US$ chart that goes all the way back to 1982. You can look at the value of the Euro versus the US$ or the opposite. But for the sake of our discussion here, we will refer to the number of US$ there are per Euro. Just a little side note here; I will always refer to charts and data that are commonly available and easily accessible. You don’t need to subscribe to expensive services to get access to them.
Of course, the Euro was only launched at the beginning of the 2000’s. So the number that the chart shows you here is an extrapolation based on the conversion rate of each currency joining the Euro at the date of their membership. Once you know that, you can calculate the Euro going back as far as you can. Here, Google manages to pull a history as far back as 1982. For example, the German Mark was locked at 1.956 German Marks per Euro, the French Franc at 6.56 FRF per Euro, the Italian Lira at LIRA 1936.27 per Euro, and so on. You get the picture. So once you know that rate that was baked into the Euro, then you are able to extrapolate the Euro for as far as you can, and that’s how Google did it. Sorry for the technical side, but I thought you should know.
So that history since 1982 is good enough for us, because once you take a look at that chart, it will tell you a fascinating history, a history that will help you project what is most likely to happen in the months and years to come.
Take a look at it and what you will see is extremely instructive and likely to shed some light on what is to unfold in the near future.
You see, that relationship at that time was at the heart of the world economy. China was yet to implement its model and Asian tigers were barely starting to shake the world. Japan was already well established as a member of the G3, among the top three economies in the world, but its model was still strongly reliant on the other G7 members, the core of the world economy namely the US, Germany, France, the UK, Italy and Canada. In other words, the world’s center of gravity was still hovering somewhere around the North Atlantic ocean. That relationship between the US$ and the core currency of Europe, the German Mark, was the crucial anchor of the world, and everyone had to pay attention to that one. It was the backbone of the world. And it still is, even though we talked to you few days ago about the rising share and power of the BRICS.
So when the Federal Reserve of the US started to hike rates in the early 80’s, the world was shaking. First, back at the beginning of the 80’s, you had a situation almost similar to what we are witnessing now; high inflation with a federal reserve much more inclined to fight it at any cost. It was just doing what it was supposed to do. “You got to do what you got to do”, and that was Paul Volker’s motto back then. That’s a style and that’s what built the Federal Reserve credibility. That was an aura that magically started to hover above Paul Volker’s head, and it never left him. So it obviously contributed to the US$ renewed strength, and the US$ flew through the roof, literally, pushing the hypothetical Euro (the DEM then and all the other European currencies) to the abyss at US$ 0.5930 per €uro at the beginning of 1985. Or to put it differently, one US$ reached a peak of DEM 3.3002.
Keep that number in mind; DEM 3.30 !!!
So as that chart shows, that extreme strengthening of the US$ was becoming untenable for most of the European economies. Among themselves, it triggered intense dizzying gyrations within Europe that left every single European policy maker powerless and much more prone to irreparable decisions and mistakes. In the end, leaders of the G5 (France, Germany, US, UK and Japan) decided to gather and cap the extreme strength of the US$. In fact, the US currency had gained strength not just versus European currencies, but also versus the Japanese Yen (look at the chart here); between 1982 and 1985, the US$ versus the Japanese Yen was fluctuating within that intense range of Yen 230-266.
As a result, all these central banks joined forces to push the US$ back to more reasonable levels of US$1.17 -1.24 per €uro (DEM 1.67 – 1.58), and Yen 150 per US$. The move was led with such success that another agreement was needed to prevent the US$ to slide even further. So the G5 +1 (Italy) met again to sign the Louvre Accord. It was then stipulated that each country would pursue the necessary reforms in terms of public expenditures, trade imbalances and market liberalization. There is so much more to say about these two agreements (Plaza and Louvre), because they literally stand at the heart of the world order that was to unfold. Every observer looks at the fall of the Berlin Wall as a tipping point to what came afterwards, but the real harbinger of what was to follow really took root during these two agreements. But that’s the topic of another discussion and we’ll get back to it. In any case, the US$ stabilized and the G7 could find solace in the fact that the Eastern bloc was collapsing at the same time.
