New World Order

IN THE NEWS

🇯🇵  Japan Intervenes to Support Yen (Bloomberg)

Explained:

• Japan intervened to support the yen for the first time since 1998, looking to quell a 20% decline this year against the dollar. A top Japanese currency official said the government was “taking bold action” to avoid further deterioration by buying yen and selling dollars.
• The Bank of Japan policies had previously accelerated the fall of its currency by continuing to maintain ultra-low interest rates. The yen is currently the worst performer among the Group-of-10 currencies.

What to know:

• The rare intervention is the latest example of global concern over the strong dollar, which has gained ground due to the Fed’s interest-rate increases.
• Japan, the third largest economy in the world, gets hit hard by a strong dollar which means it has to pay more for essential imports such as oil, natural gas, and food. These imports are generally settled in dollars and now cost more in yen terms.
• The intervention buys Japan time, gives pause to traders shorting the yen, and slows the pace of further declines in the currency. However, unless US Treasury yields turn lower or Japan reverses its monetary policy, it is likely that the yen will remain weak against the dollar in the long term.

🔋 Electric Car Demand Pushes Lithium to Record Levels (WSJ)

Explained:

• Surging prices for lithium and a move to lock up its supply by automakers are raising concerns that a shortage of the battery metal could slow electric vehicle adoption.
• Lithium carbonate prices in China are currently $71,000 per metric ton, which is nearly a four-fold increase in price in just a year.

What to know:

• Lithium is an anomaly in the commodity markets as prices in several goods, such as Brent crude oil and copper, have retreated broadly due to concerns about a global economic slowdown.
• The rising price of lithium is due to surging demand for electric vehicles in China, the world’s biggest EV market. The China Car Passenger Association forecasts six million new EVs will be sold this year, double the 2021 levels.
• As the auto industry phases out internal combustion engines in favor of electric vehicles, demand for lithium is expected to continue to surge. Only a small group of companies control global lithium supply, and all have reported booming profits. US-listed shares of Albemarle Corp. (ALB) are up more than 20%.

🏠 Housing Paralysis (Bloomberg)

Explained:

• The US housing market has gone from high levels of FOMO to just plain fear. Prices have fallen from their peak levels and the days of bidding wars seem to be over.
• In theory, it should mean an opportunity for would-be buyers, but instead, they’re facing the worst affordability in 40 years. Mortgage borrowing costs are at their highest levels since 2008, and house hunters have become increasingly scarce.
• The result is transactions are falling: sales of previously owned homes fell for the seventh straight month in August.

What to know:

• “Everyone is coming to the view that prices are going to decline,” said Mark Zandi, chief economist for Moody’s Analytics. “Until that happens, nobody is going to buy.”
• Zandi is fairly bearish on the housing market and expects prices will fall nationally 5-10% without a recession and as much as 15% in a mild recession. He says in some overheated markets, values could crash as much as 25%.
• Both buyers and sellers are at a standstill. Listings are staying active longer because demand has withered. However, less supply is coming onto the market as homeowners who don’t need to move don’t want to trade cheap rates for higher ones. Roughly six out of seven homeowners have mortgage rates far lower than the current rates of around 6%.

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DIVE DEEPER: THE FUTURE OF THE DOLLAR

We’ve discussed the dollar’s role in the global economy before, the leverage that it provides to the United States, and the challenges that its economic dominance face.

On this topic, we listened to a recent podcast with Zoltan Poszar, who, of late, has become something of an all-star on Wall Street.

Who is Zoltan? 

As a macroeconomist and the Head of Credit Suisse’s Short-Term Interest Rate Strategy team, he’s an authority on the dollar’s outlook, especially given his recent musings on “Bretton Woods 3.0.”

“FinTwit” (Finance Twitter) frequently lights up with #Zoltan after his research is released — It’s a big deal many macro enthusiasts.

Given his huge surge in popularity, when he talks, Wall Street listens. And so did we.

He stands out because his opinions are bold. He’s argued that the world is experiencing, in slow motion, the development of an entirely new monetary system.

“We are witnessing the birth of Bretton Woods III (a reference to an international meeting in 1944 that cemented the dollar, backed by gold, as the basis for the world’s financial system) — a new world order centered around commodity-based currencies in the East that will likely weaken the Eurodollar system and also contribute to inflationary forces in the West.”

Breaking it down

If true, the ramifications are huge, particularly for American consumers and savers who’ve enjoyed the benefits of wielding the world’s reserve currency for decades.

Should his thesis prove accurate, this would be, perhaps, the most significant monetary event to transpire since President Nixon took the United States, and correspondingly the entire world, off the gold standard in 1971.

Bretton Woods, in Zoltan’s parlance, refers to an era where global currencies were backed by gold bullion.

Bretton Woods II represents the system that’s dominated for the past 50 years or so with a “fiat” era where currencies are backed by liabilities like Treasuries.

Under Bretton Woods III, money will once again be backed by real-world commodities and gold, according to Zoltan.

For him, when the U.S. responded to Russia’s invasion of Ukraine by seizing the country’s foreign exchange reserves, this signaled that the dollar’s hegemony had forever changed, as countries’ savings could now be weaponized against them via sanctions.

