“Is it your intention to ban or limit the use of cryptocurrencies, like we’re seeing in China?” asked Ted Budd, Republican congressman from North Carolina. “No,” replied Fed Chairman Jay Powell. “No intention to ban them?” asked Budd again. “No intention to ban them, but stablecoins are like money market funds, they’re like bank deposits; they’re to some extent outside the regulatory perimeter, and it’s appropriate that they be regulated,” answered Powell. And as it sunk in that the world’s largest economy would not chase China to stifle private sector innovation in the field of blockchain technology, digital assets prices surged.
Overall: “All streams flow to the sea because it is lower than they,” appeared unexpectedly in Xi’s empty mind, the Lao Tzu quote disturbing his morning meditation. Agitated, he inhaled deeply, pausing momentarily, his lungs full, in search of stillness. “Humility gives it its power,” further penetrated Xi’s thoughts, interrupting the moment. As a child, Xi studied the philosophical teachings of Lao Tzu, committing his ancient wisdom to memory. “If you want to govern the people, you must place yourself below them. And if you want to lead the people, you must learn how to follow them.” This of course, is the source of Xi’s greatest anxiety. China’s swift rise from utter destitution required the state to dominate the activities of its citizens. “Water is fluid, soft, and yielding. But water will wear away rock, which is rigid and cannot yield,” now leaked into Xi’s mind, his meditation a mess, haunted by Lao Tzu. “As a rule, whatever is fluid, soft, and yielding will overcome whatever is rigid and hard.” As China rises and its centrally controlled bureaucracy flourishes, it grows increasingly brittle. All such structures ultimately do. “If you are untrusting, people will not trust you.” Lao Tzu’s words gnawing at Xi, his security state tightening its grip on individuals in ways that would’ve made an East German Stasi blush. Beijing’s latest technological vice is its central bank digital currency, which in a nation where the government remains above the rule of law, gives leaders vast new power over its 1.46bln subjects. Xi had naturally hoped Washington would follow Beijing’s lead, undermining the source of America’s strength - which is to defend the value of the individual over the collective. But now it appeared Washington would do no such thing. The WSJ reported Washington would instead seek to regulate private-sector US dollar stablecoin using existing law. Limiting government dominion in sensible ways. Paving the way for innovation. Xi sighed. “The world belongs to those who let go.”
Week-in-Review (expressed in YoY terms): Mon: SPD narrowly defeat CDU/CSU in German elections though forming a coalition could take months, Erdogan says will proceed with purchase of new defense missiles from Russia causing US to respond with threatening sanctions, UK suspends “competition laws” that regulate oil firms amid panic fuel buying amidst shortage, Fed’s Rosengren (Boston) and Kaplan (Dallas) step down amid ethics concerns, China experiences power cuts amid electricity shortages due to rising prices, US durable goods orders 1.8% (0.7%e), S&P -1.7%; Tue: PBOC injects 100bn RMB into system, Russia launches another case against Navalny, US Case Shiller home prices 19.7% (18.61%p), US cons conf 109.3 (115e), US Richmond Fed -3 (10e), S&P -0.1%; Wed: Fumio Kishida set to be appointed next Japanese PM after winning the party vote, GPIF says will not include CNY denominated debt in its portfolio, Fed’s Powell expects the global supply chain bottlenecks to prolong the period of higher inflation but still to be transitory, , US added 23 species to the extinct list, German impt prices 16.5% (16%e), Spain CPI 4% (3.6%e), US Pending home sales -6.3% (-13.8%e), S&P +1.0%; Thur: US passes a continuing resolution to avert gov’t shutdown without increasing the debt ceiling, Czech CB hikes 75bps (50bps exp) – largest hike since 1997, CB of Mexico hikes 25bps as exp, Erdogan looks to expand Russian arms relationship with warplane and submarine cooperation – further exacerbating the relationship with the US, S&P posted its first monthly decline since Jan, Japan IP 9.3% (12.1%e) / ret sales -3.2% (-1%e), China mfg PMI 49.6 (50e) / serv PMI 53.2 (49.8e) / Caixin mfg PMI 50 (49.5e), Australia prvt sector credit 4.7% (4.6%e), UK house prices 10% (10.7%e), UK Q2 GDP final 23.6% (22.2%e), France CPI 2.1% (2.2%e), German unemp 5.5% as exp), Italy unemp 9.3% (9.2%e), EU unemp 7.5% as exp, Brazil unemp 13.7% (13.9%e), German CPI 4.1% (4%e), US init claims 362k (330k exp), US 2q GDP 6.7% (6.6%e), US Chicago PMI 64.7 (65e), S&P +1.2%; Fri: US progressive democrats stand firm on their pledge to not support the $550b bipartisan infrastructure package unless their larger $3.5t stimulus package passes, China orders energy companies to secure supplies for this winter at all costs, Manny Pacquiao files to become Philippines presidential candidate, Japan unemp 2.8% (2.9%e) / cons conf 37.8 (37.5e), EU mfg PMI 58.6 (58.7e), UK mfg PMI 57.1 (56.3e), EU CPI 3.4% (3.3%e) / Core CPI 1.9% as exp, US Personal inc 0.2% as exp / personal spending 0.8% 0.7%e), US PCE Deflator 4.3% 4.2%e), US market mfg PMI 60.7 (60.5e), US UofM 72.8 (71e) / 1y infl forecast 4.6% (4.8%e) 5-10y infl forecast 3% (2.9%p), US ISM mfg 61.1 (59.5e), S&P +0.2%.
