U.S. slams the ICC, Navalny poisoning complicates Nord Stream, China considers nuclear options
For years I wrote a weekly column for TIME and later for Reason. Then life got busy and I gave up the habit of writing so consistently. I’m trying one more time to kickstart the a practice with this newsletter before you, and I hope you’ll come along for the ride.
The idea is simple: recap the week in global politics through the lens of money and finance, and throw in some analysis along the way. Planes, ships, and bombs are increasingly being replaced by sanctions, embargoes, and blacklists. Capital controls, restrictions on technology transfers, and tariffs are in vogue. Around the world, economic policy is merging with national security strategy. So it surprised me that I couldn’t find anyone else writing such a recap. (Let me know who I missed.)
I don’t know what form this newsletter will ultimately take or exactly what I’ll cover, so I welcome your suggestions. That said, I’m fascinated by the dollar’s role as the sole global reserve currency and the power this gives the US to completely control the financial system. How does it exercise that power and how do others resist it? I’m also fascinated by a rising China that is riddled with unsustainable contradictions just below the surface. Can it reach escape velocity or will it crash spectacularly? And I can imagine that cryptocurrency and the new class of sovereign individuals navigating the global disorder will surely make appearances here too.
Here’s what’s on the docket this week:
- The U.S. sanctions International Criminal Court officials
- The hit on Alexei Navalny puts on Angela Merkel in a tough spot
- Is China going to dump its US treasuries?
- Dollar deathwatch
- Various & sundry
So please subscribe, forward it to your friends, share it on Twitter, and above all read it and please tell me what you think. Thanks for coming along!
U.S. to ICC: No, seriously, do not mess with us
The United States on Wednesday imposed sanctions on International Criminal Court prosecutor Fatou Bensouda, Secretary of State Mike Pompeo said, over her investigation into whether American forces committed war crimes in Afghanistan.
The State Department also restricted the issuance of visas for individuals Pompeo said were involved in the court’s efforts to investigate U.S. personnel, though he did not name those affected.
If you had any doubt the U.S. is disengaging from the global order it created and going its own way, this should put that doubt to rest. Sure, the U.S. is not a signatory to the Rome Statue, but it helped create the ICC and has helped facilitate its prosecutions. With these sanctions, the U.S. is making it blindingly clear (if it wasn’t already) that International law, such as it is, does not apply to the U.S. unless it concedes to the application, and global institutions should not imagine it’s any other way.
German Foreign Minister Heiko Maas on Friday described the sanctions, which include freezing the US assets of chief prosecutor Fatou Bensouda and one of her aides, as “a serious mistake.’’
His comments follow calls from France and EU on Thursday for Washington to withdraw the sanctions.
French Foreign Minister Jean-Yves Le Drian said in a statement that the US sanctions were “a grave attack against the court and beyond that a questioning of multi-lateralism and the independence of the judiciary. France calls on the United States to withdraw the announced measures.’’
Josep Borrell, the EU’s foreign policy chief, said the US sanctions were “unacceptable” and “unprecedented.”
Yes, yes, but you can bet your bottom euro they will nevertheless help enforce the sanctions. What choice to they have?
What’s funny about this is that the stated reason for the sanctions is that, among other things, the ICC’s investigation threatened U.S. sovereignty. And yet, this comes just a few weeks after the U.S. threatened sanctions on Germany (which last I checked was a sovereign state) if it proceeds with completing the Nord Stream 2 pipeline from Russia. Again, given the power it wields, the U.S. applies concepts like sovereignty differently to itself than it does to others and is increasingly unembarrassed by the apparent contradiction.
Merkel in a tough spot after Alexei Navalny’s poisoning
Speaking of Nord Stream, the Kremlin’s obvious hit on opposition leader Alexei Navalny has created quite the headache of Angela Merkel.
“We must pursue hard politics, we must respond with the only language (Russian President Vladimir) Putin understands - that is gas sales,” Norbert Roettgen, the conservative head of Germany’s parliamentary foreign affairs committee, said on Thursday.
Late on Wednesday he had said completion of Nord Stream 2 “would be the maximum confirmation and encouragement for Putin to continue this kind of politics”.
It is not clear Merkel, who has been unwavering in her support for the project, will bow to pressure.
Showing she was in no hurry to act, she said on Thursday any response depended on Russia’s behaviour.