Global markets could then feel reassured that currencies would fluctuate within these newly found bands versus the US$. These narrow ranges and wider ranges were implicitly agreed and everyone was fine. When tensions were at the lowest and the economies were cruising smoothly, parities would settle within a narrow range that contributed to cement further confidence in the near to medium term. When tensions were rising against one side of the other, the currency parity would tend to move outside of that narrow range to more extreme limits. For the €uro/US$ parity, anything within US$ 1.05 – 1.22 (DEM 1.86 – 1.60 per US$) would act as a narrow range. For the Yen/US$ parity, that narrow range would be US$130-150. The red zone for both parities would be outside of those ranges.
In any case, for both parities, since the Louvre Accord, currency markets have been fluctuating within these outer and inner ranges, alternating against one or the other party.
And up to now, everyone appears to abide by these ranges, at least implicitly, even in the absence of an explicit statement from monetary authorities. Speculators and hedge fund managers have respected these lines that cannot be crossed.
At least, that’s an order that makes everyone comfortable, but for how long?
Because the questions that we must all ask ourselves as we stand today are the following;
- Now that the FED is engaged in a rate tightening campaign, will the ECB follow in lock step ?
- Which Central Bank is more likely to succeed in its fight against inflation ?
- What differential of growth can we expect over the longer run?
Needless to say that for the first question, we have to admit that the ECB cannot go as far as the FED, because of the internal chaos likely to emerge within the Euro area, especially from those countries that are the most highly indebted.
It follows that, for the second question, the FED will probably succeed with a softlanding, whereas the ECB could crush inflation, but at the cost of a crash landing. Now, it would be a total disaster if it crashed and inflation remained elevated nonetheless.
And finally, for the 3rd question, the differential of growth remains of course a lot more favorable to the US.
In other words, the €uro still has a lot more to go on the way South. Remember, it hit US$ 0.60 in the early 80’s and US$ 0.86 in the early 2000’s.
That’s what I wanted to share with you today. Let me know if you have questions and feel free to comment.
by Ben G | Jul 28, 2022 | Economics of Connectedness
Week after week, it feels like the Eurozone is inching closer to the brink. Of course, there is still a lot of denial. We are made to believe that all is well in the best of all possible worlds.
But the danger of fragmentation and dislocation within the Euroarea is getting even more present and clear. Yes the euro zone is in existential danger.
The danger threatens our economy, our savings. So we have to prepare. We have to be ready because this will have global consequences.
The powerful hot winds of disruption are blowing from many directions;
- From France where inflation keeps creeping up and consumer confidence is collapsing.
- From Italy where a political crisis paves the way for totally uncertain elections in the Fall.
- From Germany which is hit from all parts with inflation, energy supplies and with increased doubts regarding its role within the Euroarea.
- From the European Central Bank with a decaying credibility that will limit is ability to have an impact and precisely generate this new crisis in the eurozone, perhaps even destroy the zone?
Let’s start with the European Central Bank. It just increased its key interest rate (the refi rate, the bank refinancing rate) from 0% to 0.5%. That’s good but it’s time for the ECB to smell the coffee. That rate hike alone, is not going to do anything. The ECB’s target is 2% for inflation, yet the actual inflation in June was at 8.6%, an all-time high which did not happen overnight.
So, if the ECB is really intent to fight inflation, it would have to go with another series of 800 basis points at least. So far, this was barely an olive from the starters menu.
And yes, that inflation did not pop up just like that, like thunder in a blue sky.
We have been announcing this rising inflation for months and months and seen it creep up higher and higher every single month. Meanwhile, the European Central Bank was doing nothing. Just watching and calling it “transitory”, that magic word to exonerate itself from its own responsibility.
