By Michael Every of Rabobank
Try Not To Be Rash(omon)
The 1950 movie ‘Rashomon’ from director Akira Kurosawa a classic which infamously telling the story of a terrible crime from four different points of view. The “Rashomon effect” is a related term describing the notorious unreliability of eyewitnesses, where an event is given contradictory interpretations or descriptions by the individuals involved. A bit like markets: Everyone thinks they know what’s going on when they actually don’t.
With the full disclaimer that I don’t either, let’s try to thread together a narrative, however. In doing so I personally find an alternative cinematic technique —split screen, as used in The Thomas Crown Affair (1968)— works very well to try to tie simultaneous narratives unfolding in different places which all build to a unified conclusion.
On one screen we have the Fed, which is now lower-er forever-er, with no real change yesterday other than an extension of its swap lines and the FIMA repo facility through to March 2021, alongside a verbal reiteration that they are not even thinking about thinking about raising rates. With 5-year US yields hitting a new low of just below 0.25%, who needs yield curve control? Nobody is thinking about the Fed thinking about thinking about raising rates until at least 2026. And with 10-year yields at 0.57%, there isn’t more than one hike expected in the next decade.
On a second, the US Congress seems incapable of finding an adequate fiscal response to keep the economy afloat, despite the Fed’s pleas. Another few days, perhaps(?) Perhaps not. US tech giants were given a mixed reception, meanwhile. Some came to praise and some came to bury. Few came to seriously call for regulation or breaking them up
On a third, China is flexing its muscles. In Hong Kong, student activists were arrested last night in line with the new national security law, which will almost certainly trigger Western pushback. The Global Times also ran an extraordinary attack on Australia that went beyond the usual threat of massive economic consequences of ‘wrong actions’ to actually state it would “likely face unbearable consequences” if there were a US-China clash in which it chose the US side, as US allies in the Indo-Pacific region would then all be targets for the PLA. The article even underlines that Australia is “further away and less vulnerable to missiles fired from the Chinese mainland” (for now, at least).
On a fourth, the US is withdrawing 12,000 troops from Germany as, in the words of US President Trump, they won’t be taken for a “sucker” any longer. Yes, the move will take years. Yes, Congress might intervene. But a message is being sent to the most recalcitrant parts of Europe: wake up and smell the coffee – or brew your own. There are voices for and against this: but note Edward Luttwak, who knows more about Grand Strategy than any journalist, is in favour.
On a fifth, Japan is leaning towards joining the Five Eyes intelligence-sharing group as “The Quad” of India, Japan, Australia, and the US edge towards deeper military cooperation in the South China Sea and the Indian Ocean. That was as Chile announced it prefers building an undersea internet cable to New Zealand and Australia and then up to Japan rather than straight across to China. Thailand, however, announced it was signing up with China’s ZTE to build 5G access, and the Philippines agreed to do so with both Ericsson AND Huawei. Sides are being drawn up, even if it is telecoms that are marking ‘territory’ – apart from that whole nine-dash line thing. Yet that may not be the end of it.
On a sixth screen we see a report from Bank of China International (BOCI) which Reuters summarises thus: “Chinese banks urged to switch away from SWIFT as US sanctions loom”. Indeed the report, co-authored by a former foreign exchange regulator, advocates greater use of China’s own Cross-Border Interbank Payment System (CIPS) instead of the Belgium-based, USD-centric, SWIFT. “A good punch to the enemy will save yourself from hundreds of punches from your enemies,” it adds, and. “We need to get prepared in advance, mentally and practically.” So we are openly seeing the word “enemies” used in investment-banking research now.
The report adds that if the US were to cut off some Chinese banks’ access to USD settlements via sanctions, China should consider stopping using USD as the anchor currency for its foreign exchange controls – or dedollarisation. It also recommends China develop legislation similar to the EU’s Blocking Statute, which theoretically allows the bloc to maintain trade with Iran, a country targeted by US sanctions.
So how do our screens link-up? The narrative is a very weak virus-plagued global economy (to be underlined by Q2 GDP today); a lower forever world, where fiscal enthusiasm may be waning regardless; where US-China tensions escalate as geopolitics is exacerbated by that weakness; sides being taken; and a worrying escalation in the rhetoric suggesting a potential point of praxis ahead. Of course, all of these were narratives we were already telling before the virus struck (and none of them matter to equity markets, who are running their own movie inside their head where everyone swims happily in rivers of cash forever without a care in the world).
However, in cinematic terms, we need the final reveal: who is going to join China on CIPS? Knowing that tells us how this story ends.
CIPS’ data shows only USD19.8 billion in value was transacted through it daily in 2019 against US Treasury estimates of USD5 trillion through SWIFT. As importantly, CNY accounts for about 1.8% of transactions through SWIFT, and if one takes out CNY-HKD it is far below 1%. Neither statistic suggests there is going to be a shift to CIPS if China is put under the cosh by the US – certainly not if it is a binary choice between the two. More so when there is talk of missiles being fired at you (Australia), or of having to do your own on-ground fighting (Germany). Moreover, the SWIFT work-around the EU set up to trade with Iran, which BOCI is backing, is a tree that has produced no fruit. European firms understand what the potential consequences are of crossing US sanctions on Iran – it seems unlikely they will not see the same if the nuclear option were ever used on China. Yes, it’s a vast market. But it’s still small in SWIFT terms, and people just don’t want CNY.
In which case, the final shot of this movie still points to a China potentially isolated using CIPS to trade with a small subset of countries like Cambodia and Laos (both of which happily take USD on the street all day long), as well as Russia, probably, while the global takes a further hit and global markets lie divided by politics, currency, and clearing system just like they were in the 1930s when the gold standard ended.
Let’s hope those in charge aren’t too Rash(omon), and we never see this movie play out again.