A Brexit in Name Only?

Our weekly commentaries provide Euro Pacific Capital’s latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.

By: 

John Browne

Thursday, July 14, 2016

The BREXIT vote on June 23rd was part of a growing global trend in which ordinary people are expressing a desire to retain national sovereignty regardless of the cost and suffering that may be involved. The result is rightly seen as a repudiation of the political and financial elites, and should be viewed as evidence that the economic optimism presented in the halls of power has found scant credibility on the streets. The same sentiments can be seen on this side of the Atlantic in the surprising successes of the Donald Trump presidential campaign.
 
Having failed to obtain a ‘re-run’ of the vote, the elite in the UK now appear to be trying to erode BREXIT from within. If successful, this disregard of the people’s wishes may result in a deepening political crisis but could affect investments and currencies in the short to medium term.
 
The most immediate and apparent result of the Brexit has been the wholesale change in the leadership of Conservative, Labour and UKIP (United Kingdom Independence Party) parties. Perhaps the most stunning development has been the departure of Nigel Farage, the leader of UKIP and perhaps the most recognizable face of the Brexit movement. With the help of senior Conservatives such as Boris Johnson, Michael Gove and Andrea Leadsom, Farage achieved an historic and potentially game changing victory. However, UKIP, which pulls a majority of Thatcherite votes, has long been a thorn in the side of Conservatives who treat it in a manner similar to that in which elite Republicans treat Donald Trump and his supporters. Despite his preeminent role in the victory, Farage was offered no role in the BREXIT negotiating team. Feeling he had done all he could, and perhaps exhausted by the strain, he resigned the UKIP leadership.
 
The machinations within the Conservative Party, which was split by the Brexit vote, have rivaled the palace intrigues of the Byzantine Court. The most immediate casualty was Prime Minister David Cameron, who had staked his career on the remain vote. His resignation became official today. Although late into the “Leave” camp, Conservative mayor of London Boris Johnson played a significant role in the Brexit victory. With some justification, he felt he should become the next Conservative leader. However, in a fit of excessive ambition, his main ally, Justice Minister Michael Gove, decided to knife Johnson in the back and stand himself as the Conservative leadership candidate. Apparently his disloyalty shocked even Parliamentarians within his own party. He was struck down rapidly. Last week, the Conservatives selected Theresa May, the current Home Secretary to become party leader and Prime Minister. She will be the first female occupant of 10 Downing Street since Margaret Thatcher. Interestingly, May remained largely quiet in the run-up to the Brexit vote and tepidly backed the “remain” camp.
 
The Labour party, the main proponent of the “remain” campaign, is in similar disarray after having lost the most crucial vote in generations. Many Labourites ascribe the failure to the divisive influence of Party leader Jeremy Corbyn, who many view as too far left on the political spectrum to unite the opposition. As a result, there is a strong movement underway to replace him as the leader. There can be little doubt that this effort will bear fruit in the coming weeks.
 
Only Britain’s fourth party, the Pro-EU Liberal party, has kept very quiet.
 
The power of the political and financial establishment in the UK should never be underestimated. While the new Prime Minister has expressed a strong desire to follow the will of the people and to stridently pursue dissolution of the union with Europe, her actual policies may be far more equivocal. It is my belief that Tory grandees have quietly placed a “remain” supporter in the top seat expressly to frustrate the will of the people. The implication of this is that most likely the BREXIT will be watered down and possibly drowned at birth. Such a development is totally in keeping with the massive EU con of enticing peoples into a free trade area only to transform it into a superstate to which all member nations will be subject.
 
It has become clear increasingly that many powerful EU and international elite rulers want the UK to stay within the EU. Furthermore, some 75 percent of Conservative MPs want to remain. It was apparent from the start that even the most committed BREXIT Prime Minister would have had a difficult task to steer a successful and complex renegotiation through Parliament. A Prime Minister of less conviction will find it all to easy to tell the electorate that, try as they might, they were simply unable to get the new treaty obligations through Parliament.
 
Already Theresa May has spoken of ‘controlling’ net immigration rather than ‘stopping’ it. This portends a very weak treaty whereby the demands of the EU will be met only by token resistance from a Conservative cabinet with secret ‘remain’ sympathies. Of course, this will all be clouded with high sounding, but largely meaningless, achievements by the UK and painful concessions by the EU.
 
What will it all mean for investments? The Pound Sterling could soon appear to be oversold, as will UK government bonds and the shares of some British companies. The euro also may be seen as undervalued.
 
Many assume wrongly that the euro is an ‘economic’ currency. In reality, it is a ‘political’ currency, depending on political will rather than on economic strength. With the recapture of the UK, the EU will appear stronger, a fact that could be reflected in the euro’s price.
 
