In this newsletter we continue to examine the changing geo-political and macro-economic landscape. The message is that the changes we have been reporting over many years are now starting to have an impact. We recognise that this newsletter covers a lot of ground as we bring together important interrelationships.

GEO-POLITICAL EVENTS

Back from the Brink

In our newsletter dated 6 February 2024, we outlined that there is a risk that the world could “stumble” into a world war. Pleasingly, and to the credit of the USA and Iran their back-channel communications prevented a further escalation after the Israeli attack on the Iranian consulate in Syria. Iran warned the US that it would respond to the Israeli attack, and then gave 72 hours’ notice of the response, as well as taking other steps, e.g. advising Turkey, Jordan and others the attack had commenced knowing the drones would take 3-5 hours to reach Israel. Immediately after the attack, the US advised Israel the attack had been a failure and to take the win. Iran said that the matter was closed from their viewpoint. Israel decided a response was necessary and it was reported to be muted, as Israel also decided that stepping back was in everyone’s interest. Iran played it down and said the matter was over. Cooler heads in Iran, Israel and the US prevailed. Of course, financial markets reacted to the increased tensions and possible escalation with the price of gold and oil jumping up. Tensions in the Middle East remain high with the risk of regional war ever constant.

Global World Order: Russia/Ukraine and Israeli/Hamas Conflicts

The selective and hypocritical positioning by the West to these wars is having a major impact on the world’s rules-based order that was created after World War 2 with the US, UK, Russia and France the primary architects of framework with the United Nations (UN) at its core. The ineffectiveness of the UN, the Security Council, International Court of Justice (ICJ) and International Criminal Court (ICC) has again been highlighted because of the veto rights of the permanent UN members and the selective adoption of treaties by members, e.g. the US has not ratified the ICC and Israel is not a member of the nuclear non-proliferation treaty. North Korea has not ratified the Chemical Weapons Convention. On 2 November 2023, Russia withdrew from the treaty banning nuclear weapon tests. This selective adoption by all member states and non-compliance is making a mockery of the rules-based order that the world is supposed to be applying.

The UN’s single most important feature is that it provides a forum for countries to outline their position on matters and provides a place to talk. Communicating with adversaries is much better than silence, as it will lead to an improved understanding of each other’s position, and hopefully find common ground and eventually lead to a solution. Back channels are playing an ever-increasing important role when there are diplomatic stand offs.

The UN’s major deficiency is its inability to act on critical matters because of the veto rights of the permanent members that override the majority votes in the UN Security Council and UN General Assembly. The Global South is very frustrated with the double standards and consider the rules apply to them, but not to the West, so they are seeking change. India the most populus country in the world is not a permanent member of the Security Council, there is no permanent representation from South America, Africa or Southeast Asia on this body. The calls for change including the removal of the permanent members veto have increased, while those holding veto powers are resisting such a move. Will a new world order organisation evolve out of BRICS because of the Wests’ double standards being exposed by these conflicts, or will the current UN framework be amended? Something must happen to re-establish a sense of fairness into the system.

In 2024, 64 countries will hold elections. Will the world swing to the right or left? Recent history tends to indicate a swing to right leaning parties as the backlash against globalisation continues and support for nationalism surges.

Some recent geo-political developments include:

1. Saudi Arabia (population 36m) has not yet taken up its BRICS membership offer yet. It is playing both sides and continues to rely on the US for security, i.e., Petro-dollar agreement where oil is sold in US dollars in exchange for Saudi Arabia’s defence security. 

2. Nigeria (population 220m) has now applied for BRICS membership. The next meeting where the proposed non-USD payment system is to be discussed further will be from 22-24 October 2024, in Kazan Russia.

3. Niger (population 26m) has ended its military pact with the US. Niger has asked the US to withdraw its 1000 troops located there. France was forced out in 2023.

4. Iraq has asked the US to close its bases and leave. Negotiations are underway.

5. On 8 April 2024, Zimbabwe (population 16m) in its 6th attempt to introduce a functioning local currency introduced the ZiG, a new currency which is pegged to Gold. The aim being to create exchange rate stability and tackle inflation.

The major geo-political tensions continue. These being: 

1. Increasing cyber attacks by both state and non-state actors.

2. The US and China appear to have settled into a long-term competitive trade and security war with semi-conductors and Artificial Intelligence (AI) at its heart. Recently, the US Congress has passed legislation requiring Tik Tok to be divested of Chinese ownership, or it will be shut down in the US. Tik Tok and other social media platforms have become a main source of news for the younger generations, particularly for the wars which are being live streamed. Governments have lost control over the narrative to the thousands of social media influencers.

3. Russia/NATO conflict.

4. Climate change gridlock.

The above are all impacting on the geo-political landscape and macro-economic environment.

MACRO-ECONOMICS

Back in October 2023, we did not foresee a major impact on global economic activity from the Gaza conflict, as the US was doing its best to contain the war to Israel and Gaza; however, as the war has dragged on it has widened to include non-state actors from Lebanon (Hezbollah), Yemen (Houthis) and Iraq (various). With Iran being directly targeted by Israel, this has further changed dynamics of the war with global economic implications. Simply, the Straits of Hormuz where 50% of the world’s oil trade passes through could be shut down quite easily by Iran, just by saying it would attack commercial shipping without doing so. Insurance companies have already told ship owners that they must re-direct their ships that normally transit the Suez Canal to go around Cape Horn. The cost of this re-routing is adding to global inflationary pressures.

