Mohamed Inthi Sameem
A decade ago author Stefano Guzzini did a comparative study on the relationship between the end of the cold war and the resurgence of geopolitics in Europe in his book the return of geo politics to Europe which was published in 2012.
Since then Europe has had its own set of challenges, concern and questions with regards to Brexit - the future of the European Union and the uncomfortable and uncertain outcome of Russian incursion into Ukraine. The economic repercussions of geo politics especially to Europe also remains a major afterthought.
Unlike in 2022 which had a topic sentence per say about President Putin's audacity and the resolve to challenge the West and NATO, this year on the contrary has been about political punctuations and economic footnotes that pertain to China's post pandemic recovery, climate change effects , USA debt ceiling and the ramifications thereof to the global economy, and the emergence of upstart BRICS ready to challenge the United power of G7 and the introduction of a BRICS currency with the intent and ability to challenge the global hegemony of the US dollar. The list is rather long.
However beneath this mundane reality this year also has posed a very important question - as to whether geo political power play can override globalization - a word that captured the fancy and idiom for the better part of the last 30 years.
Historians contend that Globalization actually started with Columbus’s discovery of the Americas in 1492. But this would not have been possible had it not been for the rise of the new monarchs Isabella and Ferdinand of Spain, who were able to finance Columbus’s expedition. But the superseding reason for Columbus voyage was because the over-land Silk Road from China to Europe that crisscrossed the Middle East ceased to exist with the conquest of Constantinople (Istanbul) by the Ottoman Turks in 1453, hitherto the capital of the Byzantine Roman Empire.
Paris favored the peasant whilst London created the landlord
Glance to the year 1600 came along the British East India Company which was set up as a trading entity for English merchants to engage in the spice trade. But more than trade itself the British East India Company was able to wield soft power and win allegiances over rivals without the use of military force, something the British were adept at doing, unlike their rivals the French in keeping with the axiom - Paris favored the peasant, whilst London created the landlord.
Since the fall of the British and the French colonial empires and the end of World War 2 the United States emerged as the undisputed global economic power on the back of consumerism and free enterprise. The great American power stability for over 50 years was driven by the fact that there was no single or a group of countries that could seriously challenge the USA’s dominance. The fall of Communism in 1989 further solidified the faith in USA’s economic model, as economic barriers became defunct and countries rushed to fill in demand. The world was becoming an ever more connected place.
Prior to 1990, the Global Economic colossuses were USA & Canada, the twelve capitalist cum democracies in Western Europe, four countries in Asia led by Japan and the oil rich and undemocratic but pro-west Gulf Monarchies. But one common denominator gelled these countries into unison despite their cultural diversity, the United States sponsored economic-trading system.
Countries which were not part of this US sponsored eco system had an ideological chip on their shoulders against the USA (A handbook of World Trade, Johnathon Reuvid). For example, the Latin America military juntas leaders were not only pro-communist but were also anti trade and anti-American. In the tumultuous period from the mid 1970’s to the end of the 1980’s there were a dozen or more civil wars each being supported either by the USA or the USSR (The Theory and Practice of Third world Solidarity, Daryl Thomas). But all this proxy powerplay was to change by the latter part of the 1980’s.
By 1991 the United States had won the cold war and asserted the superiority of the free market economic model. The second and the third largest Economies at the time, Japan and Germany looked at USA for Economic partnership and or their security needs either unilaterally or under the NATO umbrella. And Countries which had up until then looked at the Soviet Economic system turned course to embrace the USA’s free market enterprise.
The effect on Global trade was unpreceded. In 1960 it stood at USD 134 billion and by 1990 it had reached 3.4 trillion and by 2010 the figure skyrocketed to 15.01 trillion and by 2020 it was 17.2 trillion (WTO Statistical Review).
Around 1992 there was a great China debate about its integration into the global economy and also whether its political system would be accommodating for such an adoption. China had first contemplated free market policies when leader Deng Xiao Ping visited President Carter in 1979.
But it was not until 1991 that China really got into the free market groove. Unlike Japan and South Korea where the USA had a fair bit of leverage in the process of their integration into the world trading system, in China’s case there was little or none. It was no doubt that China was going to chart its own course.
But during this period the USA itself was undergoing an economic change. According to a study by McKinsey on the correlation between recession, economic recovery and employment normalcy from 1945 till 2010, the lag time between economic recovery and employment normalcy was 6 months. This pattern held true for all recessions even during the President Carter’s administration. But in 1990 the pattern shifted into a different mode.
The lag time between economic recovery and employment normalcy became 15 months. By the year 2000 recession, the lag time had increased to 29 months and by the time of the Global financial crisis the lag time had extended to over 60 months.
The USA created the blank cheque for debt ceiling way back in 1917, during President Woodrow Wilson’s administration under the second Liberty bond act. Since then successive US administrations have continue to raise the debt ceiling many times.
