Regarding… Vol 3 no 14 – Turning Point

Dear Fellow Investors and Friends,

Welcome to this edition of my newsletter, where I share my efforts to understand markets and the world around me.

I do appreciate you taking the time to read this. I welcome all feedback; it’s great to get conversations started.

Today is Thursday, April 17th, the 107th day of the year. There are 258 days until the end of the year.

Just over 500 years ago, on April 17, 1521, the Trial of Martin Luther at the Diet of Worms began. During the trial, he had to defend his teachings, which challenged the centralised authority of the Catholic Church’s religious power. His teachings weakened the Catholic Church’s universal influence, leading to centuries of religious diversity. By 1600, half of Europe had become Protestant, reshaping the spiritual lives of millions.

Today, the world faces a similar critical turning point in its affairs.

“Potentially, the most dangerous scenario would be a grand coalition of China, Russia, and perhaps Iran, an “anti-hegemonic” coalition united not by ideology but by complementary grievances. It would be reminiscent in scale and scope of the challenge posed by the Sino-Soviet bloc, though this time China would likely be the leader and Russia the follower. Averting this contingency, however remote it may be, will require a display of U.S. geostrategic skill on [all] perimeters of Eurasia simultaneously.”

Zbigniew Brzezinski, “The Grand Chessboard”, 1997

Historically, the world was categorised into the “First World” (Western capitalist countries), the “Second World” (Eastern communist bloc), and the “Third World” (non-aligned countries, primarily developing nations). The term “Third World” became increasingly irrelevant as the Cold War concluded and globalisation intensified. Despite geographical differences, the “Global South” concept emerged as a more nuanced way to describe countries facing similar economic, social, and political challenges.

“The Global South” is not global (there are no European or North American members), not from the South (most members are from the Northern Hemisphere) and far from homogenous. It’s also most definitely not a humanitarian “peace movement,” as some would like to think of it.

How big and strong is this “Global South”?

By the end of the century, the population of developed markets will decline from over 20% of the world’s population to less than 10%. Sub-Saharan Africa will go from 11% to 34%, and the “Global South” will increase to 85% of the global population. Defining economic growth as population growth times productivity growth, the “Global South” has a considerable tailwind over the next 50 to 70 years.

A glance at a map and commodity production tables reveals how Asia’s land giants complement each other economically. Russia produces raw materials, China manufactures capital and consumer goods, while India provides the affordable workforce that China has lost. Perhaps more importantly, these three countries, along with Iran, now account for the majority of the world’s graduates in science, technology, engineering, and mathematics fields.

Aggregate government debt in the BRICS nations is only 10% of the developed world’s government debt despite representing a larger share of global GDP.

What is causing it to become so agitated?

For the better part of two centuries – taking the Monroe Doctrine of 1823 as the starting point – the United States has aimed to be both a “Great Power” and a “Good Power”. Over time, this ideal evolved into what is now known as Manifest Destiny, a belief in the United States divine right and duty to expand its territory and promote democracy and capitalism. In the twentieth century, “Manifest Destiny” transformed into “American Values Apply Globally,” which has enabled the USA to justify engaging in conflicts in nearly every corner of the world based on the notion that they are somehow American domestic issues.

American exceptionalism writ large.

What Trump is doing now – issuing a hodgepodge of executive orders, discussing the annexation of other sovereign states, renaming the Gulf of America, and issuing tariffs left and right – is just an extension of what he (and the majority of American voters) see as the USA’s “Manifest Destiny”.

American exceptionalism has also manifested in the significant privilege of the U.S. dollar, allowing the USA to export bonds (and dollars) in exchange for “stuff”. This has greatly benefitted U.S. consumers and investors at the expense of their own manufacturers and blue-collar workers.

Conversely, while “The Global South” has experienced a manufacturing boom, its consumers and investors have not benefitted, resulting in dissatisfaction with the status quo.

The resulting deep resentment towards the dollar bloc is driving the Global South to create an alternative. The USA’s weaponisation of the dollar in the fight against Russia has accelerated this trend. Unsurprisingly, the Global South is eager to de-dollarise its trade, establish new settlement systems independent of SWIFT, and diversify its central bank holdings.

There are tangible recent signs of a shift in the global monetary system:

• Increased gold holdings by Central Banks
• Energy transactions are increasingly denominated in non-US$
• The US$ share of global FX reserves is declining
• Cross-border transactions are increasingly denominated in non-US$

What is happening is not just the erosion of the dollar’s dominant role, but also a gradual transformation in the operation of the global system. No other currency or payment system currently can displace the dollar at the centre of this system, and there is a practical limit to reserve diversification. However, an increasing number of smaller pathways are being constructed to circumvent this core, and many countries are participating.

Some thoughts on potential investment implications

• Given these shifts, it’s no surprise that precious metals have reached new highs while long-dated US Treasuries have sold off. I discussed this in The Rhyme of History, where we see a mirror image of the 1930s: debt/inflation in the USA (Europe then) and debt deflation in China (USA then). The world requires more inflation in the USA to encourage it to produce more, and it needs deflation in China to motivate its consumers to spend more and save less. Tariffs can help achieve this.
• The developed world will choose to inflate away its debts, and investors seeking to preserve and grow the purchasing power of their savings should avoid this process at all costs. Regulators in the developed world will want to trap as many financial assets as possible in the killing pens of inflation, so prescribed assets and capital controls are on the cards. The power of the regulatory state is now one of the greatest threats to savers.
• Switzerland is ‘not your father’s Switzerland’. For those seeking to preserve the purchasing power of their savings, there are better places to have your funds regulated, such as Singapore and maybe even Dubai.
• To the extent that developed markets use fiscal dominance to stimulate their economies, banks and the shares of certain industrial companies might be attractive. However, “growth” stocks will face an extended period of multiple compression. I believe that process is already underway.
• In those markets, contractual assets – i.e., bonds and disintermediated property (REITs, etc.) – are also likely to suffer. Contractual assets should be owned in the Global South, where the temptation to inflate is substantially lower. Hard assets – the kind with limited supply – are the ones to own in developed markets.
• China wins by enduring a debt deflation. Here is a nice piece from this WSJ overview of China’s difficult economic situation ($): “In a low-leverage economy with a fixed money supply, deflation is a measure of real GDP growth: if your wages are flat, but your purchasing power rises, you’re richer. China, however, has a highly leveraged economy, where declining price levels mean that debt burdens are higher in real terms. The 4D-chess interpretation is that some of the most levered entities in China are local governments and politically connected conglomerates, not the consumer. Hence, engineering a disinflationary or deflationary scenario means that the central government can choose which fail and which get bailed out (and on what terms).” The Chinese private sector will suffer less from debt deflation.
• Energy is life, and energy is growth. China is among the few countries worldwide investing significantly in power generation – whether it be oil, gas, coal, nuclear, or even some solar and wind. China is a leader in low-cost, reliable energy, which is good for economic growth, even with a declining population.
• At first glance, Africa and South Africa seem to be losing in this game. We are experiencing declining diplomatic influence, as our poor performance has diminished the value of our national brand, and our government’s venality and incompetence have undermined its effective diplomatic capacities. Nevertheless, partnering with the other BRICS giants could be a strategic move despite any discomfort it may cause those of us with a Western sensibility. That is, if our politicians can pull it together, which seems unlikely.