After the Israeli attack on Iran, the price of oil increased but has since fallen back below USD90 a barrel. With the threat of a wider Middle East war along with inflationary pressures, oil prices could once again increase quickly. If they move higher than USD110 per barrel (a sustainable 20% increase) it will drive energy deficit countries of China, India, Europe and UK into recession. The US which has an abundance of natural gas and the largest producer of oil (because of shale oil) in the world, should be able to weather the storm as it has the advantage of the holding the world’s reserve currency. The US will be indirectly impacted through reduced trade which will put downward pressure on the US dollar. This is exactly what the US Federal Reserve is seeking as it makes US exports cheaper; however, in 2023, 17 countries central banks cut rates strengthening the US dollar against those countries’ currencies, not what the US Federal Reserve wants. Please see further comments below on this topic.

Monetary Policies

In several of our newsletters (see newsletter dated 6 February 2024), we have outlined that monetary and fiscal policies are not aligned. This continues to be the case where fiscal policies are dominating monetary settings and thus reducing their impact. While governments across the globe are fiscally stimulating, recessions are deferred. The aim is to create enough economic stimulus in the short term to outweigh the recessionary forces, i.e. keep an economy going while the recessionary elements are worked through the system, and the “prayer” is that during this time private enterprise will come back and take the leading role in driving economic growth. As outlined in newsletter dated 3 August 2022, as a government’s budget deficit to GDP ratio increases, the positive marginal impacts of each successive stimulus program diminish.

As noted above and not well reported, 17 central banks in 2023 cut their cash rates because of recessionary fears. This weakens their currency against the US dollar which makes those countries more competitive, while at the same time making the US economy less competitive. This is a never-ending game where countries take steps to make their exports cheaper (lower the price of their currency through interest rate reductions) to drive GDP growth and improve their terms of trade. Understanding this game and its impacts (short and longer term) provides a better basis for monetary and fiscal policy settings.

The US economy appears to be booming. However, a close examination of key economic metrics show the US economy is not in as good shape as it appears. US fiscal deficit is now 6.5% of GDP, this percentage has not occurred since WW2. The steepness of key yield curves’ inversions has flattened while key curves are shifting up and to the right. This is distinct from the cash rate falling and to remove the inversion. The move of these yield curves is pointing to higher interest rates for longer across key OECD countries as reflected in US bond auctions which are getting harder to fill, i.e., investors seek a higher real return for tying their money up when inflation is stabilising around the 2-5% mark. If these bond investors don’t buy, then the US Federal Reserve will monetarise the debt creating further inflation. US treasuries are meant to be risk free, but institutions are concerned about holding long dated 10 & 30 year US treasuries because the loss in purchasing power, i.e. negative real yields. Therefore, the US Treasury working with the US Federal Reserve will eventually need to make longer dated bonds more attractive, i.e., issue bonds at lower prices which means higher yields.

In our newsletter dated 6 February 2024, when most market commentators were predicting the Reserve Bank of Australia (RBA) would cut rates, we wrote that we did not see the RBA reducing interest rates for some time, especially when the residential property market is running hot. The RBA does not want to super charge it. We now see some commentators saying the RBA will increase rates this year. The RBA reaction will substantially depend on the stimulatory nature of the upcoming Federal Budget, i.e. if fiscal dominance continues and based on the global economy, then a rate rise is possible.

Fiscal Policies

US interest payments now exceeds USD1 trillion or Debt to GDP is 120%. Yes, that’s not a typo! The US Government will pay for it through taxes and the inflation tax (notionally inflating the real value of debt away).  As outlined in our newsletter dated 24 May 2023 normally, monetary and fiscal should be aligned so one does not dominate the other, rather they complement each other. When interest rates were falling with growing GDP, a Government’s interest expense was of less consequence. Now with slowing GDP growth, higher interest rates and increasing budget deficits matter, as a higher percentage of tax receipts go to debt servicing.

Gold and Oil – Shift in Market Dynamics

We have been reporting for several years that the largest buyers of gold are central banks, notably Chinese and Russian. The current price rises appear to be driven by China, global monetary instability and the threat of the Middle East conflict expanding.

As economic problems in China come to the forefront, e.g. real estate and geo-politics, the more Chinese buy gold in Yuan, not in US dollars. This is possible because China is running 30 year high manufacturing surpluses in Yuan and US dollars. They need to invest the funds somewhere, and not in US Treasuries because of the possibility of confiscation (as happened to Russia) and negative yields, so the best place is gold because there is no counterparty risk. The Chinese are using both Yuan and US dollars to buy the gold, so we are possibly seeing a shift in control of the gold market from the UK to China. Time will tell if this is the thin edge of the wedge.

When the world priced oil only in US dollars, this was a problem for China because they needed US dollars to pay for the oil. Now that oil and commodities are being bought in Yuan, this is changing the dynamics of the price of oil and gold as both are priced in US dollars. With China now buying oil in Yuan and not US dollars, and if the trend continues, they will in the future be able to influence the value of the US dollar, and therefore inflation expectations and thus interest rates in the US.

Global Demographic Changes

According to Lancelet, only 4 countries globally are replacing their populations, so birth rates are declining as people live longer. The challenge for governments is to finance the increasing number of people retiring and requiring some form of welfare assistance. Government retirement systems rely on younger workers entering the workforce and paying for the social security, this equation is no longer working, so the model is unsustainable. Governments irrespective of political persuasion will be forced to introduce changes to address the looming budget expenditure on social security that will be a drag economic growth. Changes will likely include an increase in retirement age, reduced pensions and higher taxes. Please see this article we wrote 11 years ago in June 2013, where we outlined the impact of increasing life expectancy and shorter working life on superannuation savings. Please note the comparative table that illustrates the point very simply.

As always, we are available to discuss investment and debt strategies, so please feel free to reach out. WealthMaker Financial Services has both an Australian Financial Services Licence (AFSL) and Australian Credit Licence (ACL) and therefore is able to provide holistic solutions.

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.