About 20 years back
archaeologists discovered a new site, Gobekli Tepi, in south-eastern Turkey
which they have been digging till almost 2014 given the expanse and number of
layers. The site dates back to some believe 11,500BC and it suggests a level of
human ability and organization which was earlier believed to have been possible
much later, as in 3,000-4,000BC. Of course, there are multiple other theories
on the human race from alien intervention to decimation of advanced race but
this is front and centre of mainstream academia. In essence confronted with the
provable facts we have changed our views. But changing our views has not lead
to material change in people’s lives except the perception of it. Such is not
the case with many other areas where changes in views and actions have much
deeper and lifetime consequences.
In the mid-90s and then
continuing into the new millennium, US had significant trade imbalances with
the rest of the world. These trade imbalances were settled in the financial
markets through import of savings and keeping cost of capital substantially
lower than in the past. However, on the other side was the impact on industry,
wages and employment. To alleviate the social impact of stagnating wages, Fed
essentially kept interests artificially low creating a housing bubble
generating home equity or income out of thin air. In 2008, the effects of the
imbalance and the consequent policy came to roost. I am sure this story has
been told many times over (http://poleconomyindia.blogspot.com/2015/12/imbalance.html).
To prevent the blow-up of
financial markets all the developed major central banks created unprecedented
balance sheet expansion and China essentially gave its banks a free hand to lend.
The intention was (1) to prevent a significant slowdown; (2) prevent collapse
of financial institutions; and (3) create wealth effect resulting in demand
creation. This third intention has resulted in inequality across markets by
punishing savers of all types - pensioners, insurers, workers etc. (http://poleconomyindia.blogspot.com/2017/07/when-economics-plays-politics.html)
The above actions have led us to
where we are today. Many may trace these events to even earlier act of moving
to fiat money and they may be correct leaving a system open for human
intervention leaves a door for corruption of action but that is for another
time.
We are moving to world that
neither my generation or before experienced. What we have seen is for most
parts is a unipolar world, with open trade and capital flow was where
incrementally the world trended towards. The US was the global balancer ensuring
free global trade and the settler of global imbalances with its deep markets. The
clear direction is being disrupted and we are looking at a world getting more
chaotic. There are two other aspects which have ensured that political elite
have lost appetite to be an instrument of change:
- The decisive intervention of central banks post 2008 financial crises and beyond have made the political elite reliant on them to rescue the markets and asset prices and not undertake structural changes;
- The rapidly emerging problems of demographic decline and technological change have sharpened inequality. It is a problem the OECD countries have no clear answer to and it is sapping their political energy.
So, what has changed in the
world’s largest economy,
- Open economy has resulted in real wages in the US stagnating for 4 decades while college tuition and healthcare costs have tripled in value leading to wealth of top 0.1% being equal to the below 80%;
- US military in the last few decades has been continuously involved in many theatres of which the nation is now tired of expending blood and treasure for no strategic benefits;
- The internal politics is undergoing fractious change with the “baby boomers” retiring over the next decade while the “millennials” emerge as the next big voting bloc, who have not even a distant image of the 2nd world war or the cold war and, therefore, why should the country remain engaged. This retirement will also raise the cost of capital as the boomers draw their retirement funds;
- This means a US economy which is the least dependent on global trade and with the massive expansion in shale production the dependence on middle-eastern oil is minimal and no political inclination can afford to “let go”.
With these factors in play why
should the security architecture and the economic institutions shaped by the
America even survive. Global supply chains will shift as a new protectionist economic
architecture takes shape besides low energy cost. Trump is nothing but a
manifestation of these factors.
China has benefited hugely from
its accession to WTO and the US navy has ensured a
relatively free of cost global commerce. This period of cooperation is coming
to a close. US sees this as a free ride while continuing to use the American
markets for trade, investments and intellectual property resulting in an emerging
threat to US supremacy. This for the China would mean:
- Lack of ability to earn US dollars via exports will result in a current account deficit. Therefore, increasingly there is a desire to price commodities in yuan. Whether the exporting countries are willing to take a limited liquidity instrument is a critical decision point. Any problem in this count means an implosion in the currency and delay in rebalancing the economy. Increase in USD interest rates (10Y - 2.99%) by Fed and the spreads to China bonds (10Y - 3.47%) is narrowing making any alternate strategy by China ever more difficult to execute;
- The Chinese prior to the opium wars always had a current account surplus. What happened subsequently is regarded as a century of humiliation. The Chinese will always remember this and they do not want revisit this at any point. Further, the economic structure needs open export and investment markets. High dependence on the real estate and infrastructure of almost 30% of GDP which creates almost no incremental economic value, high internal leverage (since 2012 incremental nominal GDP growth has been less than total interest service cost) and declining population (of ~1billion working age, China will lose 45 million by 2030 and then additional 150 million by 2050) will keep the dependence on export market high. The trade war and deleveraging is already bruising the currency, stock and credit markets. The US wants China to rebalance faster along with change in political direction. This essentially can sink the Communist Party. So, this trade war has a long way to go before any party throws in the towel as much one may read about any reconciliation or even an interim settlement;
- As in the US, inequality is high. More than 550 million live on less than $5.50 a day while top 1% owns 33% of wealth. Legitimacy will require the regime to resolve this issue. Anti-corruption campaign is much showing purpose to address this as it is about removing obstacles to Xi’s power;
- Lack of protection of the US navy means one will have to expend the effort to build a blue water navy to ship oil from a warring middle-east across the Indian ocean, through the Malacca straits into South China Sea. Not only this increases the cost, it leads the Chinese to build expensive ports and pipelines in Pakistan and Myanmar to protect these shipments;
- The American pressure could not have come at a worse time when its seeks to rebalance its economy and Xi cannot afford to look weak just as he declared himself the latest emperor.