So, that rate hike is encouraging because it shows that the ECB just removed its rose colored glasses. But by waiting for so long to step up to the plate, it has also eroded its credibility. You see, what makes a Central Bank efficient has nothing to do just with what it does, but with how it does it. Moving rates higher or lower is a monetary motion that has a certain importance, but that alone is not what makes the move potent. It’s also the style and gusto with which it is performed. For those of us who are old enough to remember, we knew that the Bundesbank had a certain style when it delivered a monetary move. Probably 80% of the impact of that move came from the style with which it was doing it. And that’s the aura and style the ECB is missing. It’s trying to act as if it is the Bundesbank but it’s not the Bundesbank…
So the argument used so far is the following; Euro rates have to be raised to somewhat follow the FED and reduce the interest rate differential between the United States and Europe.
In theory, that’s true. Ideally, with that rate hike, the euro should have appreciated a lot more. But that’s not what happened. The Euro did bounce back but just a little bit up. We are barely at $1.02 for the Euro. It hardly moved. And that alone is testimony to that eroding credibility for the ECB.
That alone is very concerning.
And why ?
First, because the ECB waited for so long.
And second, because this rise in interest rates couldn’t come at a worst time than the one we are living now. What is crucial to understand is that normally a central bank must anticipate what is going to happen. When in 2021 we saw inflation looming on the horizon, a forward-looking and vigilant ECB should have stopped printing money, or even raised interest rates a little bit. This would have built a necessary cushion, which would have made it possible today to reignite the economic engine.
But, that’s not what happened.
Not only did the ECB appear like it was sleeping at the steering-wheel all the time by losing control over inflation, but now, in order to correct that impression, the ECB is now raising rates precisely when the euro zone is plunging into recession. That whole mishmash alone is enough to seriously harm the credibility of the European Central Bank.
Add to that mixture the most recent economic indicators. The latest leading indicators for the Euro zone, the so-called purchasing managers’ indicators in industry, in services, all sectors combined really stands on the brink between recession and growth.
But we are probably already in recession.
And that’s the time the ECB chooses to wake up and hike rates…
….. Bravo !!!
We are definitely in the process of falling back into recession and, moreover, we have also seen this for several months in the household confidence index.
With inflation soaring beyond reason, from then on, households have no margin to continue consuming. So household confidence is collapsing. In France, the figures for July are at the lowest since the 2009 recession. It is even worse than the 2013 crisis with the Greek crisis, or even the coronavirus.
So this is what is happening today in the Eurozone.
And unfortunately we did not anticipate this, and above all we used all our ammunition during the coronavirus pandemic. We no longer have the means to restart the machine and we see that of course everywhere, especially in France.
The latest indicators in the industry are therefore back below 50 for France. In services, it is still resisting thanks to tourism. The GDP has already seen a decline in the first quarter of 2022. Two consecutive quarters of decline in GDP, would qualify the business cycle as a recession. And France is directly under that threat.
That recession is certainly already there, here in France, and in the eurozone as a whole. And the margins to restart the engine have evaporated.
Everywhere in Europe, we have public debts which are still at stratospheric levels, as in Italy. In Italy, a political crisis has now been added to the mix with Mario Draghi’s resignation. We are therefore going to have new elections next fall. Public debts are indeed extremely dangerous in certain countries, such as Italy and France.
In Germany, it is at 70% public debt of GDP. If we look at the euro zone, it’s around 95% on average, below 100%. And then after, obviously you have Greece and Italy. Greece is at 190%, Italy at more than 150%. In Portugal, Spain and of course France, we are at about 115% of GDP in public debt and soon 120% certainly.
Take a look at the Italian GDP excluding inflation from 1999 to 2021, and you’ll notice that the level of the Italian GDP is at the level we had in 2000. Incredible, isn’t it ? Because it means that Italy wasted two decades. For Greece it is even worse, because we are at minus 27%. The Greek GDP today that is equivalent to the level we had in 1998.
So this crisis is societal. It threatens political stability as a whole. There are temptations on slightly anti-system politicians and if they come to power in the Fall in Italy, that could explode the EURO zone.
As a result, Italian interest rates have risen very sharply. The rate spread between Italy and Germany is at extremely high levels with a spread of 240 basis points.
Until now, Greek yields were always above the Italian yields. Guess what? Recently, we witnessed something quite incredible. Something historical; the Italian yield exceeded the Greek yield, meaning that markets have less confidence in Italy and more in Greece.