From the time President Nixon removed the gold standard of the USD in 1971 thereby making the greenback a fiat currency, the US treasuries have functioned as the anchor. But over the years owing to the sheer magnitude and growth of the overall debt stock there have been concerns about the solvency and the overall stability.
2023: Year of Debt-ceiling and Fiscal-reckoning
By 2022 Central Banks across the world had opted to reduce their holdings on US treasuries and simultaneously increase their holdings in gold. By January 2023 USA’s debt ceiling had reached a whopping USD 31.6 trillion, a figure well above the GDP as of December 2022, (CEIC data 2022) prompting US Treasury secretary Janet Yellen to sound the alarm bells; that some extraordinary measures are in order.
That if the lawmakers failed to raise the statutory debt limit her vested powers to delay a default would exhaust by June, given low levels of cash at hand. In the event the lawmakers failed to act, would result in long term fiscal challenges, a crippling of the US Economy with overall reverberation effects felt in the Global Economy.
So far President Biden has refused to budge on this matter stating that the Congress must act without any conditions. However, this impasse may potentially lead to a situation of debt default that can send the USA’s investment grade sovereign ratings haywire, not to mention the pandemonium it will create in the global financial markets of monumental proportions. Dr Nouriel Roubini contends that even the equities market will experience a downward correction by 25 % propelled by this debt crisis.
With the FED embarking on 7 cycles of rate hikes in 2022, as a fix for Quantitative easing, it was difficult even for developed nations to grapple with the FEDS harvesting of wealth spreads. Because of this precarious scenario, the action to de-dollarize has been given a severe push.
According to the US Treasury International Capital Report (Dec 2022) many developed nations had shed their holdings in US Treasuries. For example, Switzerland sold USD 36.4 billion in third quarter of 2022.
This sell off was based on Switzerland’s decision to avoid the constraints of the USD when trading with Iran using digital currency (Iran under US sanctions). In addition, the SHTA between Switzerland and Iran has already carried out transactions in non-USD currencies, making it clear that Switzerland is keen on expanding its non-USD trading mechanism (www.swiss.info.ch). But the story doesn’t end there. At least 23 other nations are collectively looking at the process of de-dollarization, which may prove detrimental to the US Dollar in the future.
Moreover in 2022 seven countries have increased their Chinese Yuan reserves at the expense of the USD, prompting billionaire investor Jim Rogers to state that tradition of US dollar as the de facto reserve currency has been questioned. Just like the one time go to currencies the Dutch Guilder, and the Sterling Pound which has been relegated to Economic history, perhaps the USD is also entering that phase (www.forbes.com 2022). A development compounded by the fact that more countries are increasing their holdings in gold at the expense of the green back with China being a notable example.
Japan currently holds over a USD 1 trillion worth of treasuries. It is likely that Japan will shed its holdings to spruce up liquidity at home with a view to tighten monetary policy. In the event this happens it may well act as a trigger a mini financial crisis in the USA, which may progress to a more intense financial meltdown post 2023. Japan has already sold USD 240 billion of US treasuries since 2022, resulting in a net position USD 1.078 trillion as of January 2023 (www.ceicdata.com).
Moreover, the Bank of Japan is expected to abandon negative interest rates in 2023 and begin to raise policy rates which may create a ripple effect in US treasuries and a spike in US Treasury Yields, causing severe turbulence in the US treasury markets.
The dominance of the US Dollar goes all the way back to 1944, in the final days of the World War 2, the developed nations at the time met at Bretton Woods with the objective of creating a stable monetary system. One of the outcomes of that meeting was to tie the value of the other currencies to the USD and make the USD the global reserve currency. The USA in turn agreed to redeem the value for gold.
This made sense at the time as the USA held three quarter of the world’s gold supply. This move also meant that there was a de facto transition from the gold standard to the Dollar standard.
By the 1960’s the USA Vietnam war was hampering the USA fiscal position -sustained war spending- with accelerating inflation (In the shadow of Vietnam - Thomas Schwartz). By the end of the 1960’s foreign banks were requesting redemption in gold. The USA simply could not afford to deplete its reserves at Fort Knox thus prompting President Nixon to decouple the USD from the gold standard in 1971.
However, by 1974 the US Dollar emerged with a new extension; the Petro Dollar, when secretary of state Henry Kissinger was able to negotiate with Saudi King Faisal bin Abdul Azeez to trade oil only in USD after the Arab oil embargo.
By 2006, the great capitalism dream of creating value out of a vacuum began to show its negativities, the subprime mortgage crisis that laid the foundation for the global financial crisis.
The world markets viewed the entire saga of the Global Financial meltdown as a US concoction, financial zealousness and exported to other markets via the long reach of the US Dollar.
