Tuesday, November 1, 2016

Restatements


“A lie can travel half way around the world while the truth is putting on its shoes.” ― Mark Twain

In today’s hyper media world, news creates its own “mirage of reality”. The challenge is understanding the historical, cultural and technological aspects that underlie the behaviour and continuously reinforce this reality.

We continuously see in the media that we may see the end of American military and economic dominance very soon. This is extremely unlikely any time in the next half a century if not more. It is the most economically vibrant open economy having one of the best demographics in the developed world with a culture of immigrations. Despite the extreme budget stresses, it faces, it is within its power to manage those by altering the social security, healthcare and other benefits it has committed to its people. For example, it can simply change the retirement age. The current election season may seem to suggest that practically everything has broken down in America but that is the resilience of the structure. Imagine the Chinese or Russians having such a noisy debate without tearing the system apart. The constitution gives the President great latitude internationally but his domestic agenda is subjected to approvals of the Congress and the Senate. The system is designed for creeping changes with consensus almost similar to the drag the Indian system imposes. See how much time the GST took to get this far. The notion that all hell will break loose if either candidate get elected is extreme. Obama wanted to end the Afghanistan and Iraq wars much sooner, but could he? Dollar denominated funding remains the core of the global economic system. This works beautifully as persistent current account deficits and deep finance markets in New York keep the global system well supplied with dollars. The USD has continued to decline with these persistent deficits except for 2 intermittent periods. The first rally in the early 1980s driven by Volcker interest rate regime causing the Latam crises, the second was in the mid-1990s when the Asian Financial Crises played out. Both these crises were caused by over-dependence on foreign capital. We are in the 3rd leg of the dollar uptick with global economies not having recovered yet. Where this will cause a crisis is anyone’s guess? American’s spend over US$600bn on the military more than 4 times the next kid on the block with a completely dominant position on the hemisphere it occupies allowing it massive global displacement power maintaining over 700 bases, with the ability to effect balance of power at any point on the globe. Thucydides made two amazing observations in his book 2,400 years ago, “Your empire is like a tyranny: it may have been wrong to take it; it is extremely dangerous to let it go.” The transition between empires is typically marked by wars. But, however, it is it will be surely less suffocating than the absolutism that would mark a Chinese or a Russian empire. The second observation was, “In other ways, too, the Athenians were no longer as popular as they used to be: they bore more than their share of actual fighting, but this made it all easier for them to force back into alliance any state that wanted to leave it.” The Americans have been involved in every major war across the globe since the 20th century or have started it. Think the last time the Chinese or the Japanese fought a war, new technologies and postures are only developed during that period. The Saudi’s despite the massive spend on expensive equipment are fighting a war in Yemen and proxy war in multiple other Middle Eastern states and they are being tested to the point which got a senior US official to comment that they are afraid of committing their troops unlike the Iranians for the fear of a significant defeat and its impact on the Royal family. Taiwan is 90 miles from China but the Chinese fear changing the status quo and not because of Taiwan I am sure! At some point all empires decline but now is not that time for America…

In December, 2014 I had written, “China is likely next year to follow with its own depreciation given the impact of lower yen on competitiveness, a sharply declining factory production and increasing real rates.” I had then written an article in August 2015 on China’s economy (http://poleconomyindia.blogspot.in/2015/08/china-everything-overdone.html). Since then the capital outflows have accelerated, the credit cycle has added an estimated US$4.5 trillion (yes the number is right) more than US, Europe and Japan combined in the last 12 months. This expansion continues to finance almost US$5trillion in investment every year in industry and real estate even while it seeks to shut excess capacity in industries like steel. Who will put any capacity anywhere else? Maybe the Chinese authorities are adding 100m urban units in the quest to house all of us also in China!! This credit expansion is already feeding into crazy house prices and accelerating car sales. A UBS report showed the ratio of house prices to household disposable income in first-tier cities had risen to 18 to 20 times from 14.7 times at the end of 2015. "This puts China's tier-1 cities' affordability close to Hong Kong and more expensive than London," the report said. Beijing is looking at the household sector to up leverage backed by real estate to help the corporate sector deleverage, down payments for property have been cut to 20% from 30% in June. Mortgages were up 71% in July and August. Home prices have risen ~28% in Beijing, 33% in Shanghai, 37% in Xiamen and 47% in Hefei in the last year. This happens at a time when US$ continues to rise against the yuan at almost the same pace as the nominal growth keeping GDP trapped at the same levels. As the Fed threatens to raise rates, the yuan weakness will only intensify and one is seeing a surge in Chinese purchases internationally which they are increasingly facing more opposition including American real estate (a trend very similar to Japan in the late 1980s). Excess capacity and continued depreciation of the yuan complicates the global picture, where countries are seeking inflation to reduce the debt burdens. While the economic picture plays out, Xi is consolidating power to rival that of Mao. Such consolidation of power is a sign of weakness and the scale of challenge China faces. From adverse demographics, pollution (https://en.wikipedia.org/wiki/Pollution_in_China#Pollution_statistics), economic health, an increasingly more hostile external environment and a more suspicious suffocating internal politics. Any rapid decline in economic well-being will threaten the legitimacy of the communist party and that is what is causing this ever-precarious balancing like an engineering project unlike a natural healing process that a democracy can adopt. The Soviet Union and Japan both tried to manage this centrally and failed but the communist party knows know other way.