Weekly Close: S&P 500 -2.2% and VIX +3.40 at +21.15. Nikkei -4.9%, Shanghai -1.2%, Euro Stoxx -2.2%, Bovespa -0.3%, MSCI World -2.6%, and MSCI Emerging -1.5%. USD rose +2.0% vs Mexico, +1.3% vs Chile, +1.1% vs Sweden, +1.1% vs Euro, +1.0% vs Sterling, +0.6% vs India, +0.5% vs Brazil, +0.4% vs Indonesia, +0.3% vs Yen, and +0.1% vs Australia. USD fell -10.1% vs Bitcoin, -9.5% vs Ethereum, -0.5% vs South Africa, -0.3% vs China, -0.3% vs Turkey, -0.3% vs Russia, and flat vs Canada. Gold +0.6%, Silver +0.7%, Oil +2.4%, Copper -1.7%, Iron Ore +1.2%, Corn +3.1%. 5y5y inflation swaps (EU +6bps at 1.80%, US +8bps at 2.46%, JP +1bp at 0.23%, and UK -2bps at 3.81%). 2yr Notes -1bp at 0.27% and 10yr Notes +1bp at 1.46%.
Sept Mthly Close: S&P 500 -4.8% and VIX +6.66 at +23.14. Nikkei +4.9%, Shanghai +0.7%, Euro Stoxx -3.4%, Bovespa -6.6%, MSCI World -4.3%, and MSCI Emerging -4.2%. USD rose +15.0% vs Ethereum, +10.6% vs Bitcoin, +6.9% vs Turkey, +5.7% vs Brazil, +4.6% vs Chile, +3.7% vs South Africa, +2.8% vs Mexico, +2.1% vs Sterling, +2.0% vs Euro, +1.7% vs India, +1.6% vs Sweden, +1.2% vs Australia, +1.2% vs Yen, +0.5% vs Canada, and +0.3% vs Indonesia. USD fell -1.0% vs Russia, and -0.2% vs China. Gold -3.2%, Silver -7.4%, Oil +10.0%, Copper -5.9%, Iron Ore -22.7%, Corn +0.5%. 5y5y inflation swaps (EU +15bps at 1.84%, US +7bps at 2.44%, JP +11bps at 0.24%, and UK -2bps at 3.80%). 2yr Notes +7bps at 0.28% and 10yr Notes +18bps at 1.49%.
Quarterly Close: S&P 500 +0.2% and VIX +7.31 at +23.14. Nikkei +2.3%, Shanghai -0.7%, Euro Stoxx +0.4%, Bovespa -12.5%, MSCI World -0.4%, and MSCI Emerging -8.8%. USD rose +10.3% vs Chile, +9.5% vs Brazil, +5.5% vs South Africa, +3.7% vs Australia, +3.5% vs Mexico, +2.6% vs Sterling, +2.5% vs Sweden, +2.4% vs Euro, +2.3% vs Canada, +2.1% vs Turkey, and +0.2% vs Yen. USD fell -28.1% vs Ethereum, -19.5% vs Bitcoin, -1.3% vs Indonesia, -0.6% vs Russia, -0.2% vs China, and -0.1% vs India. Gold -1.0%, Silver -15.7%, Oil +6.0%, Copper -4.2%, Iron Ore -49.2%, Corn -8.7%. 5y5y inflation swaps (EU +25bps at 1.84%, US +9bps at 2.44%, JP -8bps at 0.24%, and UK +10bps at 3.80%). 2yr Notes +3bps at 0.28% and 10yr Notes +2bps at 1.49%.
