Originally published May 2023.
Emergence of new currency blocs will change everything
There is a growing feeling that the economies of the west are going through some form of Paradigm shift, but that it isn’t going to be the one envisaged by the men of Davos with their notion of ‘The Great Reset’ and a Fourth Industrial Revolution, where we will apparently “own nothing and be happy”. The technocracy required for their so called ‘New Normal’ is foundering against popular protests, while the emergence of a new cold war between the US and China under Trump has been transformed over the last 12 months under Biden to include Russia and crucially, thanks to the ‘freezing’ of Russia’s FX reserves by the US, has effectively put an end to the PetroDollar system. This is of enormous significance, even if right now the financial markets remain obsessed with the fine print about exactly how many basis points the Fed are going to tighten. Indeed, I believe we have not seen something so important to the western financial system since the US came off gold in 1971 and the PetroDollar system was created.
Understanding how this new ‘New Normal’ is going to look should thus be a key focus for all investors.
Certainly, we know that there is going to be a division between ‘The West’ – essentially NATO plus Japan – and ‘The Rest’, centred around China and the BRICs countries, but now also including much if not all of the Middle East and Asia. This is not so much the end of the $ as a reserve currency as the emergence of an intra-bloc trading currency for ‘The Rest’, involving a whole new set of financial institutions and, it has to be said, a diminished role for the $. Indeed, probably the most important announcement to come out of this year’s Davos meeting was from the Saudi Finance Minister announcing that they were prepared to sell their oil in other currencies, a step towards formalising what will in reality be the PetroYuan.
The first step then has to be diversification away from the $, particularly towards Emerging Markets and Asia, but also towards UK, Europe and Japan, where many investors have been heavily underweight in recent years. After all, if we are moving towards two competing economic ‘blocs’ then ideally the approach should be to focus on the best companies in each bloc. This also means a look at Emerging Market local currency debt as opposed to EM$ debt, not least because they did not indulge in the runaway fiscal expansion and monetary printing of the Covid era and thus have fewer inflation problems. Linked to that is a recognition that many of the global ambitions of some of the megacap corporations will be in need of their own ‘Great Reset’ – either in terms of lower demand for their products, or lower supply of their inputs from low-cost labour countries.
This is actually a very important point, for the new ‘New Normal’ is going to involve very different supply and demand dynamics and thus pricing power and inflation. To return to the PetroYuan, a point largely overlooked is that with the ability to pay for its more than $100bn a year energy import bill in Yuan, the Chinese government have no need to earn $100bn in export earnings to pay for it. If they want to they can just print the money. This is not to say they will, rather that the prioritisation of exports will change, almost certainly towards supporting the growing domestic consumption dynamic. In particular, it means that low wage or energy intensive manufacturing of low margin exports to ‘The West’ is going to decline, which is going to harm some of the big western retailers, as well as leading to, at the very least, an end to disinflationary pressures in the west.
The second key part of the paradigm shift is not so much geo-political, as an end to this latest phase of Globalisation and its three defining policies, or as we like to put it, the tragedy (or tyranny) of the three zeros; Zero Interest rates, Zero Carbon and Zero Covid, policies that have collectively served to massively distort markets as the Fed, the WHO and the UN effectively took over economic policy in much of ‘The West’. All of these were a disaster, not only failing to achieve their aims, but also delivering consequences completely counter to their intentions. Zero Interest rates distorted savings, resource allocation and markets generally, kept zombie companies alive and promoted inflation everywhere except the high street. Zero Covid policies first broke supply chains, then hit them with unprecedented demand as the monetisation of huge fiscal stimulus through Central Bank Money printing flooded back as restrictions were lifted. This surge of temporary inflation was then exaggerated by the huge surge in energy prices as the Western Sanctions on Russia collided with the reality of years of under-investment in energy and commodity infrastructure thanks to the well-meaning but unrealistic ambitions of Zero carbon.
The first two policies are all but dead and the third is nursing a bruising contact with reality, but the message for investors is that this new paradigm needs to focus more on making and selling things and less on playing around with financial instruments. It means looking at corporate profitability and cash flows that pay dividends rather than speculating that the bigger fool will buy your SPAC. It’s not about telling each other stories about the wonders of cloud computing and AI, it’s about going back to our economics textbooks to understand demand and supply and our business school textbooks to understand concepts like Porter’s Five forces or Dupont analysis. It’s about understanding discounted cash flow models. In fact it seems to us that this new New Normal is pretty much like the old Normal, the one before globalisation and the triple zeros. It’s just that most people are too young to remember. Maybe we should ask Chat GPT to explain them all to us?