Judging from recent events, it is likely that with the aid of the UK and international elites, the EU will succeed in recapturing the UK regardless of the expressed popular will. We may have seen the passing of Britain’s last peaceful attempt to regain its sovereignty.
 
John Browne is a Senior Economic Consultant to Euro Pacific Capital.


Source: John Brownes Market Commentary

Brexit Fears are Deliberately Overblown

Our weekly commentaries provide Euro Pacific Capital’s latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.

By: 

John Browne

Wednesday, June 8, 2016

As the June 23rd BREXIT (the UK-wide referendum to leave the EU) vote draws near, the polls indicate a close result. Those urging a vote for the UK to remain inside the EU are suggesting increasingly dire economic consequences that would follow a yes vote by the British people to leave. Voices from London, Brussels, and Washington have all put immense pressure on British voters to bend to the will of the elites. To listen to their commentary one would think that apocalypse was just around the corner. But is there any substance to their warnings?

The Pro-EU membership camp is led by Prime Minister David Cameron, supported by most of his cabinet, the Bank of England, the BBC and the massive support from the UK and EU governments that have funded enormous advertising campaigns against separation. Given this weight of their power, it is amazing how strong the support for a British exit (BREXIT) has remained.

When Britain first joined the European Economic Community (the precursor to the EU) in 1973, the primary motivation was the hopes of increasing British trade through participation in the world’s largest free-trade zone. However, the hope that the union would simply be a free-trading zone of sovereign countries has morphed into a drive for an EU superstate that has relentlessly pushed for greater regulations on businesses and people and greater control of local laws that have nothing to do with trade.

It has been kept remarkably quiet, for instance, that the EU intends to divide the UK into eleven administrative regions, all reporting directly to Brussels. Although Scotland, Wales and Northern Ireland will remain intact as individual national regions, England will be split into eight regions. Worse still, the coastal counties of England will be teamed with regions in Portugal, France, the Netherlands and Germany, where they will remain in a minority role. Even the English Channel is to be renamed. Very little mention is of the EU proposal for EU-wide ID and tax numbers, likely heralding a heavy EU taxation regime.

Likewise, the proposals to create EU-wide armed forces have been put quietly on the back burner. England has a long and proud history of struggling for its sovereignty. In just the past two centuries she has stood alone against Napoleon and Hitler, before inspiring other nations to join the fray. The presence of French or German armed forces used to support a European police force in the UK will not sit well with the English.

All this and many more threats to the British people have been kept largely quiet. Instead, the main activities of the Pro-EU group have been concentrated on the economic and monetary catastrophe that would face the UK if it were to cut itself off from trading with the EU. Some call this, ‘Project Fear’. The actual underlying facts paint a somewhat different picture, one that makes the Pro-EU case appear misleading, even deliberately so.

The basic argument is that with about 50 percent of its current trade with the EU, the UK would face a catastrophic economic and monetary collapse if it left the EU. As a threat, this sounds potentially devastating. Doubtless it has persuaded some. But in the light of reality, a different and far less worrying image emerges.

The UK has the fifth largest national economy in the world, according to 2015 figures compiled by the International Monetary Fund. In its present state of economic stagnation, the EU can ill-afford to lose the UK. According to the March 2016 Statistical Bulletin from the Office for National Statistics, the UK has had a negative trade balance in goods with the EU that has averaged about $8 billion a month this first quarter. If the UK were to leave without being able to negotiate an independent trade deal, the EU economy might shrink by some $96 billion a year. The UK was the second largest net contributor to the EU budget last year. It follows that the 8 English regions (with Scotland, Wales and N. Ireland considered as 'relatively poor') may in aggregate be the second largest suppliers of future intra-EU money transfers from the so-called 'rich' to the poorer southern and eastern regions of Europe. In that sense, the EU needs the UK more than the other way round.

The Pro-EU camp ignore the trade balance issue completely and threaten, as did President Obama, that the UK would be left out in the cold, like Switzerland, and unable to negotiate its way out of a disaster. Switzerland is not an EU member and has an economy of less than a quarter the size of the UK’s. And yet from 2009-2013 she exported, on average, 4.6 times the value per person to the EU than does the UK (The Truth About Trade Outside the EU, William Dartmouth MEP, June 2015). With a negative EU trade balance, why would the UK be unable to negotiate, from outside, a trade agreement at least as good as that achieved by Switzerland?

[As an aside, over dinner many years ago, my occasional Lords and Commons golfing partner Dennis Thatcher asked me how the UK would survive alone in an era when world power blocks and corporations were getting bigger? I replied, “In the same way as Switzerland.” He retorted while hitting the table hard with his hand, “That’s just what Margaret thinks!”]

