11 Aug 2023
Global Macro-economic and Geo-political Update
In this newsletter we continue to explore some important events and activities which are part of the de-dollarisation trend which has both short and long term consequences for investors.
Geo-political – Emerging New World Order
From 22 to 24 August 2023, there is a meeting of Brazil, Russia, India, China and South Africa (BRICS) countries in South Africa. The importance of BRICS, a growing global power should not be underestimated as 40 counties have expressed interest in joining and it is expected that most will be admitted as members. It is reported that France asked to attend the meeting and was re-buffed which may be considered as a snub to the western world.
BRICS started about 18 years ago, it has representation from all major continents in the world, with its membership making up nearly 50% of the world’s land mass, they have significant natural resources. The current members have approximately 50% of the global population and around 40% of the world’s GDP. If as expected Saudi Arabia joins, then it will mean that two of the three largest oil producers in the world are in this organisation and with Iran also likely to join this will add even more oil producers. In joining BRICS, Saudi Arabia that is now selling oil in Yuan to China is a further signal of the change to the long standing petro-dollar agreement, i.e., Saudi Arabia sell of oil in USD for US military security.
BRICs membership includes three nuclear powers (four if Pakistan joins) and it has a growing military strength, albeit still not the fire power of NATO and its allies. These countries central banks have large gold holdings and they have been running current account surpluses as major suppliers of goods to the world. Their surpluses have funded the USA budget and current account deficits. Simply, the BRICS bloc is emerging as a challenger to USA hegemony and current world order.
BRICS over the last 20 years has copied western models by creating competing bodles. It set up the Contingent Reserve Arrangement, which is a fund that provides liquidity for short term balance of payments problems, and it established the New Development Bank. These organisations are the equivalent of the International Monetary Fund (IMF) and World Bank, respectively.
A rumoured agenda item at this meeting is for the Shanghai Cooperation Organisation (SCO), the members being China, India, Iran, Kazakhstan, Kyrgyzstan, Pakistan, Russia, Tajikistan and Uzbekistan with observer and associate countries will be merged into the BRICS forum. Similarly, the Eurasian Economic Union (EEU), a group that Putin started to mirror the EU in central Asia is looking at also joining. Given Russia and China are members of all these groups, it is apparent that China and to a lesser extent Russia are running the BRICS show. If these organisations merge into BRICS it will represent 80% of the world’s population.
The Chinese “belt and road” initiative can be seen in the light of BRICS, as China coalesces countries into membership. At the same time China is positioning itself diplomatically having facilitated the Iran/Saudi Arabia rapprochement and has offered to be an unbiased mediator in the Palestinian/Israeli dispute. Even the Australian Government’s freeze with China is ending with tariffs and trade impediments that China introduced on Australian goods are being lifted.
As outlined in previous newsletters, and most recently the newsletter dated 6 April 2023, we reported that there are moves to introduce a new currency. The proposed currency model has gone through several iterations and work accelerated after the US confiscated Russia’s reserves as part of its sanction response to the Ukraine war. The US scored an own goal by freezing Russia’s reserves as it broke the trust of the world in its weaponizing of the USD. The US has 30 countries under sanctions and more countries are questioning the wisdom of having reserves dominated in US assets, e.g., US treasuries and the US control over the international payment messaging SWIFT system. Understandably, countries are questioning whether the USA will confiscate their assets, if they have a disagreement with them?
We do not have any insider information, however we understand that the latest version is the BRICS currency will be like the Euro, i.e., a currency union. Furthermore, rather than been backed by gold, in the same way that the USD was under the Bretton Woods Agreement, it will be tied to the weight of an ounce of gold, i.e., the value of a currency will be determined by the value of the weight of gold where the weight of gold is priced in USD. Does this mean that the BRICS currency is pegged to the USD price of gold? The implications are not yet clear, however the demand/supply (volatility equation) of gold and the USD will play an important role in its valuing. We understand that the BRICS currency will not be redeemable in gold which is what caused the end of the Bretton Woods Agreement in August 1971.
Will a new currency be announced at the BRICS meeting? We do not know. What we do know is the trend of reducing BRICS members dependency on the USD continues as recent statistics reveal that as a percentage of world trade, the USD’s use has fallen from over 74% to around 58%, as bi-lateral trade increases.
