Money Printer Go Brrrr -Asset Bubble Inflation and De-Dollarization

A version of this article originally appeared in Beijing Review.

With the U.S. economy still reeling from the COVID-19 pandemic and record unemployment, real estate prices continue to skyrocket pricing thousands of house hunters out of the market in the U.S. and Canada. This may seem counterintuitive for an economy that has technically been in recession since February 2020 and saw unemployment peak at just over 14% last April. The last time U.S. home prices raised this quickly, it led to an ensuing crash that brought down the global economy.

This asset bubble is not restricted to the US but is crossing borders and going global making housing or even renting unaffordable for many – especially those worst affected by the global pandemic. In fact the rate of price increases has alarmed policy makers in both the U.S. and Canada. “The dream of homeownership is out of reach for so many working people,” Senate Banking Chair Sherrod Brown told Politico recently. “Rising home prices and flat wages means that many families, especially families of color, may never be able to afford their first home.”

According to World Population Review “the typical value of U.S. homes was $269,039 as of January 2021, a 9.1 percent increase from January 2020. Between 1999 and 2021, the median price has more than doubled from $111,000 to $269,039.

Canadian Prime Minister, Justin Trudeau has also weighed into the topic recently in a statement saying that the cost of owning a home is too far out of reach for too many people in Canada’s largest cities, noting it can take 280 months for an average family to save for a down payment in a place like Toronto or Vancouver – a favorite with Chinese migrants.

But real estate is not the only asset class that is being inflated; both the NASDAQ and S&P 500 have increased by nearly 40% in the last 12 months despite unemployment near record COVID highs in the U.S. The NASDAC increased by 39.51% in the last 12 months while the S&P 500 rose 38.46% over the same period.

Source: Yahoo Finance
Source: Yahoo Finance

The source of this asset bubble inflation is the Federal Reserve’s policy of Quantitative Easing or QE – a term economist use to describe printing money and using it to buy back domestic treasury bonds from banks and other financial institutions.  This, in theory, is designed to reduce the interest rate and encourage lenders to lend to industry or individuals to stimulate the ‘real’ or productive economy.

In reality, much of this ‘free money,’ as Professor Michael Hudson, financial analyst and president of the Institute for the Study of Long-Term Economic Trends, contends is instead used to speculate on assets both domestic and international – particularly in emerging markets where the biggest and quickest gains can be made. In essence, QE disproportionately benefits those closest to the Fed. These asset bubbles show no sign of abating as the US is expected to approve an addition 2 trillion in stimulus this year and the Fed has said it won’t take it’s foot off the pedal when comes to pumping liquidity into the market.

 

Source: FRED
The chart above shows the growth of money supply from the Federal Reserve since 2002. Note the volume doubled during the Financial Crisis of 2008. From then on the economy continued to be buoyed up with periodic bouts of money printing before rocketing during the 2020 COVID-19 pandemic.

With many of these dollars being spent abroad the central banks of the receiving countries keep them and pay the receiver in local currency. But what can central banks around the world do with all these dollars.

As congress often blocks attempts to purchase U.S. companies and assets under the guise of national security – as with the Chinese oil company CNOOC’s $18.5 billion bid for Unocal in 2005 – there is only really one option left; to purchase U.S. Treasury Bonds or T-bills to further underwrite U.S. debt. All of this is made possible because of the U.S. dollar’s unique status as the world’s reserve currency.

Source: FRED
The graph shows how Federal Reserve money supply has nearly doubled in the last 18 months.

Aside from printing money ad infinitum, this special status as global reserve currency gives the U.S. another ability. Namely, to sanction countries or individuals that do not align with their foreign policy objectives. Potentially, it gives the U.S. the ability to essentially turn off the economies of counties that don’t follow U.S. hegemony for whatever reason. But it is this threat and the increasingly liberal use of unilateral sanctions that are leading some economies to attempt to de-dollarize their economies and insulate them from economic bullying.

One such country is Russia. On June 3, the Kremlin announced its policy outline for de-dollarization. The plan to abandon the US dollar was developed by the government in response to tougher US sanctions. Finance Minister Anton Siluanov announced plans to reduce the share of the dollar in the Russian National Wealth Fund (NWF) to zero.

“I can only say that the de-dollarization process is constant,” said Siluanov, expressing doubts about the reliability of the main reserve currency, at a press conference at the St. Petersburg International Economic Forum. According to him, this process is taking place not only in Russia, but also in many countries. “We made a decision to withdraw from dollar assets completely, replacing them with an increase in euros, gold, and other currencies,” the minister said.

According to him, as the share of the dollar is reduced to zero, the share of the euro will be 40%, the yuan 30%, gold 20%, pounds and yen 5% each. Siluanov, noted the replacement will take place “rather quickly, perhaps within the month”. Even before the Ministry of Finance announcement, the Bank of Russia carried out a large-scale restructuring of its gold and foreign exchange reserves, shifting about $100 billion in 2018 into euros, yuan and yen.

Added to this, at the end of 2019, several European countries set up a new transaction channel designed to facilitate companies to continuing to trading with Iran despite US sanctions after President Donald Trump unilaterally withdrew from the nuclear agreement or the Joint Comprehensive Plan of Action (JCPOA).