“If we want to send a clear message to Moscow with our partners, then economic relations must be on the agenda and that means the Nord Stream 2 project must not be left out,” Wolfgang Ischinger, chairman of the Munich Security Conference and a former ambassador to Washington, said.
By Sunday the Germans were saber-rattling a little:
Germany, the current head of the European Union, will discuss possible
sanctions on Russia over the poisoning of Alexei Navalny if the Kremlin does not provide an explanation soon, its foreign minister said Sunday.
"If in the coming days Russia does not help clarify what happened, we will be compelled to discuss a response with our allies," Heiko Maas told German daily Bild.
Any sanctions decided should be "targeted", he added.
"I hope... that the Russians do not force us to change our position on Nord Stream," he said, adding that the consequences of any potential cancellation of the project would also need to be weighed, and that the debate on sanctions should not be "reduced" to one point.
It’s cliché to say it, but Putin is a real Bond villain. I think he take special pleasure toying with Merkel, who has been put in a position of pretending we don’t know what happened to Navalny. Putin calculates (accurately, I think) that he can get away with it because Germany is increasingly dependent on Russian natural gas.
Meanwhile, in his last NYT column, Brett Stephens calls on Congress to pass a “Navalny Act.”
A Navalny Act would take the Magnitsky Act several steps further. When I proposed the idea to Bill Browder, the American-born investor who once employed Magnitsky and who’s been the prime mover of Magnitsky legislation in the United States and elsewhere, he jumped at the possibilities.
“There needs to be a list compiled of government officials who were complicit in the poisoning or cover-up of poisoning,” he told me. “And the list should be long. And the list should include people with command responsibility. And the sanctions should be simultaneously put in place by the United States, the U.K., Canada, the E.U. and Australia.”
Among other things, Stephens wants to:
- create “a standing bipartisan commission to investigate other Putin-era political crimes”
- countering “Russia’s disinformation campaign in the West with a Western information campaign for Russia”
- to “formalize sanctions against companies from any country that do business with Nord Stream, prohibiting them from doing business in the United States — and barring their corporate officers, including Gerhard Schröder, the chairman of the Russian energy company Rosneft and a former German chancellor, from traveling to the United States.”
Neocons gonna neocon.
Is China going to dump its US treasuries?
The past week saw economic saber-rattling by China, as well as fear of real financial warfare breaking out.
China is considering a range of options to push back on the U.S. Global Times—a nationalistic newspaper owned by the People’s Daily, which is the official publication of the Chinese Communist Party—said Thursday Beijing could seek to leverage its U.S. debt holdings to increase pressure on Washington, D.C.
China is second only to Japan in its U.S. Treasury securities holdings, totalling more than $1 trillion. This is down from a peak of some $1.32 trillion in 2013, after which Beijing has focused on diversifying its holdings.
Global Times said China may slowly reduce its holdings to around $800 billion “as the ballooning U.S. federal deficit increases default risks and the Trump administration continues its blistering attack on China.”
Chinese economists who spoke to Global Times suggested this plan could be accelerated if the U.S. imposes further sanctions on China.
I agree with Michael Pettis who tweets:
[F]or Beijing selling US Treasuries isn’t the hard part. The hard part is what the PBoC does with the proceeds.
-If they buy other USD assets, then nothing has changed.
-If they buy euro, yen, sterling, etc., they will unleash anger from these countries who will suffer disinflationary pressures as their currencies rise against the dollar, and who will have to absorb the consequent reduction in the US current account deficit.
-If they buy the currencies of developing countries, they take highly pro-cyclical credit risks that they have been actively trying to reduce.
-If they stockpile commodities, given how important Chinese growth is for commodity prices, they lock in a huge amount of volatility and more unwanted pro-cyclicality into their balance sheets.
-If they remain in RMB, of course, their currency will rise in value and their trade surpluses will disappear.
Over the short term Beijing is probably better off by reducing the threat of Washington’s cutting it off from the USD system, but economically, and geopolitically over the longer term, the US benefits more than anyone else from a gradual Chinese reduction of USD holdings, which is why Washington should be pushing for this, not Beijing.
Meanwhile, it’s not Americans who are getting scared of the prospects of financial war…
A sharp escalation in tensions with the United States has stoked fears in China of a deepening financial war that could result in it being shut out of the global dollar system - a devastating prospect once considered far-fetched but now not impossible.
Chinese officials and economists have in recent months been unusually public in discussing worst-case scenarios under which China is blocked from dollar settlements, or Washington freezes or confiscates a portion of China’s huge U.S. debt holdings.
