Can the Current Economic and Inflationary Crisis Upend the Post World War II Security Order?
Thus, Creating a Brand New Global Economic and Security Structure
Image Courtesy: Euractiv; Nordstream 2
I was recently listening to the MacroVoices podcast where the featured guest was the one and only Luke Gromen. Luke Gromen is a macro and financial markets analyst and runs a macro consulting shop called Forrest by the Trees. He is one of few macro analysts who has made sense of inflation, COVID-19 supply chain disruption, and economic ripple effects due to the Russian invasion of Ukraine. One thing that struck me was when Luke mentioned that the current economic crisis, energy inflation, and Western sanctions on Russia are going to finally upend the post-World War II security order. This may happen sooner than expected.
To give you context, after World War II the US was the strongest economy in the world. The US was more than 50% of global GDP growth. This gave America the opportunity to create the rules. The once-mighty British empire on the other hand could not afford to maintain its massive empire spanning the globe and thus had to retreat. The Sterling Pound, which was the pre-WW2 reserve currency traded places with the US Dollar. During the Bretton Woods conference, the US Dollar was named the global reserve currency. Also, IMF became the global lender of last resort and the World Bank became a global development economic agency. The American Navy, which grew to become the largest blue water navy in the world, patrolled the seven seas as America traded with the world. In terms of security, the North Atlantic Treaty Organization (NATO) was created to counter the Soviet Union. The US signed defense treaties with Asian pacific nations of Japan, South Korea and the Philippines where the US agreed to come to these nations’ defense if any of these nations were attacked. The collapse of the Soviet Union made America the unipolar superpower. But the unipolar moment is slowly coming to an end.
In 40 years China has gone from an agrarian backwards economy to an economic powerhouse on-par with the US. In just 40 years China has overtaken the United States to be the largest economy in terms of Purchasing Power Parity (PPP). In terms of key technologies like AI, Quantum Computing, Blockchain, E-Commerce, Telecom, and Consumer Internet China is on-par or ahead of the United States.
Courtesy: HowMuch.Net
As you can see above ever since China joined the WTO in 2002 China has grown to be the largest trading nation in the world. As the global economy changes so does the post-WW II order.
After the financial crisis, China was outspoken about flaws in the US financial system and thus finding an alternative to the US Dollar system. Then came the BRIC nation conference (Brazil, Russia, India, China with later South Africa joining the group of emerging market nations that turned into BRICS). The BRICS group was spearheaded by former Brazilian President Lula DeSilva. It was mainly aimed at creating a new global economic, trade, and strategic order to counter the Wester-dominated institutions and Dollar dominance. China has already taken steps to counter the old Bretton Woods system. To counter the World Bank the BRICS created the BRICS Development Bank. To counter the IMF China created the Asia Infrastructure Investment Bank (AIIB). America’s staunch ally Britain was the first European nation to be a founding member of the AIIB. Many American and Asian key allies and partners became founding members of the AIIB. Former US Treasury Secretary famously called the creation of the AIIB the day the US lost its “Superpower” status. I have to agree with Mr. Summers in this instance (probably the only thing I agree with the Former Treasury Secretary). The day the AIIB was created was the end of America’s unipolar moment.
Now let’s fast forward to the current Russian invasion of Ukraine. For anyone following my work, you would have been of aware how Western sanctions are hurting the West more than Russia (as we have discussed here, here, and here). We have also discussed how Western sanctions on Russia are unprecedented. Many macro analysts like Louis Vincent-Gave, Luke Gromen, and Credit Suisse’s Zoltan Pozsar also share this view. Zoltan has gone far as to call the Western sanctions on Russia the beginning of Bretton Woods III. According to Zoltan, we are headed to a commodities-based currency system where commodity producers (like Russia) are going to be winners. Furthermore, Zoltan has said that inflation and rising commodity prices are going to hurt Western currencies and strengthen the Chinese Yuan.
As these unprecedented Western sanctions have been put on Russia, Russia may emerge less hurt economically than its Western counterparts. The Ruble is the strongest currency globally. Russia has earned more than $90 billion just in fossil fuel sales 100 days after the start of the Russian invasion. As you can see below, many EU countries still depend on Russian fossil fuel imports to keep their economies running.
Courtesy: Michael A. Gayed, CFA
As you can see in the chart above Germany is a close second after China when it comes to importing Russian fossil fuels. Germy, Italy, and the Netherlands are the three largest importers of Russian fossil fuels right after China. As Europe needs to power its economy, it has no choice but to rely on the Russians to get their energy. Relying on the Russians meaning that paying in Rubles. EU companies have already opened up Gazprombank bank accounts to pay for Russian energy. Even Ray Dalio, in his July 4th reflections, highlights how Russia is overall winning the Ukraine crisis over the West.
Outside of the West, we are already seeing a realignment of nation-states. Geoeconomics and geopolitics and realigning fast. This year the world’s largest trade deal the Regional Comprehensive Economic Partnership (RCEP) came into effect. This is the world’s largest trade pact and US and no stake in this partnership. Countries with vast political differences and rivalries, like China, Japan, South Korea, Australia, New Zealand, and ASEAN nations (which spearheaded the trade talks) are all in one trade pact. One of the biggest news to come during the Russia Ukraine crisis was Saudi Arabia agreeing to sell oil to China in Yuan. This was a game-changer and straight-up dismantling of Bretton Woods II. After the Dollar was taken off the gold standard Nixon and Kissinger flew to Saudi Arabia to guarantee the safety of the Gulf in return OPEC pricing oil in US Dollars. This gave the US financial system a huge advantage as demand for Dollars went up because to buy oil countries need Dollars. Now with the fraying US-Saudi relationship Crown Prince MBS is looking east. Saudi Arabia and the Gulf States have gone against sanctioning Russia. To make matters worst for the White House UAE and Saudi leaders are not even taking President Biden’s calls to help resolve the oil inflation crisis. UAE has been attracting Russian Oligarchs and other high-networth individuals and protecting them from Western sanctions. As the Gulf turns east, it is not surprising that Saudi is looking to sell its oil in Yuna, to please its largest customer. The Chinese are maybe even twisting the Kingdom’s arms into selling oil in Yuan in return for China supporting Crown Prince MBS’ Vision 2030 Project (and maybe combining Vision 2030 with China’s Belt and Road Initiative).
