Contrary to what many Fed and government officials may think, the effects of Quantitative Easing in the US shouldn’t just be measured by the stimulative impact money printing has on American employment, output and inflation expectations. Were the country an isolated and self sufficient economy then this simple analytical framework might be theoretically appropriate. However, this view is totally divorced from the reality of the economic powerhouse which exports $2.3 trillion and imports $2.7 trillion in goods and services each year, not to mention the fact that its currency is the global reserve currency and the pricing mechanism for a further multiple of international transactions.
Messing with monetary policy in the US inevitably means messing with the world. Thus ignoring the hugely detrimental impact that current Fed policy is having in other countries runs the risk of allowing significant systemic tensions to build up and which could ultimately have extremely negative consequences for the US Dollar. In particular, it is quite feasible that if the current situation is left unchecked then the Dollar’s status as the world’s reserve currency could even be called into question. At the moment, very few seem concerned with such an eventuality, safe in the apparent belief that the Fiat system of currencies is so embedded in global economics that nothing will threaten the status quo. But of course, history is littered with examples of such hubris ultimately falling foul of traumatic events. Portugal, Spain, France, Britain are just some of the examples of past holders of the world’s reserve currency status and look at what happened to each of them…
Unlike the recent positive current momentum that is present in the US economy, or more specifically in its financial markets, investors in the BRICS don’t currently have many reasons smile. The recent tremendous growth these countries have experienced has come to a stuttering halt and their outlooks have worsened dramatically. Global demand is weak and the surplus trade balances they could previously rely on are being eroded, largely as a direct result of QE programs abroad. Additionally some of these nations, most notably Brazil, have come under more pressure as their domestic currencies have become increasingly volatile.
While the S&P 500 has risen almost 20% YTD, and more than 52% in the last 3 years, countries like Brazil, Russia, and China have seen their stock markets go into reverse. India is flat while South Africa is the only BRICS nation getting on board the QE express.
Although composed of just five countries (Brazil, Russia, India, China and, more recently, South Africa) the BRICS are much more powerful than many realise. In those countries there are 3 billion people and their combined GDP amounts to $14.8 trillion, which is just shy of the total separate amounts of America and Europe. The BRICS are recognized as important producers, but increasingly they are also heavy consumers of commodities. Given that the US Dollar is still the pricing mechanism for the overwhelming majority of commodities, how much longer can the BRICS be expected to withstand the very detrimental side-effects of a Fed policy? My expectation is not much longer…
An unstable and debased Dollar, printed out of thin air and weighed down by a $17 trillion Federal deficit is not exactly warming the hearts of foreign policy planners. In fact, there are already some signs of dollar fatigue. Brazil has been very vocal in the last few years against Fed policies and China has started making bilateral agreements, priced in alternative currencies, with the other BRICS and even with some European trading partners to bypass the dollar. China has a localised trading partnership agreement to trade using the Renminbi with Southeast Asian countries.
This week, China, through Yao Yudong of the PBOC’s monetary policy committee, has just fired another salvo against the Dollar. In an article published in the China Securities Journal, Yao calls for the establishment of a new gold standard. He spoke about a multi-sovereign currency system able to place some restraint on currency issuance. Yao expressed the view that the world now needs a currency backed with a hard asset (no doubt one of the reasons why China is the largest importer of gold), with monetary expansion taken out of the hands of governments and central banks (if there’s any difference between the two!). Wise words indeed…
Whether a gold standard is truly the solution remains to be seen, but there is plenty of trouble ahead, as American planners wake up to the reality of dealing with their debt burden – a burden that has a very long tail and is, frankly, insurmountable. Perhaps Yao Yudong’s vision of the future of money might be a little closer to hand than most people currently expect. If he is right, then we are positioned extremely appropriately in our Precious Metals fund.
R Jennings, CFA, Fund Manager Titan Investment Partners