With the shock US presidential election result behind us and the upcoming Italian referendum (December 4th), it is fair to say that they are both generating some fascinating dinner table conversations. During the past few weeks, we have reviewed the Gavekal October conference themes, to focus our minds on the longer-term implications of global liquidity, reserve currencies and the potential for populist politics to derail the current economic path, or should I say the ‘experiment’, of central bankers and politicians. Upcoming elections in Holland, Germany and France, during 2017, may also deliver potentially tricky results for financial markets.
So why are these elections important from a portfolio construction perspective?
The ‘elevator speech’ answer is “That it impedes business activity and confidence by implication of potentially new leadership policies.”.
Currency volatility has influenced portfolio returns in a major way over the past year, and I guess it always will. Let me be straight; If anyone can trade currencies successfully over the long-term, they would be very wealthy, with no need to work.
However, from a macroeconomic perspective, it is important that global consumers have faith in a reserve currency as a medium to finance, invest and trade globally.
To become a reserve currency, a country would need to have a standard of value, and a means of exchange, as well as being dominant in the following areas:
- Militarily (To control sea and air lanes.)
- Scientifically (To have the best weapons.)
- Agriculturally (To be able to feed other countries in case of war.)
- Culturally (To be able to educate the children of that nation’s elite.)
- Financially (For bonds to be issued in the country’s financial markets by the other countries.)
According to Charles Gave at Gavekal, there is no one – for the time being – who could challenge the US dollar. His contention, however, is that China has no intention of challenging the dominant role of the US dollar, but wants only to offer the rest of the world in general – and Asia in particular – a substitute to the US dollar for international or local trade between countries. Similar to the Deutsche mark in Europe during the 70’s.
Gave goes on to debate that, to achieve such a goal, the underlying country must have a strong infrastructure and capital spending industry, excess savings visible through a large Current Account surplus, as well as a competent banking system. This country will then be in a position to offer financing to other countries suffering from a lack of savings (Current Account deficits). Gave concludes that the arrival of a new provider of international liquidity may be a major event with quite a few long-term implications.
I argue that ‘populist politics’, potential new trade agreements (due to Brexit) and protectionism instead of globalisation may, in fact, speed up the arrival of a new reserve currency, which will undoubtedly cause new portfolio allocation challenges for global portfolio managers as back testing, quant models and many years of study may have very little meaning in such a regime shift.
Is the US Dollar Safe as a Reserve Currency in the Future?
