By Michael Every of Rabobank
"Johnny's in his room, building a bomb," are words spoken by no responsible parent, not even if they reassure, “Bomb-making is hard, so he won’t be able to do it right.” Yet global markets are watching as wires, fuses, solder, and the goods needed to make TNT are all assembled. Consider that the last few days have seen:
More supply destruction from OPEC+ pushing oil up, which the White House claims it knew about in advance, and which was apparently driven by its refusal to rebuild its Strategic Petroleum Reserve at lower prices, as pledged;
A Russian national security doctrine for long-lasting “hybrid war” vs. the US and Europe;
More articles on Chinese and US war preparations, or lack of, as Graham Allison of ‘The Thucydides Trap’ claims “American politics is driving towards a provocation that China could not avoid,” and that we are sliding into a catastrophic new conflict;
The EU call for de-risking supply chains vis-à-vis China, and China warn them not to;
Singapore’s PM call for new ground rules so global trade can continue without decoupling, but with expectations the playing field will be much less flat, and that “we may end up on one side of the gulf or on the other. And that’s just the way the world is going to be.”;
The Financial Times’ Gillian Tett say, ‘Prepare for a multipolar currency world’, noting the CEPR view that: “the renminbi can play a more important role in the future, even in the absence of full financial liberalisation. This process would involve trade invoicing and settlements, central bank swap lines, and offshore renminbi markets. This would not lead to the renminbi overtaking the dollar, but rather to a multipolar world of key currencies, including the dollar, euro, and renminbi.”; and
India and Malaysia agreed to settle trade in INR.
This Daily had already been saying shifts in trade invoicing could matter to the global financial architecture; and yet that there is no ‘Bretton Woods 3’ system to replace the US dollar, as IMF data underline it is top dog, and energy expert Anas Alhajii argues there is no global alternative to it for oil. There is no contradiction there because if the dollar falls, it won’t be replaced by a global system, but with a market explosion.
The FT is right: some commodity producers are now being offered CNY, not dollars. They aren’t taking it yet because of technical difficulties – but they are talking about it. Yes, CNY is useless internationally as it doesn’t have an open capital account; but, as the CEPR note, what if PBOC CNH swaplines to central banks for trade financing, bridge that gap? Yes, CNY offers no assets like US Treasuries; but a commodity exporter isn’t a central bank, and just wants to get paid. What if the CNY price is higher than the dollar one, or CNY is politically more acceptable in some locations?
Because commodity producers in emerging markets tend to be pivot points in the broader economy, if replicated, real trade flows could be redirected even more towards China, and pricing in some commodities shift more towards CNY.
That isn’t bullish for CNY: the trade maths says we still don’t need more CNY holdings globally even if this happens – but that’s not the point. Physical supply chains and raw geopolitics are.
As long as the US runs huge trade deficits, this also doesn’t decouple China from it, which is why you can’t have a Bretton Woods 3 global system: but the aim here is a firewall for a future Russia-style crisis. Which, ironically, may be how one is precipitated, if you think like Graham Allison.
For other emerging economies, local FX settlement starts to deepen bilateral trade relations, and corresponding asset holdings, even as it unravels more of the larger global system. It can also mean de facto barter priced in dollars as a firewall against FX volatility, as many markets struggle with a soaring dollar and outright dollar shortages - and no Fed swap lines ever offered. That some are prepared to regress trade all the way back to the pre-history wrongly taught in every economics textbook --read Graeber or Polanyi and see debt came first, not barter-- should concern Western markets far more.
I’m not waving a US flag but raising a red one when saying the above actions aren’t building a new global architecture as much as a bomb underneath the current one. So what if it’s very hard to actually do? The fact it’s happening at all should worry markets.
If some commodities aren’t priced in dollars, we would get bifurcated supply chains for downstream goods, and in FX clearing, as in the 1930s - which China says it doesn’t want to see.
If fewer dollars are earned via global trade, how are global Eurodollar debts then serviced?
My view remains that the US would, after a period of adjustment, thrive in a mercantilist world. But Wall Street, in its present form, would not.
On which note, do you think the US financial hegemon “encircling” and “containing” China, and running a “hybrid war” vs. Russia, is going to do nothing if this FX shift really is looming at the margin?
As Alhajii also notes: “We should not forget that even if the switch to non-dollar pricing does not affect the US economy, the US will not let OPEC members slap it in the face. It will not quietly accept such an insult in front of the whole world. The dollar is a symbol of America’s strength, and the US will not let others disregard this symbol. OPEC members are part of the world community. Its leaders fully understand the political ramifications of pricing oil in a currency other than the dollar.”
With this US administration that’s perhaps not so clear-cut, but some on Twitter are quoting the White House press secretary as saying non-US dollar settlement of global trade ‘violates the rights of American citizens'. (I can’t find her saying that myself.)
If you still can’t link commodity invoicing to stocks and bonds, yesterday had a Bloomberg op-ed titled ‘Can Powell’s Fed Afford to Ignore Geopolitics?’ It argues the Fed must consider EM, and not push rates up too high, as Volcker did: “Think of the EM!”… now talking about invoicing more in CNY. Conversely, the Fed can’t ignore geopolitics because of what some EM are trying to do to it, as we see via oil this week already.
Hypothetically, how could the US respond to all of the above, if someone drew a simple diagram in crayon for those responsible?
One way is explosive, as Graham Allison, suggests, and is risk off;
Another involves sanctions and global bifurcation, which is risk off – but as Senator Rubio just said, “We won’t have to worry about sanctions in five years’ time because so many countries will be transacting in other currencies that there won’t be any sanctions.”
Or there are even higher US interest rates for even longer, at least relative to others, which is risk off.
Except we have the dilemma of weak data like the US ISM survey, and the FT talking about trouble brewing in shadow banking (and the ECB calling for a clampdown on commercial property loans), which are a whole different problem going tick, tock because the responsible adults long took their eye off the ball.
What’s the number for global social services?