I have a history of periodic insomnia. It comes and goes for no apparent reason. It doesn’t seem to correlate with external stresses but with my own obsession about certain things, things that keep me awake at night even though there is nothing I can do about them at 3:00AM. I toss and turn and play out scenarios in my mind. It’s exhausting.
The economic and foreign policy “experts” are probably living this right now. The faith that threatened sanctions and world disapproval would deter Vladimir Putin from invading Ukraine was gospel right up to the moment the tanks began rolling. The pundits misread all the signs, misinterpreted the facts and misdiagnosed the disease based on asking themselves; “What would I do in Putin’s situation?”. Now they tell us that economic sanctions and banishment from the cool kids’ lunch table will inflict such pain on Russia that either Putin will relent or the Russian people will throw him out. Before you roll over and go back to sleep it might pay to remember that these are the same people who told us a couple of months ago that Putin was bluffing, just using threats to get at least some of what he wanted.
In a bald-faced effort to cover their malodorous arses they are now opining that “Putin is a madman!”. After all, who could have predicted the actions of an insane despot? They weren’t actually wrong, he’s just crazy. And so some of them have taken to extreme saber rattling while others hatch dream plots where the “civilized world” avenges their miscalculation for them in the form of economic pain like some financial Marquis de Sade, only using trade and currency instead of whips and chains. The problem is that in this highly interconnected “one world” system that they have been pushing for almost a century the backlash from the whip is just as painful as the lash itself. We have filled the financial world with counterparty risk.
As supply chains and multi-national businesses and bankers have tried their best to erase borders it has been a boon to some of them. The ability to add international numbers to their TAM (Total Addressable Market) calculations has made some outsized growth expectations seem almost reasonable to willing stock purchasers. But now the realities of war and geopolitics are giving lie to the infinite TAM numbers being trumpeted by companies trying to justify insane PE multiples implying markets that are now, or will soon be, cut off to them. The realization is strongest in the tech sector where in the past an unbounded internet has been counted on to enable global reach for social media marketing and unlimited movement of goods and funds. Crypto-currencies would eliminate politico-nationalist friction from the system and circumvent any regulatory impediments to world trade. But this conception falls apart in a world made up of separate and government censored, tightly controlled networks, the so-called Splinternet. It only works in a smoothly cooperative Internet.
As the Chinese tiger economy grew in power and scope, containing 20% of the world population and increasing amounts of the world economic activity it should have been obvious to the experts that something had to give. The era when the US financial system was all-powerful is over. As far back as the “Asian contagion” or the Argentinian default the signs were all there. Economies had become so intertwined that a butterfly sneezing on one side of the world could cause a tempest on the other. Even after Lehman Brothers and the fiscal devastation in the economic flood of 2008 we built back our houses in the same flood plain as if it could never happen again. This time it’s different.
We have allowed the reemergence of derivatives as a tool in financial engineering designed to pass risk on down the line to someone else. But the machine has become so complicated that no one is sure how it actually works or where the final accounting lies. Already, with the sanctions and excommunications from the global financial system, the Russian attack on Ukraine is throwing monkey wrenches into the gears. It is not lost on China or the rest of the non-Western world that being dependent on the US dollar and institutions like the World Bank or the IMF may not be as safe as they once assumed. Holding foreign reserves in US treasuries and dollars is no guarantee of anything, especially with Washington D.C. on an unparalleled and unaffordable spending spree. If other countries decide that US debt is not a safe place to put their foreign reserves who will buy the bonds to refinance what we obviously cannot ever repay?
China has been distancing its economy from the possibility of US or other external coercion for a few years now, diversifying its export markets, clamping down on American listings of its company’s stocks, banning crypto and stockpiling gold and other commodities. How long until they start selling off the 30% of US debt that they own thereby driving up our borrowing costs? They will never get a higher price than they can get now. How soon until they insist on payment in yuan for exported Chinese goods? The risk that the dollar-based exchange system could cripple them if they invade Taiwan has been demonstrated with Russia. Would the US sanction China to the exclusion of most of our pharmaceuticals, many of our electronics, most of our computer chips and consumer goods? I doubt very much if we have the will. Our carping about NordStream 2 giving Russia power over Europe pales by comparison.
In short order we will have to deal with new realities regarding national borders, international organizations, protectionist currency manipulation and internet segmentation that will change the calculus for businesses and whole economies the world over. America, while having the dominant position presently, also has the most to lose. A consortium of China, Russia and its former minions, along with a smattering of “Belt and Road” beneficiaries are in a position to challenge the West for economic supremacy or at least a separate but equal parity in world power. The Eurozone, the Arabs and India could pick a side or they could divorce themselves from the protagonists and try to play the middle. Counterparty risk indeed. Sleep well.