YTD Close (thru Q3): S&P 500 +14.7% and VIX +0.39 at +23.14. Nikkei +7.3%, Shanghai +2.7%, Euro Stoxx +14.0%, Bovespa -6.8%, MSCI World +11.8%, and MSCI Emerging -3.0%. USD rose +19.5% vs Turkey, +14.0% vs Chile, +7.8% vs Yen, +6.5% vs Sweden, +6.5% vs Australia, +5.5% vs Euro, +4.8% vs Brazil, +3.6% vs Mexico, +2.5% vs South Africa, +1.9% vs Indonesia, +1.6% vs India, and +1.5% vs Sterling. USD fell -75.3% vs Ethereum, -33.4% vs Bitcoin, -1.7% vs Russia, -1.3% vs China, and -0.4% vs Canada. Gold -8.4%, Silver -17.4%, Oil +57.2%, Copper +16.4%, Iron Ore -34.9%, Corn +23.6%. 5y5y inflation swaps (EU +57bps at 1.84%, US +13bps at 2.44%, JP +11bps at 0.24%, and UK +29bps at 3.80%). 2yr Notes +16bps at 0.28% and 10yr Notes +57bps at 1.49%.
YTD Equity Indexes (high-to-low): UAE +52.6% priced in US dollars (+52.6% priced in dirham), Saudi Arabia +32.3% priced in US dollars (+32.3% in riyal), Argentina +29.1% in dollars (+51.5% in pesos), Venezuela +28.2% (+366.9%), Russia +27% (+24%), Czech Republic +26.6% (+29.5%), Austria +24.7% (+32.1%), India +23.5% (+25.4%), Hungary +22.9% (+27.5%), Norway +19.8% (+20.4%), Israel +18.1% (+18.6%), Poland +17.1% (+24.2%), Canada +16.7% (+15.6%), Netherlands +16.4% (+22.7%), S&P 500 +16%, Russell +13.5%, Taiwan +13.5% (+12.5%), NASDAQ +13%, Mexico +12.9% (+15.9%), Sweden +12.6% (+20.2%), MSCI World +12.4% (+12.4%), France +11.4% (+17.4%), Denmark +9.9% (+16.4%), Italy +8.7% (+15.2%), Ireland +8.7% (+14.5%), Belgium +8.4% (+14.2%), Finland +8.2% (+14.7%), UK +8.1% (+8.8%), Euro Stoxx 50 +7.8% (+13.6%), Singapore +4.6% (+7.3%), Germany +4.3% (+10.5%), China +4.1% (+2.7%), South Africa +3.9% (+5.3%), Spain +3.4% (+9%), Australia +3.1% (+9.1%), Switzerland +2.7% (+8.1%), Indonesia +2.5% (+4.2%), Greece +2.1% (+7.7%), Portugal +1.5% (+7%), Thailand -1.4% (+10.8%), New Zealand -2% (+1.4%), Japan -2.5% (+4.8%), Korea -3% (+5.1%), Philippines -8.1% (-3%), Chile -8.2% (+3.6%), Brazil -8.8% (-5.1%), Malaysia -9.9% (-6.3%), HK -10.1% (-9.8%), Colombia -13.8% (-4.7%), Turkey -20.5% (-5.1%).
Getting Real: The US dollar is the world’s reserve currency. 59.2% of all official foreign exchange reserves are held as US dollars. 20.5% are euros. 5.8% are Japanese yen. 4.8% are British pounds sterling. 2.6% are Chinese renminbi -- slightly more than the 2.2% of reserves held in Canadian dollars. 1.8% are Australian dollars. The remaining few percent are various other small currencies that don’t matter in the grand scheme of things. Swiss francs would be an example. Some reserves are held in gold. Someday, there will be digital asset reserves too.