Certainly, this fact had reasonable resonance as the US policy in the 1990’s undermined the US policy of 1930’s - the repealing of the Glass Steagall Act of 1933. The Glass Steagall Act of 1933 had prevented investment banks from engaging in Commercial banking activities.
President Clinton ‘s decision to reverse this act in 1999, has been directly attributed as one of the major reasons for the subprime mortgage crisis and then the Global Financial Crisis years later.
Greenspan not for green back but Pro Euro
In the aftermath of the Global Financial Crisis, then FED Chairman Alan Greenspan hinted that it was time for the Euro to play a bigger role in the global reserve currency status.
According to the IMF Euros accounted for 25 % of the global aggregate reserve currencies in 2006, compared to 17.7 % in 2001. Surely the Euro had made a strong case as a competitor to the US Green back.
Perception and reality are two different things. The 2010-2012 the euro-zone crisis dented the prospect of currency, Euro progressing to make an even more compelling case.
It exposed the difficulties of a monetary union guided by separate political agendas. For example, Germany’s Merkel wanted austerity measures and fiscal discipline, whilst France’s Hollande wanted stimulus programs via a bond buy-back program. With such divergent policy alternatives, the prospect of Euro making further gains as a reserve currency phased out. So, the US Dollar lived to tell another tale.
The 2023 BRICS summit agenda in South Africa is very likely to include the debate about Saudi Arabia joining this emerging market block, as per the media announcement of South African president after his visit from Riyadh in Oct 2022. BRICS represents 24 % of the global GDP, 41 % of the World population and 16 % of global trade (www.statista.com).
Apart from Saudi Arabia, Turkey, Iran and Egypt have all expressed their intention to join the union which is expected to be debated at the upcoming BRICS summit. Unlike the other members, Saudi Arabia’s joining will be significant because the country is one of the top global energy suppliers and a principal protagonist of the Petro Dollar.
Saudi Arabia joining the BRICS will be a game changer to the global balance of power; vis a vis in terms of the current held sway by the US and Western European dominated G7 block. The enhanced BRICS can challenge the G7 in policy alternatives such as the imposition of the carbon tax on steel from India citing green house gas emissions and global warming. Perhaps the catalyst to the enhanced BRICS balance of power is the US and Western Europe’s opposition to the Russian Invasion of Ukraine.
The enhanced BRICS union will be much more of a lethal challenge militarily and economically to the G7 quite unlike the USSR and Warsaw pact countries. Moreover, the Russian adventure into Ukraine has accelerated a collective push to construct a universe of economies to challenge the Western (G7) domination. Cases in point are Turkey, a NATO member, and a geopolitical strong republic located between Asia and Europe and in conjunction with the country’s techno potential.
The other being the UAE which will add the global financial center Dubai into the matrix. The addition of Istanbul and Dubai into the BRICS environment may create a significant shift of power to the East from the west and result in the formation of a bipolar world.
The Oil rich Saudi Arabia and UAE joining the block will also perhaps halt or subvert the Petro dollar recycling into the USA economy. Between 1974– 1981 and 2005-2014 oil exporters amassed large surpluses of petrodollars, a result of rising oil prices.
In conjunction with China and India being major oil consumers may circumvent the dollarization process in oil trading and hence directly impact the use of the Petro dollar, the repercussions of which will be strongly felt in the US economy.
The BRICS currency protype’s significant backers are Hong Kong based BIZ innovation hub, the Hong Kong monetary authority, and the Peoples bank of China digital currency unit. The BRICS currency is expected to function as a basket of currencies comprising BRICS members’ respective currencies. Perhaps the most significant features will be semi decentralization and the backing by a commodity perhaps gold, silver or digital asset (www.silkroadbriefing.com).
Despite the hype of the emerging BRICS currency as a possible contender to the Dollars global status, and the monumental challenge it may pose to the US Dollar, the geopolitical issues between major BRICS members could dampen this prospect. The China-India conflict over the Tibetan plateau dating back to the 1960’s is still relevant today owing to the source of drinking water supply for the densely populated Asia. It’s not likely that the economic benefits of a BRICS currency will override geopolitical tensions between the arch rivals India and China (Batawala and Abhayagunatane 2009).
The global Economy is surely facing some serious headwinds, the brunt of it by the developed world. According to the IMF the developed economies are expected to grow by 1.2% for 2023 whilst the emerging economies are expected to grow by 4%. Inflation which still remains an issue to contend with is expected to be above pre-pandemic levels even in 2024.
But there is some hope for from the emerging market with China’s, re-entry into the manufacturing realm and India’s resurgent economy will account for a major portion of global output.
But risks do remain, owing to USA’s debt ceiling, and tight fiscal conditions will result in the repricing of the financial markets. It’s probably the first time since the end of WW2 the USA is facing internal as well as external challenges simultaneously. The Economic slowdown, a high recession probability, and above all the debt ceiling continue to weigh in negatively.