“Yuan internationalisation was a good-to-have. It’s now becoming a must-have,” said Shuang Ding, head of Greater China economic research at Standard Chartered and a former economist at the People’s Bank of China (PBOC).
Fang Xinghai, a senior securities regulator, said China is vulnerable to U.S. sanctions and should make “early” and “real” preparations. “Such things have already happened to many Russian businesses and financial institutions,” Fang told a June forum organised by Chinese media outlet Caixin.
Guan Tao, former director of the international payments department of China’s State Administration of Foreign Exchange and now chief global economist at BOC International (China), also said Beijing should ready itself for decoupling.
“We have to mentally prepare that the United States could expel China from the dollar settlement system,” he told Reuters.
In a report he co-authored last month, Guan called for increased use of China’s yuan settlement system, Cross-Border Interbank Payment System, in global trade. Most of China’s cross-border transactions are settled in dollars via the SWIFT system, which some say leaves it vulnerable.
The bad news for the Chinese is that Yuan internationalization is moving at a snail’s pace. The yuan’s share of global foreign exchange reserves is stuck around 2% and it accounts for fewer than 5% of payments. Here’s a case study of the RMB’s performance in Belt and Road partner Pakistan published last week that exemplifies the challenge:
Not all has gone according to plan. Pakistan’s messy local political economy, IMF-imposed austerity, concerns over the rising current account deficit, and now COVID-19 have cast a pall over CPEC’s expansion. Furthermore, despite China’s vocal push to internationalize the RMB, until now, all CPEC projects were funded in U.S. dollars. Recently, however, there has been a renewed push to look for alternatives to dollar-based project financing, and expansion of the RMB in Sino-Pakistani cross-border trade. CPEC will likely have an impact on the RMB’s internationalization.
Yet headwinds remain. Even with official backing, private sector enthusiasm remains low. Chinese firms have proven reluctant to embrace RMB financing, a conspicuous reminder of the dollar’s staying power. For the same reasons that Pakistan seeks to protect its dollar reserves by expanding RMB-denominated funding, Chinese firms prefer to be paid in dollars.
I mean, even Chinese firms don’t want yuan. The good news for the Chinese is that the U.S. is not likely to exercise the nuclear option since the consequences for itself would not be great. Indeed, the way The Economist sees it, China is actively trying to make those consequences greater by hugging US as hard as it can, or more accurately by enticing U.S. investors to hug it.
Many observers focus on the decoupling between America and China. Yet for those managing the trillions of dollars that flow through global markets every day, the main trend looks more like coupling. Consider these moves by investment and commercial banks in the past half-year alone. Goldman Sachs and Morgan Stanley took majority control of their Chinese securities ventures. HSBC acquired full control of its Chinese life-insurance venture. Citi received a coveted custody license to serve institutional investors in China. Among asset managers, BlackRock received approval to sell its own mutual funds in China and Vanguard decided to shift its Asian headquarters to Shanghai.
Even more astonishing are the money flows. Roughly $200bn has entered China’s capital markets from abroad over the past year. Foreign holdings of Chinese stocks and bonds at the end of June were, respectively, 50% and 28% higher than a year earlier (see chart 1).
Despite talk of a new cold war, there are two reasons to think that coupling, not decoupling, will remain the better description of Sino-American financial ties. The first is China’s own actions. It is pursuing what Yu Yongding, a prominent economist, has described as a “linking strategy”, seeking to create more connections with foreign companies. Since late 2019 the government has lifted foreign ownership caps on asset managers, securities firms and life insurers. It has belatedly allowed MasterCard and PayPal to enter its payments industry. And it has let foreign ratings agencies cover more Chinese firms.
Don’t confuse this with perestroika, though. It’s not like foreign firms will be able to compete on an even playing field. Finally on China, here’s an interesting take from a Japanese vantage point:
The administration of President Donald Trump scrapped the appeasement policies of previous administrations and began to limit Beijing’s dollar supply by launching a trade war against China. Meanwhile, the Xi regime took control of the global financial hub of Hong Kong, with the latter’s accumulated dollar assets as Beijing’s base for resisting the U.S. In the end, Hong Kong has become the last stronghold for the dollar-starved Xi administration.
Hong Kong accounts for more than 70% of international transactions in RMB and serves as a hub for the flow of capital into and out of China.
The Xi administration is most likely trying to kill two birds with one stone by blocking the route of capital flight and suppressing the Hong Kong democracy movement.