Set up by Germany, France and the UK, the ‘Instrument in Support of Trade Exchanges’ or INSTEX gives European companies the capacity to bypass the U.S. controlled SWIFT banking system – a network that enables financial institutions worldwide to send and receive information about financial transactions and one of the main tools for U.S. sanctions.

“We’re making clear that we didn’t just talk about keeping the nuclear deal with Iran alive, but now we’re creating a possibility to conduct business transactions,” German Foreign Minister Heiko Maas told reporters at the time.

In addition, China launched its Cross-border Interbank Payment System (CISP) in 2015. CISP is a payment system which offers clearing and settlement services for participants in cross-border yuan payments and trade.

At the start of the 21st Century the idea of de-dollarizing global trade seemed insurmountable. But now it seems as if the COVID-19 pandemic and America’s response may be accelerating the process faster than many imagined possible.

Developing Asia’s Economic Growth to Contract in 2020

Developing economies across Asia are set to contract this year for the first time in nearly six decades but are likely to begin to emerge from the economic devastation caused by the coronavirus next year according to a report released by the Asian Development Bank (ADB) yesterday. The report, the Asian Development Outlook (ADO) 2020 Update forecasts a GDP contraction of -0.7 percent for developing Asia this year – its first negative growth since the early 1960s.

However, the report goes on to say growth will likely rally to 6.8 percent in 2021 – in part as growth will be measured relative to a weak 2020, leaving next year’s output below pre-COVID-19 projections. With three-quarters of the regions’ economies expecting negative growth in 2020 the ADB is suggesting an “L”-shaped rather than a “V”-shaped recovery for the region.

“Most economies in the Asia and Pacific region can expect a difficult growth path for the rest of 2020. The economic threat posed by the COVID-19 pandemic remains potent, as extended first waves or recurring outbreaks could prompt further containment measures. Consistent and coordinated steps to address the pandemic, with policy priorities focusing on protecting lives and livelihoods of people who are already most vulnerable, and ensuring the safe return to work and restart of business activities, will continue to be crucial to ensure the region’s eventual recovery is inclusive and sustainable,” said ADB Chief Economist Yasuyuki Sawada.

To mitigate the ongoing risk, governments in the region have delivered wide-ranging policy measures, including support packages—mainly income support—amounting to $3.6 trillion, roughly equivalent to about 15 percent of regional GDP.However, the report points out a prolonged COVID-19 pandemic remains a major biggest downside risk to the region’s economic outlook this year and next.

According to the ADB, the PRC is one of the only regional economies bucking the trend with expected grow of 1.8 percent this year and 7.7 percent next, with successful public health measures supporting growth. In India, where lockdowns have stalled consumer and business spending, the ADB estimates GDP contracted by a record 23.9 percent in the first quarter of its fiscal year and is forecast to shrink 9 percent in FY2020 before recovering by 8 percent in FY2021.

The report goes on to highlight other potential downside risks in the region arising from geopolitical tensions, including an escalation of trade and technology disputes between the United States and the PRC; as well as financial vulnerabilities exacerbated by a prolonged pandemic.

Could China weaponize its FX in a Trade War? Does it have a ‘Nuclear Option?’

Amid the talk of a new Cold War with China some analysts are warning that China could use weaponize its vast foreign currency reserves – it’s massive US Treasury Bond Holdings (T-Bills) – and dump them on the open market. To understand this arrangement read Understanding China Foreign Exchange.

Often referred to as the ‘nuclear option,’ – and not without good reason –  has the potential to cause a massive spike in U.S. interest rates, sink the US stock market and freeze credit markets, pushing the U.S. even further and deeper into recession. This would of course create major problems for whoever happens to be President.

The problem is, for the alarmists, they underestimate the damage this do to the Chinese economy. Firstly the as the selloff started the overall value of it’s holdings would plummet; meaning China would be getting pennies on the dollar for what it has taken years to save.

A second factor is that such a move would push Beijing’s dream of the RMB as a reserve currency – a hard policy objective for many years – decades into the future. It would also leave the US relatively unscathed in the short term as the Fed – as it loves to do – could simply print the money to buy back the Treasury Bonds, in a kind of Buzz Lightyear QE ‘To Infinity and Beyond’ program. The economic equivalent of kicking the financial can another generation or two down the road.

China is now world’s second largest importer

It would also terrify foreign investors in China as the value of the RMB lost stability. One of the ways Beijing controls the value of the RMB is by maintaining a foreign currency reserve basket – of which, at present T-Bills make up about USD1.1 trillion as of March 31, 2020. The majority of which are held as reserves to collateralize trade and to capitalize China’s banking system.

Furthermore, a mass selloff would put downward pressure on the RMB and force China to devalue it’s currency and continuing the selloff could lead to a depreciation spiral. A spiral that would make it ever harder to retrieve those dollar reserves.

This spiral would have been less of a worry twenty years ago when China could claw back dollars hand over fist with its epic trade surplus. But those days are long gone, and trade surpluses in the future are likely to be far more meagre, especially as China enters uncertain economic territory as the global Covid-19 crisis continues to wreak economic havoc around the world.

