We will publish a piece on Wednesday about the evolution of international monetary policy and the aftermath of Covid-19. We have uncovered a few relatable charts to the current state of affairs that we wish to pass along.
The reserve currency is the common pool resource across the globe.
The United States is the provider of this common pool resource which remains necessary for international trade and finance. Essentially, all countries without a reserve currency must continue to hold their reserves in US Dollars, but this proportion is under fire for multiple reasons.
Think of it as a club where the US is the leader and controls a major part of the shares. The world members have some shares proportional to their foreign reserves.
Source: Yardeni.com
The reserves held by the Fed in relation to the global reserves show us that the Fed is bolstering their position while much of the world is underrepresented in US treasuries as the international reserve asset. In the short term, a shortage of USD is created, but many will look for ways to bypass the Dollar in the longer term. Therefore, we see continued strength in the USD short term, eventually waning down the line.
So, we expect a bigger drawdown in emerging markets equity prices.
In order to explain our argument we are republishing a previous piece: The Cold War of Bits and Things.
The Cold War of Bits and Things
The tech war will be a main factor in the confrontation between China and the US. The emergence of Artificial Intelligence and Blockchain technology will be decisive tools in this battle for domination in an updated version of the World-Island theory.
The US and China are on the verge of a new Cold War. This competition for geopolitical hegemony will be predominantly fought across the cryptographical world of bits and the Internet of Things. Artificial Intelligence, Quantum computing and in every realm of the Internet is where these battles will be won and lost.
Throughout history, much power has been derived from controlling Eurasia, or the World Island. The Romans, the Mongols, Napoleon, the British empire, Stalin and Hitler and countless others attempted and failed to control this region, but the quest has remained. Conquer the World-Island. Rule the World.
“Whoever rules East Europe commands the Heartland;
whoever rules the Heartland commands the World-Island;
whoever rules the World-Island commands the World.”
Sir Halford John Mackinder, a founding father of geopolitics, was one of the first to refer to this idea of Eurasia as the World Island. Whoever successfully controlled this region could dominate the world, but all attempts have fallen as a result of military defeat or bankruptcy. The transaction costs of building an empire are enormous. Next, the process of maintaining order and a hierarchical system to control a society with many different beliefs and cultures is next to impossible. For this, democracy has proven to have better longevity, but that is not to say that it is immune from experiencing similar problems.
Who controls the World-Island today is certainly up for debate. A strong case could easily be made for the United States. From its outset, the US has wielded a great amount of influence overseas. Winning World War II guaranteed leadership over the economy in the years to follow. The US understood that it was not only essential to control Eurasia, but also the surrounding ‘Rimland.’ When the US was in the midst of their expansion phase, it could be argued that they were not aiming to become an empire, but rather strategically blocking further expansion of the Soviet Union. Whether right or wrong, the goal to stop the spread of Communism was a fight that much of the world was on board with. The pressure applied on the Soviet Union by the US under Ronald Reagan during the 1980s, coupled with the drop in oil prices, proved to be a winning strategy in ending the Cold War.
The American influence can be seen in the blue area of the following map:
Mackinder's illustrated Heartland theory. Source: khakispecs.com
However, since the introduction of globalization by the US in the adjacent region, they have been met with hostility. Military interventions and other diplomacy disagreements have led to ongoing conflicts, September 11th and other acts of terror. Prior, past enemies in the region have joined forces in their fight against the US and domination of Western civilization. Intervention has proven extremely costly, both in terms of military spending and in terms of overall appeal. Through invasions and constant meddling in foreign affairs, the opposition and competition has grown bigger and stronger. We are not only referring to the terror groups or coalitions that have sprouted, but China as well.
This constant instability has allowed China to grow more quickly along with globalization. Through consolidated reforms, hundreds of millions of Chinese people have been lifted out of poverty to the point where Beijing can enter their bid into the technological leadership race.
Today, China has a leader more powerful than Mao Zedong or Deng Xiaoping. Xi Jinping has re-written the constitution, abolishing the term limit, making himself the indefinite ruler… and the people love him. They support him and believe in him. He has proposed numerous ambitious projects to control international trade in Eurasia, including Made in China 2025 and the immense infrastructure project: One Belt, One Road. As Genghis Kahn tried to conquer the World-Island with his hordes Mongolians, Xi Jinping intends to do the same.
Map of the New Silk Road. Source: The Star Graphics.
Like the USA, China understands that mere physical control is not a guarantee of anything. That's why the real strategy comes from the giants of the Internet. China will insure itself the digital avenues (Huawei, ZTE) for Chinese products of Alibaba and Tencent, among others to flow across the World-Island.
Just as geographical barriers have defined nation states, emerging digital tribes and even the development of a few digital empires will be shaped by blockchain technology and advancements across digital platforms. Various government nation states will still rule the world of things, but centralized and decentralized blockchains will dominate the world of bits. There will be room for organizations, free from traditional borders, to operate and gain power in the digital world.
We view this new frontier similar to mercantilism. When global trade and companies like the Dutch East Indian Company began to take shape, there was very little trust between empires and the standard transaction currency in their world of things was gold. We believe that Bitcoin, or some similar digital currency will be the new gold in this world of bits. The Alibabas, Tencents, Amazons and Googles of today’s world are the companies that nations will use to attempt to manage their digital zones of influence.
The quest for a new digital currency is already becoming a heated point of contention. Facebook’s Libra idea has been met with a lot of pushback from countries and companies alike, but that is where we are headed. China appears to be tinkering with the idea of injecting their own, state-controlled digital currency into the marketplace. Again, the goal of promoting economic hegemony throughout Eurasia seems to be the principal driving factor. Beijing is pushing the mass adoption of blockchain, even making it a priority.
The competition and fight for world domination is moving into the digital world. The new cold war of bits and things will be waged using cyberwarfare, cryptography, Quantum computing and advancements in Artificial Intelligence which will determine the rulers of tomorrow. That nation, or organization, that is able to best harness the powers of technology and apply them towards benefiting and connecting societies throughout the world will emerge as the victor.
So, to update Halford John Mackinder’s theory to modern times:
Who controls quantum computing, will have cryptography control; whoever masters cryptography will control the internet, and whoever dominates cyberspace will rule the world.
Guillermo Valencia A
Macrowise Co-founder
Florianópolis, Brazil
October 30th, 2019