Thank you for inviting me to be here today. I am especially pleased to participate in the Shanghai Bund Summit because of what these discussions represent for me. I’d like to share my perspective. When I first came to China in 1984, there were no financial markets to speak of. Five years later I was lucky enough to work with a small team of 7 smart and patriotic Chinese who were on a mission to bring a stock market to China. That small group, the “securities exchange executive council” had no financial resources to speak of and built that stock exchange which is in Shanghai. Since then, I have watched and have been able to contribute in some small ways to the development of the financial markets and the skills of the Chinese people dealing with them. It has been joyous for me. The mere fact that I as an American can have very frank discussions with my Chinese friends about what is best for the financial markets cannot be taken for granted.
The title of this conference “Financial Cooperation and Reform in a Changing World Order”, while innocuous sounding, is provocative because the changing world order has unfortunately reduced cooperation. One of the biggest questions of our time is what amount of cooperation will exist between the US and China as the world order changes. If you can tell me what is going to happen with cooperation, I can answer the questions you gave me more reliably. It seems to me that the conference might be more appropriately titled “Financial Cooperation and Competition in a Changing World Order”.
I was asked to place the impact of the pandemic that we are in and the government response to the pandemic in the context of the big forces that I see playing out. Those three big forces are:
1. The long-term debt and money cycle,
2. The internal wealth and political gap cycle that has people at each other’s throats, and
3. The rise of a great power, in this case China, to challenge the existing world power, the US.
I will reply as well and as forthrightly as I can to your questions. My views are controversial. While I can’t guarantee that they are accurate, I can guarantee that they are what I truly think.
Regarding the long-term money and credit cycle, my perspective comes from examining reserve currency empires over the past 500 years, starting with the Dutch empire and the Dutch guilder, which were replaced by the British empire and the British pound, which were replaced by the American empire and the US dollar, which will increasingly be replaced by the Chinese empire and the Chinese RMB.
To me, the changes in the world order that we’ve been experiencing are similar to those that have happened in the past. The last big change in the world order happened in 1945 after the US won World War 2 and was clearly the richest and most powerful country in the world. As a result of being in that position the US dollar became the world’s leading reserve currency.
Because the dollar was the leading world’s reserve currency, naturally foreigners including Chinese wanted to save in it, and that gave the US the exorbitant privilege of being able to borrow in dollars to finance its debt. It originally did that using paper dollars that were convertible to gold, so dollars were like checks in a check book having no intransic value, and the gold in storage was like the money in the bank.
Over the decades that followed, the US created much more debt than it had money in the bank, and so in 1971 it had to default on its obligation to make payments in gold. The dollar then was devalued, the world went into a dollar-denominated fiat system, a big inflation wave occurred for the next decade, and there was a continuation of a debt acceleration until 2008 when the Federal Reserve pushed interest rates to 0% and could no longer stimulate any more by lowering interest rates.
The two charts shown here convey the cycle I’m referring to. Note that in the top chart the debt levels were high both in the 2008 period and in the 1929-1930 period. In both cases, interest rates hit 0% as shown in the blue line in the lower chart, and the printing of money and buying of financial assets by the central bank began in a big way, as conveyed by the red line. In other words, the period of debt creation and big debt monetization that began in 2008 was like that which began in the early 1930’s. As you know, and can see in the chart, the Covid-triggered downturn in the world economy led to massive increases in debt creation and debt monetization in the US and in the other leading reserve currency countries. There is no doubt that this will continue even after Covid disappears as large deficits that have to be monetized will exist. So the long-term US dollar debt cycle is now at the point at which there is a lot of debt outstanding, there are fast increases in new debt being created, and fast increases in the Federal Reserve’s production of money to service all this debt. The fact that central banks can take ownership of that debt and charge negative interest rates allows them to reduce debt service costs and debt rollover risks which allows them to extend the debt cycle.