Further, the EU negotiates international trade agreements under the auspices of the World Trade Organization (WTO), in the primary interests of the EU, not of the UK. England has flourished by trading globally, especially with the U.S. and the British Commonwealth. The EU has no trade agreements yet with China or Japan. Outside the EU, the UK would be enabled to negotiate freely to trade with the entire world and be unfettered by the EU where it has a muted voice of 1 among 28 members. Furthermore, free of burdensome and costly EU regulations, the British economy likely would be re-energized, particularly among the vital job-creating small business sector.

In addition to economic collapse, the Pro-EU camp postulates that the British pound sterling, still one of the top five global trading currencies, would plummet following a BREXIT. However, many informed observers believe the international monetary system is on the cusp of a major collapse. In these circumstances, the vital interests of the Federal Reserve, European Central Bank, Bank of Japan and even the Bank of China would be to steady the ship to avert a collapse of fiat currency. Unimaginable amounts of central bank money could be deployed to save the pound, rendering it a false scare.

On the other hand, although the UK is not a member of the euro, a BREXIT indirectly could threaten the euro, now the world’s second currency.

Already a number of EU members are experiencing anti-EU sentiments among their people. The United Kingdom Independence Party (UKIP), which forced the BREXIT vote, is not alone. It is part of a sizable block, styled the Europe for Freedom and Direct Democracy (EFDD) group, in the EU parliament. It is comprised of representatives from the UK, France, Sweden, Italy, Poland, Lithuania and the Czech Republic. In addition, countries like Greece, Spain and Portugal are becoming very unhappy about the implications of Eurozone membership. A for BREXIT vote could ignite an implosion within the Eurozone rather than being a threat to Sterling. This may be what worries the international central banking and political elite most. It has led directly to massive global elite support for Cameron’s Project Fear.

If the British public wises up to David Cameron’s game of fear and vote for BREXIT, there will be some short-term shock and disruption in currencies, equities, bonds, precious metals and possibly employment. However, the global central bank and political elites could be expected to move very fast to avoid the development of deeper problems. Negotiations likely would be concluded very quickly to calm things down with minimal damage to the UK economy or its currency.

John Browne is a Senior Economic Consultant to Euro Pacific Capital.


Source: John Brownes Market Commentary

The Winter of Discontent

Our weekly commentaries provide Euro Pacific Capital’s latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.

By: 

Peter Schiff

Thursday, April 14, 2016

The Winter of 2015-2016, which came to an end a few weeks ago, has been officially designated as the mildest in the U.S. in 121 years according to NOAA. While this fact will certainly add a major talking point in the global warming debate, it should also be front and center in the current economic discussion. The fact that it isn’t is testament to the blatantly self-serving manner in which economic cheerleaders blame the weather when it’s convenient, but ignore it when it’s not. If economists were consistent (and that’s a colossal “if”), the good weather would be taken as a reason to believe the economy is weaker than is being reported.
 
The two previous winters were much harsher. 2013-2014 brought the infamous “Polar Vortex,” an unusual descent of frigid polar air that brought temperatures down significantly throughout most of the United States. The next winter was almost as bad, with colder than usual temperatures combined with record snowfalls in much of the country. These conditions were cited again and again by many economists to explain why Q1 GDP growth was so disappointing both years. Annualized growth came in at just -.9% and .6% respectively (Bureau of Economic Analysis). As both 2014 and 2015 got underway, economic optimism had been riding high. When both started off with such resounding stumbles, excuses were needed to explain why the forecasters were so wrong. The snow and cold provided those fig leaves.
 
As I quantified in a commentary on the subject two years ago, a bad winter can indeed put a chill into the economy, at least temporarily. In general, first quarter (which corresponds to the winter months of January, February, and March) shows annualized GDP growth that is roughly in line with the average of each of the other quarters. Since 1967, average annualized 1st quarter growth was 2.7%, not too far below the average 2.8% full year growth, based on BEA figures. But when winter gets nasty, the economy does slow noticeably in the first quarter.
 
The average annualized GDP growth for the 10 snowiest winters (not counting 2014) as reflected in Rutgers University Global Snow Lab (Seasonal Extent graph) was just .5%. While this phenomenon did not fully account for the poor results in 2014 and 2015, which missed the average by more than 2%, at least it provided a strong argument as to why we struggled unexpectedly. But that excuse is unavailable this year when the Q1 performance may be equally bad.  
 
