There is no doubt that the US wields enormous influence in the world today, be it in politics — with its superior global military capabilities and dominance in international institutions such as the United Nations and North Atlantic Treaty Organization (NATO) — economics or finance, as the world’s largest economy and by virtue of the US dollar hegemony. Its rise to sole superpower status has been virtually unchallenged since the end of WW2, which devastated countries across Europe and Asia, and especially after the fall of the Soviet Union in 1991.
We have written about how the US has benefited enormously by engineering the US dollar hegemony, through the Bretton Woods system — positioning the greenback at the centre of global networks as the settlement currency for international trade and financial transactions and as the world reserve currency. With this, the US is able to finance ever-growing fiscal spending with cheap borrowings — far outspending every other country on its military machinery, pursuing expansive social programmes, supporting American consumerism and elevating living standards for its population, all the time compounding the positive feedback loop.
There are obvious benefits to this US unipolarity. Its military power preponderance maintained an era of relative peace and order, as well as economic and financial stability in the world. The absence of large-scale conflicts fostered an environment conducive to cooperation among nations, innovations and sustained economic growth. The world reaped gains from globalisation. Countries such as Japan, Germany, South Korea and Taiwan “outsourced” the responsibility for national security to the US. By doing so, they enjoy peace under the protection of a powerful ally — and prosper from being able to divert resources that would have been spent on defence (and wasteful military competition) to economics. The ever-expanding US consumer market provided the export market for developing countries. As with everything in life, however, there are trade-offs. The costs are now increasingly evident.
As we said before, US exceptionalism was paid for, in no small part, by the rest of the world. This is an enormous toll, especially on low-income nations, though the effects are often more opaque. For starters, being compelled to hold US dollar assets — primarily US Treasuries — as reserves means less money is available for investments, and at higher costs, in their own countries.
Perhaps more importantly, the US Federal Reserve is sometimes called the world’s central bank, and this is not as benign as it sounds. A central bank’s role is to conduct monetary policies in the interests of the nation. And this is what the Fed does, to protect the interests of Americans. But because of the central role of the US dollar in global trade and financial systems, US monetary — and, to a certain extent, fiscal — policies have had a serious impact on the rest of the world. The truth is, most countries have to dance to the Fed’s tune, even when it is detrimental to their domestic economies, or suffer the consequences.
Case in point: The central banks of emerging markets (EMs) now have to balance the difficult task of catching up to the Fed’s aggressive interest rate hikes and keeping domestic rates low to protect their still-fragile economies, post-pandemic. For most, this means having to accept weaker currencies as a trade-off, allowing the interest rate differential to widen. For example, Bank Negara Malaysia raised rates by only 50 basis points, compared with the Fed’s 2.25% hike, thus far — and even that tempered increase has triggered an avalanche of discontent as many Malaysians struggle with the rising cost of living. The ringgit, as with most currencies in the world this year, has fallen sharply against the US dollar.
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Remember, the massive scale of the US pandemic relief measures and the Fed keeping rates too low for too long are, at least partially, responsible for inflation running at a 40-year high. The US was able to spend more on pandemic aid than any other country, totalling more than US$5.3 trillion, or 25.4% of GDP. The resulting excess savings and exceptionally tight labour market enabled consumers to keep spending amid supply disruptions and shortages, fuelling inflation in an overheated economy.
Now, the Fed has to tighten quickly and sharply, to regain control of inflation. The resulting stronger US dollar works in its favour, by reducing the cost of imports and helping temper inflation. But it also means the US is exporting inflation to the rest of the world — where weakening domestic currencies are compounding already elevated prices, by raising the cost of imported food and energy. The sharp interest rate increases and strength of the US dollar are also raising debt servicing costs for EMs, often more reliant on foreign US dollar-denominated borrowings.
US households are likely to emerge relatively unscathed from this slowdown (recession), having benefited hugely from the government largesse with excess savings buffer. The same cannot be said of people in poorer developing countries, whose livelihoods are already under stress because of the pandemic. Developing countries have far less room (compared with the US) for fiscal support. For instance, Malaysia is likely to have to tighten spending and may have to take money away from critical development to foot the ballooning subsidy bill — now estimated at RM80 billion, compared with the budgeted RM31 billion.