By studying history one can see that these big debt cycles have existed throughout time and in the past they have always led to central banks monetizing debt and devaluing currency and they have always radically changed the world credit system which is the backbone of the capital markets. That is because bonds are promises to deliver currency. So, when the currency is devalued, the debt markets are threatened. US bonds are promises to receive US dollars. The Federal Reserve can and will produce those dollars and buy financial assets, mostly debt. Naturally, the sellers of those financial assets will take their money and buy other financial storeholds of wealth, such as stocks and gold, which will cause those prices to rise. That is what we are now seeing, and that’s what happened in 1933 and 1971, and the decade-long periods that followed them. Now investors are overweight in these bonds, there is no nominal yield, and there is a negative real yield, plus a lot more new debt and new money will be created. So why would anyone want to hold these bonds? It doesn’t make sense to me. These circumstances exist at a time that the dollar is still the world reserve currency and the basis of most debt and lending in the world. That is risky.
Don’t get me wrong – I believe the US and the US dollar still have a lot of power because the US produces the money that most people around the world use to buy what they want, and the US still controls the clearing system that could cut people off from money in a capital war. Those are great powers that are most powerful over the short run, especially when there’s a lot of US dollar-denominated debt. However, in the longer run, those who can be squeezed by this vulnerability will find ways to replace their risks and in turn reduce this power.
As for the second big force, the wealth and political gaps, while capitalism is an effective system for producing wealth it naturally produces big wealth gaps. This is especially true in this era in which the value of people is increasingly being replaced by technology. It is also especially true in an era of globalization, while relatively expensive Americans have to compete with more cost-effective non-Americans. These forces are what produced the wealth gaps and the political gaps that we’re now seeing in the United States. The two charts show this. The chart to the left shows that the wealth of the top 0.1% of the US population and shows that it is nearly as large as the bottom 90% combined. The chart on the right shows that the Republican party is more right-leaning and the Democratic party is more left-leaning than at any time since 1900, so the gap between them is greater than any time since then.
These disparities in incomes and opportunities are self-reinforcing. For example, if you look at the education in the US, naturally those who earn more money spend more money on educating their children. Those in the top 40% spend about 5 times as much money on their children’s education as those in the bottom 60%. So, more opportunity goes to those that are relatively rich than those that are relatively poor, making the cycle self-reinforcing. Throughout history, those with financial wealth gain political power, and those with political power work with those with financial wealth in a symbiotic relationship to maintain the system that favors them. When things get bad, that can cause civil wars and revolutions. As a rule, when there is a large wealth gap, and there is a lot of debt, and there is a large economic downturn, there’s a lot of conflict. That’s a timeless and universal truth. We can see this happening in varying degrees around the world. We now see it happening in the US. These conflicts produce big structural changes.
As for the third big force, which is the rise of a great power to challenge the leading world power, we also have seen that happen repeatedly in history. China is now that emerging great power and the US is the existing leading world power. The chart shows indices of countries’ powers going back to 1500. I put it together to visualize where we are in this big cycle. The blue line is the US and the red line is China. The chart speaks for itself. Regrettably, I don’t have the time to delve into all the interesting pictures that come through when looking at the components of these indices. However, I want to convey the big takeaway, which is that history has shown that a country’s reserve currency strength and its financial strengths lag its other strengths, and that it now appears that destiny is calling upon China to internationalize the RMB and develop financial centers. I believe that now is right time to do it, because I believe that as China opens its capital markets, it will find favorable capital flows because the fundamentals of investing in China are strong.
You asked me what the possible paths are. In order to understand what now needs to be done, we need to understand where in the cycles we are, by which I mean what circumstances we are in, how we got here, and the range of alternatives going forward. We can’t get around the circumstances we are in. We can only deal with them in the best possible ways. For example, in the US and China there are different circumstances—we have different levels of our incomes relative to our expenses and our assets are different relative to our liabilities, our financial conditions therefore are different and we have different ways that our systems work to produce productivity. That is the nature of the circumstances that are different. But the fundamental determinants of success are always the same. To be financially strong, one has to be productive in order to earn more than one spends and to build a balance sheet in which one’s assets are greater than one’s liabilities. This is best done when most of the population is well-educated, behaves in a civil manner, and works well together. So the possible solutions are always the same. Have great leadership that educates people well, teaches them civility, enables them to work productively, and has them operating in a financially sound way. These are the challenges that lie ahead for all countries.
Thank you for having me here today.