In Germany, the press observes all this and is absolutely not satisfied with what is happening. Beyond Italy, the criticism of the German press is now openly directed at the policy of the European Central Bank, even comparing the latter to how Turkey is handling the Turkish Lira.
We are no longer in the same situation as the one we had with Angela Merkel. Up to now, the Germans, notably thanks to the leadership of Mrs. Merkel, have always been able to rely on their credibility. Today, we are no longer on the same wavelength. When Germany was doing well, it could actually afford to accept few slippages and procrastination here and there within the EURO zone.
This time, it’s very different. Because, at the moment, in Germany things are going badly. The latest leading indicators for purchasing managers in industry and services are below the 50 mark. Germany is therefore plunging back into recession. If we look at the business outlook, we are at their lowest since April 2020 in the midst of a pandemic. So there too, that announces a collapse of the German GDP. And so, therein lies the problem. Now even the Germans are running external deficits. Their economy is bad and they are no longer willing to pay for everyone. Overall today Germany no longer has the means to support this euro zone and therefore that is what is extremely dangerous.
There is even a new echo called GERXIT, the risk that Germany itself decides to exit the Euro. That too cannot be excluded.
We therefore find ourselves on the verge of a new financial crisis of the 2008 type, but much more powerful and way more systemic. Because this time, it is not about a bank or a too big to fail institution falling apart. This time, we are dealing with sovereign states.
So what could happen?
We cannot exclude the creation of a new euro zone, made of several groups of countries. Or obviously we could also have everyone revert back to their older currency and, there obviously imagine the chaos that it would represent.
But at the same time, in the midst of this shambles and all this inflation, the great danger is that states will obviously no longer be able to finance themselves so easily.
States could then revert to schemes coming from a past that we thought we would never see anymore;
- They could for example raise taxes especially on wealth and savings accounts. In fact, there was an IMF recommendation in January 2021 advising States to draw on the savings and wealth of citizens.
- And then as this prospect will cause fears on the part of savers, it is also not impossible that another danger will point its nose, which is that of a gradual closing of the borders with of course customs duties.
- Exchange controls could also come back. For those of us old enough, we knew what they looked like. Investment and capital flows could be subject to many more restrictions and controls. It would be a throwback to the 80s. A return to the past but back to the future too. States and regulatory agencies have indeed all the technology and algorithms they need to implement these restrictions a lot more easily and efficiently than in the 80’s.
So don’t think that this seems delusional and excessive. It is a lot more possible and probable than it appears.
Clearly, we are on the cusp of a new era. That’s what I wanted to share with you today. Let me know if you have questions and feel free to comment.
by Ben G | Jul 17, 2022 | Economics of Connectedness
The last time the Euro was at perfect parity with the US$ was a little less than 20 years ago, in November 2002. And here we are again. All it took is just a few weeks to get back to that parity.
At the same time, the last few weeks also reflect nothing more than the tipping of that global order we have been used to in the last 70 years. And it’s a story which is part of the narrative we shared with you several times in the last few months.
But it is also the story of the Euro that needs to be told here with a narrative that will allow us to better grasp the unfolding of events in the times to come. The tipping of global order seems to be mirrored by what we are witnessing on the Euro/US$ parity. For the first time in 20 years, the parity fell below $1. That’s a sign of what’s to come and we’ll tell you why.
If you remember, we already talked about the shifting global value chains, and the inflationary cycles we have witnessed in the last 70 years. We also referred to the likely shifts in the dynamics of currency reserves.
This is all part of the shifting global order. And you are all witnessing under your own eyes right now is a momentous milestone in the longer ark of global history.
But don’t be fooled by appearances. There is a tendency to think that these shifts are all taking place because of the war in Ukraine. And I want here to stress that these changes were already bubbling under the surface for quite a while. All you have to do is look at the last 70 years.
