There are times when an emergent future can be seen from within the patterns of monetary flows that occur in the present. The movement of funds signifies the direction in which patterns of value and influence occur. They can be used to chart the rise to prominence of individuals, companies, or nations; as they can equally be used to chart their decline. Identifying the points at which the money flows switch can be used to map the turning points in history.
For example, the UK, prior to 1914, had been very much a creditor nation. The flows of gold - in a monetary system backed by the Gold Standard - tended to move into the country during the 19th Century. This was the consequence of Britain industrialising ahead of the rest of Europe and North America to generate trade surpluses that were further underpinned by the British Empire. The trade surpluses provided the basis on which loans were later made to overseas companies and governments in the form of overseas investments.
Although this system had weakened before the First World War - the industrial production of the rest of Europe and North America had closed the gap with Great Britain - it was the cost of the war that turned Britain into a debtor nation. War had inflated public spending to the point where the economy only stayed afloat through borrowing from abroad. The stock of UK public debt stood at 25% of GDP in 1914. It rose to 135% of GDP in 1919. This is the point from which we can establish the decline of Great Britain as a great power. It took 30 years for that decline to burn through - which we mark by Indian independence - but it was evident in 1919.
In 1919, the principal holder of UK national debt was the United States. This, in turn, is another telling point. Here we can chart the transition from one declining great power - the United Kingdom - and the rise of the succeeding great power - the United States. This transfer of indebtedness is something that has great resonance today.
The past forty years have been characterised by the rise of China as an industrial nation. The US is the largest customer for Chinese manufactured goods, which has given rise to large Chinese trade surpluses with the US for a good number of years. Rather than repatriate these earnings - which are denominated in the global reserve currency, the US Dollar - which would cause the Yuan to appreciate, the Dollar earnings of Chinese entities have been recycled into American financial instruments. Mainly into US Treasuries.
This growing source of US indebtedness to China has been a cause of concern for years and is the root cause of the bout of economic warfare in recent years. From the American perspective, the retention of Chinese funds offshore artificially supresses the Yuan against the US Dollar, giving China an 'unfair' trade advantage with the US. The growing hostility between the US and China calls into question the use of America by China as an investment destination for Chinese funds.
The COVID pandemic has served to make matter worse. The fiscal response in the US - over $US2 trillion - has provided a cash injection that has served to generate a recovery in China that is faster than expected and an increase in Chinese trade surpluses with the US. The Yuan hasn't appreciated in this process and China hasn't stepped up its purchases of US Treasuries. The question remains of where the Chinese surpluses are being recycled. Data from the Bank for International Settlements indicates that, compared with 2016, Chinese commercial banks have increased lending to developing countries, increasing the footprint from under 20% of all lending in 2016 to over 25% in 2020. This is skewed towards lending in the Asia Pacific region, and Africa and the Middle East.
We have now reached a really odd situation. The US taxpayer is funding the US consumer, who is buying manufactured goods made in China. This causes a Chinese trade surplus with America in US Dollar terms, which is recycled to developing nations along the BRI as Chinese financial assistance denominated in US Dollars. In turn, this financial assistance is subject to a flight of safety, where institutions in the developing world are looking for a safe harbour in US Treasuries, which goes to fund the US fiscal deficit. And so the circle is closed.
There are two points to note. First, the cycle is inherently unstable. The link between the US and China is not a stable one. Even with a change of President in the US, it is unlikely that the economic hostility between the two nations will diminish greatly. China is the rising power and the US is the declining one. There is bound to be a degree of friction in this process. Second, the ability of the US to act as a safe haven presupposes that investor confidence in the US Dollar remains high. The prospects are that it will not as the US struggles to deal with an ageing population later in this decade.
That all leaves us potentially at one of those inflection points in history. The key event is where the Chinese surpluses are switched from purchasing US Treasuries to commercial lending to entities in the developing world as part of a targeted foreign policy. This heralds a form of imperial expansion, with a distinctly Chinese footprint - tributary diplomacy. The key uncertainty as we peer ahead is whether or not the United States has an answer to this? If it does, then the system will continue for now. If it doesn't, then the retreat of American interests could be very fast indeed.
Stephen Aguilar-Millan
© The European Futures Observatory 2020
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