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The US’s effective socialisation of private debts during the pandemic sent public debt surging to 124.6% of GDP. Yet, the US dollar suffered no consequence from the massive money-printing, because of its “exorbitant privilege” as the world reserve currency. In fact, empirical evidence suggests that the US dollar tends to appreciate during crises. Even when the crisis originates in the US, US Treasuries and the greenback are still perceived as the safe haven asset and currency. For instance, both the dotcom bubble and global financial crisis have their roots in the US — the former in overvalued tech stocks and the latter resulting from the housing bubble and collapse in the subprime mortgage market. Yet, the US dollar appreciated against most currencies during these periods of turmoil (see Chart).
The depreciation is typically worst for EM currencies, which are perceived as risky assets — reflected in intensified capital outflows, including from the equity and/or bond markets. In fact, the selloff in EMs oftentimes precedes that in the US (perhaps seen as the safest investments, relatively speaking, and, therefore, last to be sold) and losses are far steeper — though EMs also appear to recover earlier from trough levels when investor risk appetites improve post-crisis (see Table).
Of course, each crisis is unique, sometimes overlapping, and affects countries differently. Therefore, comparisons are never perfect — nor particularly useful to predict the future. For example, the Asian market recoveries for 2000 to 2008 appear exceptionally strong — but only because of the severity of the prior collapse, during the Asian financial crisis in 1997/98. What is quite clear, though, is the fact that EM markets suffer greater volatility (sharper swings) and larger capital flights, which also means that, over the long run (across crises), US stocks generally outperform.
In conclusion, the headwinds have grown progressively worse in this current, unfolding crisis — from supply chain disruptions to inflation and the fallout from the unwinding of excessive liquidity, geopolitics and deglobalisation. Inflation may turn out to be far stickier than current expectations. Quite possibly, we have yet to fully comprehend the outcomes from so many interplaying factors, let alone tally the associated costs.
The Fed will continue to do what it perceives to be in the best interests of Americans, as it should. But the over-dominance of the US in global affairs and the US dollar have severe consequences on the rest of the world. To quote John B Connally, a former US Treasury secretary: “The dollar is our currency, but it’s your problem.” Globally, inflation and a rising cost of living — millions have slipped, or are falling, into poverty — will fan discontent, social unrest and even revolutions in some countries. The majority of EMs have very little room for fiscal and monetary policy manoeuvres. This is one reason we took the unprecedented move of selling all our stock holdings in the Malaysian Portfolio last week.
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Our portfolio has far outperformed the benchmark FBM KLCI, by some 141% since inception. Therefore, given prevailing uncertainties, holding cash to look for better opportunities down the road is a rational strategy — there is little risk that we will underperform. This is unlike the Global Portfolio, where we are playing catch-up. And, truth be told, we are also concerned about the level of household debt plus what we anticipate will be populist politics in the next few years to come. As articulated by Daron Acemoglu and James Robinson, politics do drive everything!
The risks of US dollar hegemony will, we think, be a growing concern in an increasingly fractious world. Not every country will always have its interests perfectly aligned with those of the US — and the latter has shown us just how effectively it could weaponise the US dollar. The current crisis will hasten a broader push for de-dollarisation and may well mark the inflection point towards a multi-reserve currency world.
The Global Portfolio fell 0.8% in the week ended July 27, weighed down by profit-taking on Chinese stocks including Chinasoft International (-6.8%), Guangzhou Automobile Group Co (-4.3%) and Yihai International Holding (-3.4%). On the other hand, shares in Commercial Bank for Foreign Trade of Vietnam (+3.6%), DBS Group Holdings (+2.9%) and Apple (+2.5%) closed higher. Last week’s loss pared total portfolio returns since inception to 27.1%, trailing the MSCI World Net Return Index’s 37.5% returns over the same period.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/ or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