Getting Real II: For a foreign nation to hold dollars in reserve, it must first acquire them. It can either purchase those dollars in foreign exchange markets, or it can acquire the dollars by selling its goods, services, hard assets, or financial assets. There are consequences to such transactions. One of them is that the dollar’s value relative to other currencies is higher than it would be if these nations were not buying and holding dollars in reserve. Another is that by acquiring so many dollars and holding them in reserve, the US is forced to run a current account deficit.
Getting Real III: When the US runs large deficits, it consumes more than it produces, buying goods/services/assets from foreign nations. This supports economic growth in those nations, job creation, etc. In a world of ever-expanding globalization, such a dynamic was seen as a benefit by almost everyone. Even Americans who lost their manufacturing jobs to foreigners tolerated this for a while. It fed easy credit and cheap consumer goods. Those on the losing-end of globalization remained subdued. That changed in recent years. And it is manifesting politically.
Getting Real IV: Were the US dollar to lose its reserve currency status, it would decline relative to other currencies. The US current account deficit would have to shrink. In the extreme, US deficits would turn to surpluses – foreign investors, or the lack thereof in this case, would be imposing austerity on US policy. This would be an unmitigated disaster for nations that have built economies to export products and services – almost every nation in the world. So, would any of these countries want to see that? It’s hard to imagine why they would. And it is easy to imagine these nations would try desperately to avoid such an outcome.
Getting Real V: So, if the cost of having the world’s dominant reserve currency includes running large current account deficits, having an overvalued currency, and losing manufacturing jobs, why would any nation want this? It appears no nation really does. The Germans buried their deutschmark by adopting the euro. The Europeans wouldn’t tolerate the cost of having the dominant reserve currency. The Japanese sell the yen whenever it gets too strong. There is only one other nation that has an economy that is big enough to potentially bear the costs required to shoulder the burden of issuing the world’s reserve currency – China.
Getting Real VI: China has several large problems. It is now ageing. Its working age population is shrinking. And unlike Japan, which became a rich nation before starting its demographic collapse, China is still quite poor. Being poor is rough, growing old is tough, experiencing both simultaneously is brutal. After spending decades building the means of production to supply the world with manufactured goods, it may be difficult for China to convince the world they have the fluidity to accommodate being the world’s reserve currency. The benefits to China are clear – the promise of more consumption with more access to global credit at comparatively low interest rates. But the costs are extraordinary and include a loss of control at a time when China is fixated on exerting its dominion.
Anecdote: “Appear weak when you are strong, and strong when you are weak,” whispered Xi to himself, refocusing on Sun Tzu wisdom, pushing Lao Tzu to the far recesses of his rattled mind. Xi recognized the near impossibility of his renminbi overtaking the US dollar, and yet there is value in having so many people believe this is his plan. The world’s nations hold $7.1trln in official US dollar reserves (22.7x the world’s $312bln renminbi held in official reserves). “Know yourself and you will win all battles,” thought Xi, recounting his favorite Sun Tzu quote, as true today as when the general wrote it in 530 BC, penning the Art of War. Xi’s decision to outlaw cryptocurrency trading was a risk he had preferred to avoid. It revealed a great weakness. When given the opportunity, Chinese citizens sell their renminbi to escape an economic system where his government remains above the rule of law. So, naturally, Xi restricted his subject’s ability to exchange renminbi for dollars. In the digital world, absent political coercion, the free market overwhelmingly chose the US dollar as the ecosystem’s stablecoin with 98% of that market’s $126bln now linked to dollars (representing over $100trln/yr in turnover). A large percentage of trading in US dollar stablecoin originated in China. Xi outlawed this activity too. “The supreme art of war is to subdue the enemy without fighting,” thought Xi, ordering yet more fighter planes to violate Taiwan’s airspace, distracting those who might otherwise see his nation as nearing the apex of its power, the world shifting away from globalization, as China’s working age population enters its inexorable decline. And now the US will allow digital assets to trade alongside its dollar. For all of America’s obvious weaknesses, it remained sufficiently confident to allow its citizens to choose. “Build your opponent a golden bridge to retreat across,” whispered Xi, beginning to wonder whether his adversaries would someday grant him such a path.
Good luck out there,
Chief Investment Officer
One River Asset Management
Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, drink with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.