I have a feeling this is going to be a recurring section. Here’s the wrong take:
“There are plenty of alternatives,” said [former Morgan Stanley Asia chairman Stephen] Roach, who’s now a senior fellow and lecturer at Yale University and considered a top authority on Asia and currency matters. The passing of the European Union’s 750 billion euro coronavirus recovery fund and a sovereign pan-European bond could boost the euro, he says.
The Chinese yuan could be another U.S. dollar alternative if China “stays the course on reforms,” said Roach. The idea of there being “no alternative to the dollar” is being tested by the ongoing pandemic, he said.
“I think the Chinese renminbi can also continue to move up on a broad trade-weighted basis. It’s up about 50% over the last 15 years, [and there’s more to go] if China stays the course on reform. I’m not recommending…exotic alternatives, but you have to look seriously at cryptocurrencies like Bitcoin and precious metals like gold.
“So I think the idea that there’s no alternative to the dollar is really going to be tested during this COVID crisis.”
The US Dollar year-to-date (August 2020) has strengthened relative to 96 out of 146 currencies in the Bloomberg universe. In fact, the U.S. Fed Trade-Weighted Broad Dollar Index has strengthened by 2.3% in the same period, according to data compiled by Bloomberg.
The speculation about countries abandoning the U.S. Dollar as reserve currency is easily denied. The Bank Of International Settlements reports in its June 2020 report that global US-dollar denominated debt is at a decade-high. In fact, US-dollar denominated debt issuances year-to-date from emerging markets have reached a new record.
China’s dollar-denominated debt has risen as well in 2020. Since 2015, it has increased 35% while foreign exchange reserves fell 10%.
What we have witnessed between March and August has just been a move back from an overbought exposure to the DXY Index due to the severity of the crisis, as investors increased positions in safe havens in February and March, only to reverse it as markets and the economy recovered.
The reason why the US Dollar World Reserve Currency status is not at risk is simple: There are no contenders. The euro has redenomination risk, and the constant political and economic concerns about the union’s solvency make the currency weaken, as the historical performance has shown. It tends to strengthen relative to the US Dollar when investors place unjustified hopes on the eurozone growth only to weaken afterwards when poor growth adds to an overly aggressive ECB policy, with negative rates and massive money supply growth. The yuan cannot become a world reserve currency if the country maintains capital controls and concerns about legal and investor security remain. The China Central Bank (PBOC) is also extremely aggressive for a currency that is only used in 4% of global transactions according to the Bank of International Settlements.
In the medium to long term, multiple factors could preserve the greenback’s global dominance. The dollar will continue to benefit from a broad-based system of flexible exchange rates, limited capital controls, and deep, liquid bond markets. More to the point, there simply is no clear alternative currency that could serve as a broad unit of account, means of payment, and stable store of value.
Any country vying for the US position would have to ask itself if it really wants to end up with a strong currency and the associated large current-account deficits that come with meeting the global demand for safe assets (government bonds). This scenario seems rather unattractive for Europe, Japan, or China, where strong exports are central to economic growth.
There is no alternative. Come at me.
Various & Sundry
Finally, here are some interesting tidbits on China’s CBDC…
That’s a question I’ve often pondered myself. Since Tencent and Alibaba are helping build the system, the answer is probably nothing bad. I can imagine those apps becoming integrated with the digital yuan. It could even facilitate payments between the apps, which right now are not interoperable.
Alipay has filed at least three patents in preparation for how it would theoretically facilitate a CBDC. People will be able to spend the tokens on WeChat Pay and Alipay, said Mu Changchun, head of the central bank's Digital Currency Research Institute, Shanghai Securities News reported last September.
"We expect the leading payment companies like Tencent and Ant to be part of the research and design process led by the authorities, contributing technical and operating experience and know-how," said Salgaonkar.
One interesting tidbit here is that a full launch of DCEP is years away:
The PBOC’s Yi remained coy about the e-yuan’s launch as recently as May, saying that China would keep testing the digital currency until at least the 2022 Winter Olympics in Beijing.
"Being one of the newest of its kind, we believe it will take years before an official launch of the DC/EP system in China," said Mizuho Securities analyst Ben Huang in a June 1 report.
The new digital currency wallet will also support near field communication (NFC), allowing two users to transfer money simply by touching their mobile phones together. Alipay and WeChat Pay chose to base their systems on QR codes instead of NFC, as the Mondrian-like square bars are less expensive for merchants to support.