Rabobank: "The US Will Simply Not Allow A New Reserve Currency Without A Fight"

Submitted by Michael Every of RaboBank

"Peace for our time"

Despite the fact that the German IFO survey was ‘I-ful’, with the official word being that the outlook is “increasingly dire”, and that US core durable goods were -0.4% vs. flat expected, both of which confirm that the real economy is perhaps in real trouble, markets seemed to sigh with relief yesterday. The reason? We have the promise of “peace for our time”. After all, according to the press, US President Trump held out an olive branch to China on trade; and to Iran; and was there perhaps the suggestion of another brunch being offered from Boris Johnson to the EU?

Let’s focus on the US issue first. Nothing we saw or heard yesterday--nothing at all--changes any of the dynamic that we have seen for a long time now. Trump praised Chairman Xi to the skies, and repeated that China wants to make a deal very badly, so much so that they had already called to kick-start talks. Meanwhile, China stated it knew nothing about any such call, and the editor of the Global Times tweeted “Based on what I know, Chinese and US top negotiators didn't hold phone talks in recent days. The two sides have been keeping contact at technical level, it doesn't have significance that President Trump suggested. China didn't change its position. China won't cave to US pressure.” So very little chance of trade peace for our time. Nonetheless, as usual, the equity market fell for this while the smarter bond market largely didn’t – and neither did CNH.

Meanwhile, President Macron’s Iran G-7 surprise may have achieved something more significant. Trump said he might be willing to meet Iranian President Rouhani “if the circumstances were correct or were right,” which some are selling as a huge breakthrough. Again, however, people are not seeing that there has been no change from the larger pattern. Trump also repeated what a rotten deal the JCPOA Iranian nuclear agreement was, and how Iran needs to stop funding regional terrorism and give up both dreams of nuclear weapons and its current ballistic weapons programme. None of those conditions are acceptable to the Iranians.

Indeed, let’s draw an even larger picture here, folks. Trump is willing to meet with anybody: there are no red lines after North Korea’s Chairman Kim. He’s willing to praise and deal with anybody. That’s what he is all about. And he far prefers wheeling and dealing to the traditional US neo-conservative response of bombing – which somehow seems to get very little positive attention. So far so good, and so therefore hope for peace for our time? One can dream.

However, each one of these deals--from North Korean nukes to Chinese trade to Iranian nukes--is part of a larger overall Mega-Deal, the terms of which are obvious. The US wants a new global architecture where rising powers like China and Iran allow Washington to remain primus inter pares; for the US to provide a defence umbrella to its existing allies at a price that covers its costs – and/or via new alliances that do some of the heavy lifting for it; for USD to retain its “exorbitant privilege”; and, at the same time, for the US to no longer act as consumer of last resort for countries with structural demand deficits and export surpluses--such as China, Japan, and Germany; the US will instead re-industrialise high value-add products, even if via automation, or at least draw supply chains back to a ‘defensible’ North American trade area where it has the greatest political and economic influence.

So here is the key question: will this work? Technically, it couldbut without the US running large trade deficits, demand for USD will not exist in the same way that it does now. Ultimately, that leads us to the recent Carney missive on the need for a new global reserve currency – and to chaos, as the US will simply not allow it to happen without a fight. Nobody in its position would. More importantly, one could argue that the model the US is tacitly proposing is akin to “Empire lite” – and that is not going to have many takers - though what is the realistic alternative on offer, one might ask? Prior to the post-WW2 US-consumer-centric order, that was all we ever knew.

Is China really going to sign up willingly to a new US order that doesn’t allow for Made in China 2025 or the South China Sea, or regional primacy? Or Iran (whose proxies are clashing with Israel in Lebanon and Iraq and with Saudi Arabia in Yemen)? Or the EU, which likes things just as they are, danke schöne? Clearly not. And why should they when we are 15 months away from a US election which could, in their imaginations, make this all go away with a new president? For that reason alone, while we might see a Trump-Rouhani meeting, we shouldn’t expect anything more than a trickle of new oil flows as a result – certainly no geopolitical deals will flow until 2021 at least. So, as with the EU and the UK, nothing is agreed until everything is agreed: but can everything be agreed? Note that as soon as Iranian Foreign Minister Zarif left the G-7 he headed to Beijing: coincidence, of course.

Meanwhile, on what is the larger nearer-term economic threat, but geopolitically a relative side-note, both the US and Australia have made clear to the UK that they could conclude trade deals with it within 12 months of Brexit happening. If you are BoJo thinking of the same November 2020 date that Beijing, Tehran, and Pyongyang are, what do you do? Mmm…

To conclude let me add a general, but important, point for markets against this global backdrop. Today’s title --“Peace for our time”-- is what UK PM Chamberlain waved at the British public after the Munich appeasement of 1938 – though it is mis-remembered as “Peace in our time”, which it certainly wasn’t.

Nothing is doing on ‘peace’ until after November 2020. The major risks are arguably not to the upside in terms of emerging ‘deals’ but to the downside on Hard Brexit and on any geopolitical surprise at any point along the lengthening US-China fault-line, (e.g., see the news that US senators are pushing US pension funds to reverse their decision to invest in Chinese financial markets; that as the PBOC sets CNY fixing today stronger than expected at 7.081 – even as CNY itself shrugged the last stronger fix, and ‘trade peace!’, off to close at 7.1512 yesterday). As such, the key message is very much caveat emptor.