01 December 2019

This Is The Way The World Ends

This is the way the world ends
This is the way the world ends
This is the way the world ends
Not with a bang but with a whimper. 

One of the more popular speculations among economic writers is the coming collapse of the US Dollar as the world's reserve currency. Several theories abound as to how this happens, most of which posit either President Trump as the author of dollar destruction, Fed Chairman Jay Powell as the destroyer of dollars, or an unholy alliance of both men leading the US economy over a cliff and into the abyss.

Readers of this blog will recall that I have written briefly of the chimera of US economic growth during the past decade, noting the unmistakable shift in financial market dynamics that occurred in 2008-2009, with a greatly expanded supply of fiat dollars steadily inflating financial asset prices. For the record, I freely confess to having an imperfect understanding of the financial and economic dynamics at play.

Still, there is sufficient data to suggest that the Cassandras decrying the coming collapse are all both right and wrong. 

Markets ARE Distorted And Dysfunctional

Let us begin with the obvious truth: the world's financial markets are in a parlous state, and have long ceased to make rational sense. We need only review the shift in correlations among the US money supply, core inflation, and financial asset prices to see that something is very wrong.

Let me reiterate one point about the charts I provide here: all of them are based on publicly available data put out by the Federal Reserve and other "officlal" sources. My analytics are of course subject to challenge, but the data is as the data is.

However, this dysfunction is by no means confined to the US. The linkages--and thus contagions among the world's economies are acknowledged and self-evident. One need look no further than the unremarked matched declines this past September between the Chinese yuan and the EU Euro currencies.

China sneezed, and the European economy caught a cold.

At the same time, the currency markets were rejecting the prospect of a financial apocalypse for Great Britain due to a pending "No Deal" Brexit.

In short, the economic data does not align with prevailing economic narratives. On one level, this is unsurprising, as the legacy media has been trafficking in rumors of war, famine, pestilence, and death for quite some time.

On another level, this pattern of misrepresentation is a reminder that fiat money is, quite simply, a fiction. The "value" we ascribe to the dollar, or the yen, or the yuan, or the euro, is an arbitrary and largely capricious assessment superficially based on the presumed economic performances of the economies backing each of these currencies--performances that are assessed on the basis of media reports that are themselves already proven to be of questionable accuracy and veracity.

Worse, little of the legacy financial media highlights uncomfortable truths such as the ginormous global debt overhang that has been a consequence of coordinated money supply expansions by the world's central banks.

The markets are thus badly broken, contaminated with bad reporting, bad information, and bad analysis, distorted and mis-shapen by decades of bad monetary policies world wide.

The Conspiracy Theorists Are Wrong

Yet while it is unwise to ignore the clear signs of market dysfunction, it is equally foolish to presume that all the world's unrest is driven by these distorted market dynamics. Democracy protesters in Hong Kong are not motivated by rises in stock markets and asset prices. One could even argue they are risking their personal fortunes in pursuit of greater freedom within the fascist Beijing regime.

Iraqi anti-government protesters are not risking their lives based on the movements of world currencies. 

Anti-government protests in Iran are not in defense of the US dollar. Iranians are angry at the failure and corruption of the Islamic Republic.

Trafficking in conflict minerals might be facilitated by the fiat money manipulations of the world's central bankers, but it is most assuredly not a cause.

Even where money and economics are part of the underlying facts, they are not necessarily a pursuit of or opposition to dollar hegemony. Much of the machinations in Ukraine are tied to the jockeying among Russia, Poland, and Ukraine over control of energy imports to Western Europe.

Viewing the world through a purely economic lens is benighted and simplistic, whether one is decrying the state of the world today or defending it.

Time Without History

The challenge in prognosticating the outcomes of world events is that the current state of world affairs is without historical comparison.

While the world has seen political and economic superpowers throughout history, from Ancient Persia to the Roman Empire to the many dynasties of imperial China to Spain, Britain, and the European colonial powers, the status of the United States as the sole and enduring political and economic superpower throughout the entirety of the globe is an historic first. The economic might of Han Dynasty China did not rise and fall with the prosperity of the Romans, nor did the collapse of the Roman Empire in Western Europe disrupt the rise of the Mayan cities in Mesoamerica, yet today the economic fortunes of the United States are seen by many as the economic fortunes of the world. The US is the first country to attain a dominant military position across the entire globe.

There simply are no parallels in history to the shape of the world today.

At Most, We Only Know What We Do Not Know

We know from the history of Rome, and China, and Persia that all great empires eventually decay. It is intuitively obvious that US hegemony cannot last, nor is it at all certain that we should want it to last. Yet we do not know from the history of Rome and China and Persia how to view US dominance over the world, either real or perceived. Extrapolations of various trends and geopolitical forces are in large measure wishful thinking.