Change in China is resulting in
Japanese military forsaking its self-defence posture and beginning to re-arm
itself. It recently launched a new helicopter carrier, which as per experts can
also be converted quite easily to an aircraft carrier enhancing its force
projection capability. That aside, Japan is undergoing an amazing experiment in
its financial markets. JGB market is $10trillion (>2x GDP) and BOJ has
bought 47% of it. To top this up it is now it is top 10 shareholder in 40% of
Japanese listed companies. All this to hold rates to zero. But recently the
interest rates on 10yr started to fly – 3 July 2018 it was 0.03% and 3 August
2018 it was 0.111% - 3.7x in a month. At the previous rate ~25% of Japanese
budget was used for debt servicing. Rest, I leave to the readers imagination.
The demand environment in EU has
been suffering due declining working population and it is manifesting itself in
the banking systems of places like Italy and Spain. Italy (owes 25% of its GDP
to Europe, leave alone internal debts) it seems may give up on Europe any day and
it would be catastrophe, but who can tell the time. Russians are pressing in
East trying to rework their environment before the decline in population and
economy over the next 15-20 years weakens their strategic capability. They
could cooperate with the West, it needs the West to essentially scale their
game where the Russians believe that is the only choice left. The trust option West
gave up when it pursued Nato’s incremental expansion eastward against the
commitments given post the Soviet fall. And, finally the biggest issue the
German massive export surpluses with both southern Europe (financed by Germany
itself) and rest of world. These surpluses will only grow as population ages
and internal demand declines while supply is maintained with robotics, AI and
other new age technologies. Unless the policy direction changes EU internal
sustenance and its relationship with US are always a question market.
In this chaotic global
environment, what does it mean for India (http://poleconomyindia.blogspot.com/2016/09/india-future-fast-forward.html):
- The lack of interest of the US navy over a period of time to protect the supply lines with the troubled middle-east and growth Chinese presence will mean greater pressure on the India navy to reform and acquire requisite assets. Our army-land focussed mindset and consequently the budgets will need to undergo a change;
- US pressure on Iran and Russia, will need us to deftly play the board as one is large oil supplier and our only alternate route to Central Asia and second is on whom we still depend for our military supplies;
- While lot of our focus goes towards Pakistan, it is nothing but a spoiler. Terrorists which used to number in the thousands in the Valley have now dropped to 250 or so at an average given the security measures. The internal divisions will continue to lead the Pakistan and its polity from one crisis to another. The more we build our strength and wield the stick, the more constrained their “already limited” space becomes;
- India cares about international trade but given its large domestic market and positive demographics it is not really a large player in global trade. But more importantly cares about international investment as it not only supplements its capital deficiency, its allows a technology transfusion. However, international trade and investment will both suffer given rising cost of capital and excess capacity globally. Managing local resources, expanding economic potential (education, quality infrastructure) and demand dynamics will be critical.
10-15 years hence I hope to
revise my views based on “archaeological economic” findings. But as I have said
in my previous articles, this period of stress and geopolitical disruption will
foster rapid innovation – AI, hypersonic, blockchain, quantum computing and
many others.
“Man cannot discover new oceans
unless he has the courage to lose sight of the shore.” - Andre Gide
Postscript
One of the fundamental reasons the
Congress agreed for a division of the country was Jinnah wanted a weak centre
and large share of power at the state level allowing him to significant control
over national politics by dominating Punjab and Bengal, the two Muslim majority
states. Also, given Punjab geographical position and contribution to the Indian
army Jinnah would have a veto on India’s defence.
Congress leaders were aware of the internal
divisions and hoped that the federal structure would ensure adequate freedom
for the states (and consequently for Punjabis, Tamils, Marathas or Bengalis)
while the centralization project continued at a glacial place over a period
ensuring a national identity. A strong central government is critical in this
process to accumulate, project power internationally and also in moving this
process ahead. GST, a national value added tax, extinguishing regional
boundaries, is prime example of centralizing. If we do not have a strong centre,
we will surely meander but this is not the time.