Moreover, the upstart economic powers are exerting their new found influence, either by direct defiance of the USA or via tacit undercurrents. For China it’s about the defying the status quo of the US dollar domination of global power play. Whilst for Russia and Iran it’s about contesting and navigating the long reach of the sanctions. For developed countries like Japan and Switzerland it’s about financial rationality.
As the debate continues between the future of globalization or de globalization, perhaps the better analysis is view it as a balance between globalization and de globalization factors. Events such as BREXIT, Trumpism, the Russia-Ukraine war driven supply chain disruptions, inflation and energy crisis, all add to the credence that world has entered a phase of de globalization. But then again organizations such as BRICS, NATO, and the collective global response to pandemics are all conformist to the idea that Globalization is still relevant despite its patchiness.
Perhaps the biggest anti-globalization force is populism politics in Europe and USA, which questions the efficacy and effectiveness of global organizations such as NATO’s weak response to the Russian invasion, and the WHO‘s below par response to the pandemic during the early stages.
In 20/20 hindsight the future will be a hybrid between globalization and deglobalization. Hence when Globalization gets recalibrated the fundamentals that aided the system will also be done away with or at least modified.
The international Monetary Structure
According to Jim Rickards the international monetary structure has undergone seismic shifts at least 3 times in the last 100 or so years, namely in 1914, in 1939 and in 1971. So, in essence this might well be the biggest pronounced seismic shift, as it is in the current context ofthe globalized economy.
A new edition of Bretton woods style conference may be due, that will accommodate non western stakeholders but also install an ecosystem with new set of systemic financial rules to go by. The possible outcomes may be multiple reserve currencies – the Australian Dollar and Canadian Dollar included.
The other option is SDR (Special Drawing Rights) managed by the IMF itself. The unique feature of the SDR is that it would have the intrinsic ability to reflate or re liquefy the global economy.
In fact, the IMF in the past built a strategic plan to mobilize the SDR. But reality was something else. in 2009 the US Govt passed legislation to loan USD 100 billion to the IMF intended for providing liquidity for distressed economies. But 91% of that money was used to bail out the European economies, and only 9% was used to sort out the rest of the world. However, when the money was allocated by Congress it was quote on quote meant to be for emerging and developing economies.
Another possibility is the reversion back to gold standard, reemphasizing the relationship between paper money and gold as it was between 1944 to 1971. The British Empire ran the currency successfully with a 20 % gold backing and the USA ran the system from 1944 till 1971 with a 40 % backing. The United States can run this gold backed currency on its own, but it would be counterproductive to do so as the other currencies will become less than desirable relative to the USD as it will create a deflationary scenario – a mistake committed by Prime Minister Winston Churchill in 1925 (Jim Rickards - The New Great Depression 2021, Currency Wars 2011).
When compared to the many historical challenges the US dollar has faced, such as inflationary pressures in the 1960's resulting in the fiat currency status in 1971 and the direct threat from Euro in 2010, the dollar always managed to continue in contention.
However the year 2023 is a different entity in heading and punctuations. Experts are pinning a banking crisis with similarities to the 2008 Global Financial crisis. As a prelude the Silicon Valley Bank in the USA, has become defunct after a run on the bank, making it the largest failure since the 2008 crisis. Across the Atlantic in the de-facto Banking Hub Switzerland, triggered by fears of a larger financial disintegration the Swiss bank UBS agreed to take over Credit Suisse, but on below par valuations terms.
Moody’s downgrading of the entire US Banking System and the failure by KPMG - audit to uncover the problems at Silicon Valley Bank adding to the catalogue of audit failures are important events that need to be further analyzed. Would this become a more pronounced global financial contagion? Will the US Dollar continue its dominance post 2023 ? are event driven pertinent questions, given the current dynamics .
But today, taking into account the rapidly changing structural and functional matrices in the Global financial system the US Dollar has perhaps met its potent match; in terms of a collective multi pronged global thrust towards de dollarization. In this context the Swift mechanism, which has been a vital component of the global financial architecture since 1973 has probably entered onto a phase of redundancy.
In the current scheme of tangible probability, the US Dollar may get a new classification and a different narrative. In high prospect the greenback will emerge stronger in a new form, drawing on elements of Central Bank Digital Currency (CBDC), digital assets and digital commodities by way of tokenization, decentralization and digitalization as the norm of current times.
The resultant will be a new medium of exchange which would be used as a store of value, built upon block-chain based infrastructure and encompassing cross-border payment systems that has features of scalability inter-operability and drawing on enhancements in artificial intelligence. The paradigm shift in the Global Financial System is well and truly on its way.
Mohamed Inthi Sameem
is an Investment Strategist, Management Consultant and an author on Globalization Trends and Financial Markets.
is an International Relations Analyst based in Colombo, Sri Lanka.