It’s interesting to note that when Janet Yellen, Secretary to the US Treasury was asked about a BRICS currency she did not say it would or would not happen; however, we note that senior US officials have been busy travelling the world talking to allies.
In summary, the BRICS is challenging the US based world geo-political and economic order, including the USD role as the world’s reserve currency. We will continue to closely watch BRICS developments as it will have investing implications.
The war continues to move down the escalation path. The US is providing Ukraine with cluster bombs and greater air support, and NATO and allies continue to increase their weapons support. We are seeing attacks on Russian facilities in Russia which until recently Ukraine outlined were off limits. There has been a build-up of troops on the Belarus and Polish borders.
Russia has cancelled its agreement with the United Nations (UN) to allow grain shipments from Ukraine ports which will cause food shortages in parts of Africa, and will add to inflation. Russia has reassured African countries it will look after them, which is an obvious tactic to sideline western influence. These are worrying events.
Era of Fourth Turning
Historian Neil Howe’s the Fourth Turning says that there is a recurring loop of modern history. In that loop we have entered the fourth turning which is a perilous era and occurs once in a lifetime. It is marked by “civil upheaval and nationalisation, both traumatic and transformative: which will reshape the social and political landscape”. The Ukraine war, Taiwan/China standoff and the evolution of BRICS as a global force are all examples, as are other signs we have reported in earlier newsletters. These include the world splitting into autocrats and democracies, and within democracies the polarisation of the political debate between left and right. Another characteristic is demographic evolution occurring as “Baby Boomers” time in ruling the world ends and “Generation Xs/Millennials” take over. These cohorts have a different outlook on life having been a couple of generations removed from the horrors of World War 2, Korean War and the Vietnam War, etc. To these demographics they are just pages in history books, and as they do not have first-hand family and friends experience of these events. Another signal is the significant wealth gap which is supported by those that have the most to lose.
In our last newsletter we outlined that the world is moving from stagflation to deflation environment. Recent statistics continue to support our prognosis as world trade growth has fallen to 1.7% after the post covid jump because of fiscal handouts and loose monetary policy. Consumer Price Index (CPI) figures are falling, money supply continues to contract as banks tighten lending standards, and the yield curves remain inverted, i.e., short term interest rates are higher than longer term rates.
There is good news in that unemployment continues to remain low and this may in part reflect its nature as a lagging indicator, and that our aging population means there are more folks are retiring than entering the workforce. A one-off impact on unemployment is that there were greater deaths than normal during the covid lockdown years of 2020/21. The Australian Institute of Actuaries determined that the death rate during this period was 11% higher than normal.
As outlined above global trade has fallen by 1.7% and China has been significantly impacted. Imports from Japan, South Korea and the rest of Asia fell by around 10% in July. They fell by 11% from Australia. This is the 5th monthly fall in imports to China and the 3rd monthly fall in Chinese exports. Global trade must expand if global GDP is to grow.
US Budget and Fitch Rating Downgrade
An interesting but not well-known fact is that a US Budget has not been passed by US Congress since Obama’s presidency, as Republicans and Democrats are barely on speaking terms. A procedural approach has been adopted where Congress passes “continuing” resolutions. These resolutions allow the existing budget to increase by 8% per annum for the next financial year. Eight percent growth is higher than the growth in tax receipts, so the budget deficit continues to expand and so will US national debt.
Fitch, the rating agency has downgraded US Government debt from AAA+ (the highest rating) to AA+. Although markets appear to have shrugged off the downgrade, the immediate impact is the cost of funding the US budget deficit will increase as a lower credit rating means higher interest costs.
As previously reported US fiscal policy is not aligned with monetary policy and the Fitch rating downgrade reflects this, as the US government continues to introduce new spending programs while at the same time the US Federal Reserve is increasing interest rates. If countries reduce their buying of US treasuries (see above under BRICS) along with the US having a lower credit rating means interest rates may need to rise further to attract investors to buy US treasuries.
Despite these headwinds we continue to see investment opportunities. As always, we are available to discuss investment and debt strategies, so please feel free to reach out.
General Advice Warning: Any advice or information provided is general advice only and has been prepared without taking into account your personal objectives, financial situation or needs. Before acting on any General Advice provided, you should consider the appropriateness of the advice, having regard to your own objectives, financial situation and needs. If you wish to discuss the contents of this newsletter, please do not hesitate to contact us.