Even further, this highlighted to Zoltan that countries will want to shift from storing their savings reserves in paper assets to physical commodities that buy them leverage over others, as Russia has gained over the world through controlling significant supplies of oil and natural gas.

What to know

Although we’ve seen similar things happen to other pariah states like Iran and Venezuela, for a major economy/commodity exporter and nuclear-armed superpower, the move against Russia was truly unprecedented.

He believes that countries broadly have seen what the U.S. has done in sanctioning Russia, and as a result, they’re increasingly opting out of the current trust-based system that holds them hostage to the whims of a foreign government.

Instead, the value of money, national reserves, and denomination of global trade will increasingly be defined by politically-neutral commodities that underpin the real economy, such as oil.

Zoltan debated the topic with a close collaborator, esteemed professor Perry Mehrling of Boston University.

Opposing view

Mehrling sees the current environment, with the Fed raising interest rates, and a dollar that’s performing very strongly against other national currencies, as evidence that like with many past crises, the dollar system will only emerge more entrenched.

He proposes that for the same reasons countries find it easier to coordinate economic activity around one set currency, not varying currencies for each state and region, is the same argument for why the hyper-integrated global economy today should rely on one standard currency as well.

In this regard, it’s quite natural then for the dollar to continue to be the world’s de facto currency.

Going deeper

Zoltan disagrees, though, and states that such a model only can exist in a unipolar world order, that is, when there’s only one major superpower.

Since the Cold War’s end, that’s clearly been the United States.

But as we look out into the future, we see a reality where America’s influence is challenged by a number of rising, and possibly even greater, powers.

As evidence of this crumbling system, Zoltan highlights several ongoing blockades since Russia’s invasion in February.

Firstly, the U.S. and its allies engaged in a financial blockade of Russian assets through sanctions.

To which Russia has responded with an energy blockade of Europe by restricting the flow of natural gas on the critically important Nordstream pipeline.

At the same time, China conducted military drills that essentially physically blockaded the island of Taiwan, which President Joe Biden has committed to defending.

All this while the U.S. is now seeking to block China from receiving advanced semiconductor chip exports from American tech companies.

Bringing it all together

The point is that although the dollar remains strong today, relative to other major currencies, a rewiring of the entire world order and power dynamics is occurring. With that will come profound changes to the existing monetary system.

In other words, the world is no longer a unified whole. Rather, it’s splintering into regions of influence dominated by various powerful states, at least in Zoltan’s view.

Zoltan continues by highlighting that we are learning right now just how impactful central banks are, particularly in respect to fighting inflation.

As the world “deglobalizes,” and commodity shortages plague supply chains and shape economic power, the question as to whether hiking interest rates can still temper rolling bouts of price spikes remains an interesting one.

He proposes that, unlike past crises such as 2008, central banks cannot bail out a global economy starved of energy and necessary commodities. Printing money or tightening financial conditions cannot, for example, manifest more natural gas for Europeans.

De-globalization

One explanation for why we’ve seen stable and low inflation for several decades, up until recently, is that as the global economy has become increasingly interconnected, production has been pushed to the lowest cost areas.

The most obvious demonstration of this is with China.

Since they joined the World Trade Organization in 2000, they’ve consumed an ever-growing share of world trade.

This comes, in part,  from lower standards of living, less regulation, and an artificially weaker currency, which meant China could produce goods at a much lower cost than they would be made for in, say, the United States.

The crux of Zoltan’s thinking is that with geopolitical lines getting drawn now, supply chains and production will return to many countries domestically rather than being outsourced.

While positive for factory jobs, as production shifts back towards regional spheres, inefficiencies are added to the system that will structurally raise prices for most goods and services.

Takeaway

The whole reason production was outsourced is that many goods could be made elsewhere for cheaper.

So as production returns home domestically for many countries, the opposite is likely true, that with higher production costs, many things will just cost more as the trend grows traction.

In this environment, trust between countries will likely deteriorate as interdependence lessens. The world, then, will look for a new system to manage financial relationships not necessarily governed by a single country, at least not without a peg to commodities.

And while the peg may not be explicit, the clear point is that countries who choose to inject their savings into natural resources will hold the advantage.

Rather than recycling their funds into U.S. Treasury bonds as has been common for major governments for decades, countries may now choose to invest more in, say, greater harvests of grain, increased oil production, new copper mines, building semiconductor chip foundries, etc.

In other words, countries want to hold wealth in things that give them greater leverage over the real economy, not paper currencies and nominal financial assets.

With fewer buyers of U.S. Treasuries (government debt), it becomes harder to fund the debt-based, consumer-oriented, and deficit-dependent American economy.

But we digress for today.

Wrap up

You can listen to the full podcast with Zoltan here.

For more on this topic from us, check out Preston Pysh’s interview with Luke Gromen on the consequences of Russia’s invasion of Ukraine.

Let us know — Do you agree with Zoltan’s outlook?

If not, what does your vision of the dollar’s future look like?

SEE YOU NEXT TIME!

That’s it for today on We Study Markets!

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