Viewed one way, China's Belt and Road Initiative is a new form of debt colonialism, and China's pathway to global superpower status. Yet that view ignores the structural stresses and defects observable in China's own banking system. If China's financial systems collapse, the debts they hold from other nations will cease to exist almost automatically--the dissolution of a creditor is a brutal but irresistible means of debt forgiveness.

Similarly, the desires among nations to "de-dollarize" ignores one key function of a reserve currency: establishing the relative value of other currencies to each other. Will Russia and China readily agree on the value of the ruble and the yuan? Will the Brazilian real have stable value relative to either?

As much as nations of the world might wish to dispense with the US Dollar's reserve status, there are few ready substitutes to provide a baseline of exchange among the world's currencies. While some central banks have speculated on a return to a gold standard, at the present time that shift remains largely theoretical. Central banks have been stockpiling gold, but no central bank in the G20 is pegging their currency to gold or any other precious metal at this time.

We may know that the end of the dollar's status as the world's reserve currency, but we cannot know what will come after.

We may know that China's debts must someday be paid--that the world's debts must someday be paid--but we cannot know with certainty all that will befall if those debts are not paid.

We may know that the fiat money system, demonstrably unstable as it is, must eventually collapse and be replaced, but we cannot know exactly when, or how, or what will come after.

We can project, we can extrapolate, we can say "if this, and if this, and if this, then that", but we cannot know with certainty that any projection or extrapolation is anywhere near what will actually unfold.

At most, we merely know that we do not know. At best, we merely know what we do not know.

Actions Have Consequences

The one thing we always know is that for every choice made, for every action taken, a consequence is formed. There will be consequences to President Trump's tariffs, and there will be consequences to Hong Kong's recent elections, and there will be consequences to President Xi's seeming impotence in the face of those elections.

Every action sets new events in motion. Trade tensions between China and the US have set various economic transitions in motion, Supply chains and manufacturing jobs are moving out of China, eager to exploit both the still developing economies of Southeast Asia and to avoid President Trump's tariffs on Chinese goods.

Every bank Beijing bails out inches the Chinese financial system towards crisis and probable collapse.

China may indeed seek to sell off its holdings of US and dollar-denominated debt. That does not guarantee that it will succeed, for if everyone currently buying US debt suddenly wishes to sell US debt, who would be left to buy? A small version of this scenario played out during the summer when Argentine sovereign debt turned abruptly toxic. A sudden dumping of dollar denominated debt would render all such debt worthless--that pattern has played out enough times in the past as to be a foreseeable consequence.

Further, the more China unloads US Treasuries the more the yuan is likely to appreciate as a consequence--a primary reason China purchases US Treasuries has been to keep the relative value of the yuan low so as to favor exports. If China wishes to avoid a too-rapid strengthening of the yuan, which might upend its export-driven economy, it needs to tread carefully where the selling off of debt is concerned. Selling off of foreign exchange reserves (debt) must be accompanied by sufficiently large purchases of other resources to keep the yuan stable.

The challenge of pulling off such a chain of transactions, however, is significant. If there is one lesson that can be drawn from the 20th century it is that centralized planning of economic activity simply does not work. Broad government investment invariably turns out to be malinvestment. If one were to make any prediction about a government plan to sell off foreign debt and direct the proceeds into various infrastructure and other projects, the most reasonable prediction would be that the government--any government--would make a mess of it.

Mistakes Will Be Made

How do I assess the economic prognostications that abound in the media? I say they are all wrong--and they are all right. The BRICS nations are likely to pursue a policy of de-dollarization. China in particular will seek to decouple its economy from the US economy. Iran will seek ways to evade US sanctions, and Europe will seek ways to accommodate them for the sake of doing business. As governments pursue these strategies, they will, as governments are wont to do, screw them up. Heedless of their own ignorance, the policy "experts" in government will set forces in motion they do not fully comprehend, with consequences they cannot foresee, and will then scramble to respond to those unforeseen consequences, resulting in an ever expanding series of unplanned responses. Reaction will predicate action, which in turn will predicate further unforeseen consequence, thus predicating still more reactions.

If there is one sure pattern of history that is eternally applicable, it is the power of government to make a complete pig's breakfast of anything. Mistakes will be made, and they will precipitate chains of mistakes--as has been the pattern of government since the days of Hammurabi.

Will people learn the lesson from this that governments are inherently unreliable? While that is always the hope, if people have not learned that lesson yet even after five millennia of civilization, it seems improbable they will learn it now.

My prediction for what comes next is that of T.S. Eliot: through a series of small, careless, mistakes, governments the world over will topple the house of cards that is always the world geopolitical order, thus ending that order not with a bang but a whimper.

No comments :

Post a Comment

Share your thoughts -- let me know if you agree or disagree!