This combination of factors ensures China will continue to need substantial foreign currency reserves both to maintain it’s exchange rate against hard currencies but also to ensure it retains it’s capacity to settle hard currency denominated trade – especially important now China is the world’s second largest importer.

But let’s not get complacent. While the ‘nuclear option’ may be off the table, Beijing has many more weapons in it’s arsenal it could use to make more than uncomfortable for the US. An embargo on rare earth minerals would be one.

Cold War Reboot or Electoral Rhetoric? There’s a lot to lose this time around?

And where would America’s traditional clients stand?

A Cold War could be emerging between the U.S. and China as the rhetoric out of Washington becomes increasingly belligerent according to media commentators. In fact, the relationship between the world’s two largest economies could be at its lowest point since the Nixon-Kissinger rapprochement of the 70s.  Luckily, so far, both have refrained from escalating to a major blow-up but the ongoing fallout from the Corona Virus might threaten that.

Some had last year referred to increasingly frosty U.S.-China ties as a new Cold War, but that is an entirely inaccurate description. Firstly, the original Cold War was premised on (the largely U.S) notion that the Soviet Union posed an existential threat to the existence of Western Europe as a democratic alley and the was intent on the spread of Communism as an ideology around the world.

The current situation between China and the U.S. is fundamentally different. The conflict between Washington and Beijing is counterbalanced by the two nations’ economic interdependence. A dependence Washington never had with Moscow.

This extensive web of trade and investment relationships developed over the last three decades force the U.S. to counterbalance more extreme positions.

In fact, until recently even officials of the Trump administration did their best to play down sometimes overblown rhetoric.

But unfortunately, those mitigating factors are dissipating somewhat in the wake of the Corona Virus and the talk from Washington is becoming increasingly hostile.

As the devastation from Covid-19 accumulates in the U.S., arguably exposing the failure of decades of underinvestment in infrastructure, healthcare and the growth of the wealth gap, the number American fatalities is now nearly double that of the Vietnam War – a conflict that lasted longer than a decade.

And increasingly, voices in the U.S. government are turning to blame China with the view that the CCP should be held accountable for the devastation gaining ground. Those that support the view distrust China’s narrative (and the CCP in general) of the outbreak.

The problem is, this line of arguing is increasingly looking like a direct assault on the very nature of the CCP not just its handling of the Covid-19 Crisis. Whether this is simply election-year rhetoric remains to be seen. But Washington looks, and more importantly sounds, serious.

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 On the Chinese side, the accusations are providing ammunition for the propaganda machine that claims the communist regime is superior to the disorganized Western democracies, pointing out how Western nations are still struggling to get a handle on the crisis and how a panicked Trump administration is using the Virus as part of a blame game; deflecting from their own societal shortcomings.

Either way, these are alarming signs at a time when the world most needs to pull together to tackle a problem that has no interest in borders, nationalities or ideologies.

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But so long as the two countries remain bound by the interlocking forces of globalization and their own interdependencies then there is a limit to how far this could go.

The problem is, the Pandemic could be at risk of undoing those ties and decoupling the economies. According to Reuters, the U.S. government is now considering all kinds of measures to lessen dependence on China including tax breaks for companies that relocate their production and procurement facilities across a broad range of sectors.

The US has already barred telecom provider Huawei from a stake in its 5G network and pressured its clients follow suite with varying degrees of success and looks like trying to push China out of all America considers ‘it’s sphere of influence.’ And could lead to serious consequences.

 Perhaps lurking in the back of some policy maker’s mind’s in the U.S. is Xi Jinping’s bold declaration at the that:

“China will be a global superpower by 2050.”

CCP congress in October 2017

Since then Beijing has rolled out a strategically ambitious project through massive spending on military and civilian technologies.

The perceived expansion of Xi’s power through the Belt and Road infrastructure project is undoubtedly another thorn in the side of foreign policy planners.

The Belt and Road Economies from its initial plan

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One obvious problem this situation represents is for those caught in the middle; Washington’s traditional clients, especially in Europe. A recent survey shows that Germans are now almost equally divided on who represents a more important partner – Washington or Beijing? A significant shift over 2019 which put Washington 26 points ahead.

Although many Germans are unhappy about China’s handling of the Corona-Virus and have suspicions it could have been better handled they don’t wholesale blame all CCP for the chaos being wreaked around the world.

And while traditionally, the German attitude to the US usually reflects who is sitting in the white house the Trump administration’s current perceived mishandling of the crisis; increasing belligerence toward the CCP and the WHO; and the increasing calls for Europe to pay for its own defense are putting traditional allies in a difficult position.

If the U.S. escalates the current spat into a full-blown soft-reboot of the cold war it could find itself in a lonely place with former client states between a rock and a hard place.

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More worryingly, a new Cold War between the U.S. and China could have a far larger global impact than that with the USSR.

China is far more economically powerful and technologically advanced than the Soviet Union was, and is catching up with the U.S. in other areas. That could make them dangerous rivals if some kind of accommodation can’t be reached and the world goes down that road.