We got used to the way things looked in the last 70 years and thought it was part of normality. But under the surface of that apparent normality, many deep changes were happening. Many emerging countries could see it coming because they themselves were at the forefront of the dislocation happening in slow motion. Meanwhile, many of us, in richer nations especially, could not see it coming. We were too busy with our internal election cycles and inner social-economic workings. We were too busy trying to rearrange the deck of ship without any concern about the effect our central banks were inflicting inadvertently on other countries tied to our own currencies.
That’s the Triffin dilemma we were referring to a few days ago. So let’s take a little diversion here at this point of our narrative. Let’s talk first about Central Banks.
In our current dominant monetary system, central banks are here to protect the value of a currency and maintain price stability. That’s in a nutshell what they are about. You see, a central bank just does what it is supposed to do. It’s like a robot with a clear mission embedded in the coding of its inner workings. If you tell it to fight inflation, it will do just that. That’s all and nothing else. “You got to do what you got to do”, as the saying goes, and that’s how a central bank behaves. Some of them are more activists and reactive on the short term, others take a longer view to start acting. The activist and reactive ones will handle the situation more swiftly and correct their errors more rapidly because they handle a monetary area that is smaller and less systemic for the world (the Bank of England, the Sverige Riksbank, the Bank of Canada, the Reserve Bank of Australia etc..).
Others, the Federal Reserve in the US, the ECB in Europe, the Bank of Japan, or the People’s Bank of China, act more like the super tankers of the global monetary system. Their areas of influence are much larger and reflect the size of their respective economies and their trading patterns with the rest of world. Their actions have a much longer and deeper effect. They are systemic. They are like super tankers which need a very long time to turn around. A friend of mine back when I was in business school was also studying at the naval school to become a commercial ship captain. He was telling me that these super sized super tankers can take up to 10 miles to stop. You don’t maneuver these ships like a speed boat.
So these large central banks are the super tankers of central banking. And right now, because of that sudden and violent spike in inflation, they are about to slow the super tanker down with a single concern on their mind. Stand on the breaks as aggressively as possible and bring the economy as fast as possible to a halt, even if it means that a recession unfolds. And if their action makes waves all around them that could capsize the smaller boats and speedboats of the global economy, that’s none of their business. It has happened several times in the last few decades and they will not hesitate this time again.
We saw it in the early 70s with Volker at the head of the Fed. We saw it within the older Euro area – then the European Monetary System also known as the European monetary snake in the early 90’s. Back then, both the FED and the Bundesbank just followed that adage: « you got to do what you got to do. »
And this time again, history will repeat itself. But this time, something different is happening. This time around, the inflationary tsunami is hitting everyone at the same time and concomitantly.
And this time around, the super tanker FED is about to create waves that are about to capsize another supertanker called ECB/Euro Area.
And all the other supertankers standing in nearby waters are also watching and wondering how they should protect themselves. Some of them, the BRICS, are even looking at taking things into their own hands. And this time, it looks like their initiatives could lead to some tangible results.
Let’s consider the following; back in 1950, right after WWII, US+UK+FRA+GER represented 45% of the world economy, CHINA and INDIA 9%, and the Rest of the World 46%. Yet, out of that share of 46%, the great majority was in the hands of large colonial empires. So that share allocated to the US/UK/FRA/GER should be a lot higher, closer to 70%.
China and India together, back in 1950 represented 9% of the the world GDP. In 70 years, these two same countries rose to 22.3% of world GDP (https://www.visualcapitalist.com/100-trillion-global-economy/).
Meanwhile, the same US/UK/FRA/GER economies stood at 35% of world GDP in 2022. That’s a 10 percentage point in 70 years.
But don’t get fooled by these 70 years. It took China 20 years to get to the number two spot and it is expected that it will surpass the US by 2030. Many other countries will also climb that ladder faster than expected, just because their population will provide the impetus for that economic vibrancy.
In other words, what the currently industrialized countries did in 100 years, other BRICS and emerging countries will take a fraction of that time span, maybe 15 years, or 20 years, or even 50 years. But in any case, now is the tipping point, and it’s happening right under your own eyes.
That’s what I wanted to share with you today. Let me know if you have questions and feel free to comment.
by Ben G | Jul 11, 2022 | Economics of Connectedness
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.