Another event that everyone should be paying close attention to is the BRICS+ Summit. The BRICS Summit was just held in China where leaders from the five-nation alignment met to discuss many topics ranging from Ukraine, and COVID-19, to economic development and collaboration. One key topic discussed by the BRICS alignment is using alternative payments, financial, and technological systems. This is something I have spoken about frequently on Armchair Banker, especially alternative payment systems. China and Russia have already created a SWIFT alternative to trade with their own currencies. But the biggest news to come out of the BRICS+ summit is Saudi Arabia, Argentina, and Iran showing interest in joining the BRICS Alignment. Also, as President Biden plans to visit Saudi Arabia, the Kingdom’s former Intelligence Cheif Turki Bin Faisal Al-Saud, has written an Op-Ed discussing how the current order needs to change to reflect a multipolar world order. It is clear that the Kingdom is looking to pivot east. Joining the BRICS partnership will be a game changer and thus totally dismantle the Nixon and Kissinger “Petro Dollar” deal. The Kingdom has also shown interest in normalizing relationships with Iran. With Iran, Saudi Arabia, and BRICS working together this will be a game-changer and further reduce the influence of the Western world.
The Europeans have also slowly been steering away from the Post WW2 security order. This has mainly been driven by economics. Needless to say, as China was opened up to the world in 2001 Europe’s trade with China skyrocketed. So it made sense for many EU nations to be founding members of the AIIB, a direct competitor to the IMF. The EU was also not too happy when the US reneged on the JCPOA (Iran Deal) with Iran and increased sanctions on Iran. Europe wanted to normalize trade relations with Iran. Europe even came up with building its own payments system called INSTINEX to pay for Iranian goods (in particular oil). In terms of EU-China relations, the EU’s trade with China has overtaken its trade with the United States. For many EU companies, China is an important market than the United States. As of January of 2022, Mercedez sold 758,863 cars in China while only selling 276,102 in the United States. AirBus won a $37 billion deal with three airline carriers in China, clearly making Boeing not too happy (China was one of Boeing’s largest markets). AirBus has also opened a R&D center in China. As the EV supplychain is increasingly being centered in China, VolksWagon has increased its presence in China to boost R&D in EVs. As many European companies lose the Russian market due to companies protesting Russia’s invasion of Ukraine, the Chinese market is even more important. This is why I truly believe that NATO will not be able to counter China. The current inflation and economic slowdown show that Europe cannot 100% afford to cut its relationship with Russia. As shown above, European countries are still importing fossil fuels from Russia. These countries are paying in Rubles (after all they don’t have a choice). Germany is going through a historic high inflation period. Germany’s Producer Price Index (PPI) is at an all-time high, reaching double digits.
The German auto industry has come out and said that cutting energy from Russia is going to severely impact the industry. The German Economic Minister Robert Habeck has come out and said that cutting Russian energy is going to collapse entire German Industries. For German politicians or any politicians for that matter, more than anything they want to be in power. No doubt EU politicians are looking at what is happening in Sri Lanka and don’t want their homes torched or see their citizens march with pitchforks. Dutch farmers have already started protesting. For all these reasons, the EU may have to tell Washington sorry but their economies, industries, and citizens’ needs trump geopolitics and pleasing Uncle Sam.
The same can be said about Japan. Ever since the end of WWII Japan and the US have had a joint defense cooperation treaty. Japan and US were strong partners during the US-Soviet Union Cold War and currently is very supportive of the US efforts to contain China. But Japan, just like any other industrialized developed country, needs energy to run its economy. Also, as the Yen declines substantially compared to the Dollar energy imports are only going to get even more expensive for Japan. Even Center for Strategic and International Studies’ Senior Research Fellow Taisuke Abiru has called for Japan to maintain its energy investments in Russia. Japan’s automobile industry is a big driver of the Japanese economy and the crown jewel of Japanese industry. But the Japanese car industry is losing its supremacy due to EVs. Just today the Warren Buffett-backed BYD has surpassed Tesla to be the largest seller of EV cars. If Japanese automakers need to compete with Tesla, Geely, Nio, and the VolksWagon Group, Japanese automakers need to integrate their supply chains with China. Even macro analyst Russell Clark predicts Japan getting close to China. Even former Japanese PM Yukio Hatoyama has called Japan to start talks with China and rely less on the US.
Last but not least, one news item to pass by your radar will have huge implications for the future of monetary policy and the Dollar. One of the largest Indian Cement Makers has bought Russian Coal using the Chinese Yuan. This shows that commodities and energy are more valuable and important than paper/fiat currency. This also shows that countries that are developing and need energy to run their economy and support their population are someway going to buy energy. This also shows how the world is increasingly getting multipolar and how this multipolar order can erode the Dollar and America’s current role.
To conclude, we see a massic political, economic, financial, and monetary change. We have seen over the years the rise of trade deals and staunch US allies joining multilateral economic institutions directly threatening the Bretton Woods system (AIIB). For countries close to the US orbit (like the EU and Japan), economics and serving their constituents are their priority. If that means getting closer to China and buying more Russian commodities, this may be the end of the Post WWII global order.
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