I will not cover the other three significant geographies (Middle East, Russia and Europe) which I have written over the last year which face almost an “End of their known World” kind of situation:


In India, the BJP is seeking to revive the ancient glory of the Mauryan dynasty that spread to Iran, Hindu Kush mountains, present day Bangladesh to the southern extremities that ended in present day Andhra Pradesh and Karnataka, not as much in terms of occupying those lands but in terms of dominant influence. This had been the inspiration for Sardar Patel as he sought to unite the various princely states. The Dravidian kingdom have always been elusive for Indian empires until the British. The initial phase post-independence the Congress, as it took over from the British, ruled the state of Tamil Nadu until 1969 when a Dravidian party came to power as the old cultural and historical lines came to the fore and since then no national party has ruled the state. India as we know is a land of extremely diverse cultures and languages united by the geographical enclosure of the Himalayas and ocean of all other sides. It could almost mimic the many cultures and nationalities enclosed in the European peninsula. The national integration of India is project that is work-in-progress and the election of national party to the seat of Tamil Nadu will be an important marker in this project – the day when the populace there believes that a national party can represent their voice. In March 2014, I had stated that, ”India's geography creates the sense of 'self-containment' leads it to exist with itself but we are no longer in 1,000 BC, we are part of the global economic system and technological advances have reduced the physical space in both the economic and militarily dimension.” The current government by the bent of ideology and facing the multiple pressure points of demography and geopolitics is seeking to reshape the geopolitical destiny as Curzon, British Viceroy of India, saw it, "The central position of India, its magnificent resources, its teeming multitude of men, its great trading harbors,... all these assets are of precious value. On the West, India must exert a dominant influence over the destinies of Persia and Afghanistan; on the north it can veto any rival in Tibet; on the north-east it can exert pressure on China, and it is the guardians of the autonomous existence of Siam (Thailand)." I will not comment on the Indian economy which I have written in my previous article (http://poleconomyindia.blogspot.in/2016/04/power-shortage.html).

We are witnessing a rapid aging of the society in the next 25 years across the world. While the current method of measuring dependency restricts is below 15 years plus above 64 divided by those in between or the working age. One can argue that people, given, can medical advances work beyond 64 but so do people start working much later these days almost in their mid-20s. So I will continue to use this method. The remarkable aging will create over-supply in many areas like housing, sports equipment or kid clothing but short supply in labour, military personal and nursing staff. It will also cause an automatic deleveraging of the financial system as people draw down on their savings and do not take consumption loans. This is also one of the reasons why central banking policies are not as effective as in the past. As one can see below, the Germans and the Chinese will see the most dramatic impact play out.

Dependency Ratio by Country
2015
2040
Change
China
37.4
59.1
58%
Germany
52.2
77.7
49%
Japan
63.1
81.2
29%
Russia
42.5
53.8
27%
France
58.1
70.2
21%
UK
54.7
65.8
20%
US
52.5
62.5
19%
Mexico
51.6
51.0
-1%
India
51.8
46.4
-10%

 

The US continues to consume (-$460bn) and the German (+$286bn) and Chinese (+$348bn) continue to export. The oversized role on both sides of the scale continues. But at some point, the impact on American industry and labour will play out, as it is doing now in American elections. At some point, the Chinese gaining competitiveness via devaluation to the rising cost internally will become an issue with other developing countries, although that point maybe some more time away. And, at some point the German export engine just becomes too overbearing not only to the Americans but also to the Euro Area, which has happened quite some time back and Brexit and constant disillusionment of the European voters with mainstream parties is all part of this continuing situation. This is the core point (China and Germany maintain employment at the cost of other countries) leading to rising protectionism across the globe.  

The fourth industrial revolution is coming. This will see the convergence of many technologies which have the ability to change the face of many industries. Internet of Things, Artificial Intelligence, 3D Printing, use of Big Data, nanotechnology and space based technologies will change the way we live to the way of war. Group of Head of Innovation at HSBC stated, “It is possible to imagine multiple ways in which IoT can enhance banking – for example, wearables could provide biometric authentication, payments can be embedded within household items and geo-targeted offers could expand into a more personalized service while providing more security.” DARPA, US defense research government outfit, (same that invented ARPANET the basis for future internet) is already working on space based solar technologies to power battlefield units like tanks and laser weapons held by soldiers or potentially developing space based precision guided projectiles. Not only the cycle time of the change be much shorter that we have witnessed before, given the globalized (telecom, MNCs, news…) world, we will witness much more rapid deployment.

The more these changes threaten the past rhythm of our daily lives, the more we shall look for inner forces to stabilize ourselves…

And, finally global leadership will be tested like never in this period of great upheaval. In December 2013 I had pointed out, “The ability of true leadership is to negotiate the constraints put by the system. There will be compromises and promises broken but states are not given firm direction by idealists but by realists and great leader is one who is a realist led by ideals.”
“Accidents happen. Our bones shatter, our skin splits, our hearts break. We burn, we drown, We Stay Alive.” ― Moïra Fowley-Doyle, The Accident Season
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