While official 1st quarter GDP estimates have yet to be published, researchers at the Atlanta Federal Reserve Bank put out an estimate called “GDP Now” that attempts to offer a real time estimate of economic growth. As late as mid-February, the GDP Now estimate was 2.7% for the first quarter, far below the 3.5% projection that the Fed had offered for the quarter back in December, but at least in the same ballpark. Since mid-March, the estimates have fallen steadily throughout and last week it was taken down to just .1% (although since increased to .3%). (This comes after 4th quarter 2015 growth came in at a very disappointing 1.4%)
 
So if we assume that the official estimates (when they arrive in a few weeks) do not stray too far from these projections, economists will have to explain why we had a very, very bad quarter (in fact, two consecutive bad quarters) at a time when the weather should have been encouraging robust activity.
 
An analysis of the bad winters also reveals a clear tendency for the economy to bounce back strongly in the following quarter, confirming the theory that pent up demand in a bad winter, when it’s too cold for people to go out and shop or for construction companies to break ground, results in increased activity in the spring. In the ten 2nd quarters that followed the ten snowiest winters, annualized GDP averaged a strong 4.4%, or almost four percent higher than the prior quarter. That trend was clearly seen in 2014 and 2015 when second quarter growth was an average 4 percentage points higher than Q1.   
 
Most strategists are now confident that a similar rebound will occur this spring even if there has been no bad weather to create the “snap back” dynamic. But putting that aside, there is absolutely no evidence to support such an absurd conclusion, and any such beliefs are based on hope not reason. The weather was actually so warm this winter that rather than pushing economic activity forward into the second quarter, it likely could have pulled economic activity into the first. This could weigh down 2nd quarter performance.
 
We also should take note of the fast deceleration of the Atlanta Fed’s GDP estimates and the fact that the biggest declines came at the end of the quarter. This may mean that we could be slowing down going into second quarter. Nevertheless, government and private economists still expect the traditional kind of 2nd quarter rebound.
 
But evidence arguing against this can be found in wholesale trade inventories for January and February that were released last week. Originally January inventories were reported as up .3% (U.S. Census Bureau), which was taken as a sign that business confidence was rising. At the time many thought that February would not sustain that pace and decline by .2%. Instead, January itself was revised to -.2% (from up .3%) and February was reported at down .5% (off of the already rolled back January number). This is a terrible outcome.
 
The bad dynamics have been apparent for a while in the inventory-to-sales ratio, which documents how difficult it has been for companies to move products. Last week some economists were relieved that this number had come down to 1.36 (U.S. Census Bureau). But that drop was only possible because the prior month had been revised up from 1.35 to 1.37 (a higher number indicates more stagnant inventories). Going into Q2 last year, most businesses still believed that the recovery was real, and they built their inventories throughout the quarter (which added to GDP). There is no sign that that is happening this year. I believe that based on the current high inventory-to-sales ratio companies will draw down their inventories this quarter, thus detracting further from GDP.   
 
Another big difference between this year and the last two is the trajectory of our trade deficits. January and February trade deficits averaged $46.4 billion per month this year. They were just $41.1 billion in 2014, and $41.0 billion in 2015 (U.S. Census Bureau). Trade deficits detract from GDP.
 
Despite the weather, the inventories, and the trade deficits, very few of the most influential public and private economists have marked down their full year GDP forecasts very much, if at all. Goldman Sachs even believes so strongly in the strength of the recovery that it still expects the Federal Reserve to raise interest rates three more times this year (Wall Street Journal, Min Zeng, 3/31/16).  The IMF just revised down its estimates for 2016 U.S. economic growth, but only by .2% from 2.6% to 2.4%. But if the 1st quarter matches the Atlanta Fed’s current estimate, GDP growth for the rest of the year will have to average over 3% to achieve that.  
 
This is likely the type of mindless optimism and herd mentality that caused only one in five U.S. large-cap fund managers to beat the S&P 500 in the first quarter. If you have no idea what’s going on economically, you are unlikely to pick the right stocks. High priced hedge fund managers did little better. In fact, the first quarter was the worst quarter for active managers in eighteen years, according to data from Bank of America Merrill Lynch. This tells me that the degree of denial is still very high, and that those who resist the stampede may be in a position to realize gains when the likelihood of recession finally becomes apparent to all.
 
Unlike Goldman Sachs and other big banks, I do not see any more rate hikes in 2016. Instead, I believe that it is far more likely that the Fed will have to roll out more dovish forward guidance until the point where it officially calls off rate increases for the foreseeable future. After that, I believe it will have to take us back to zero percent interest rates, restart quantitative easing, and it may even take interest rates into negative territory. Take your stand accordingly.
 
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Source: Commentaries By Peter Schiff

European QE Creates Distortions in World Economy

Our weekly commentaries provide Euro Pacific Capital’s latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.

By: 

John Browne

Thursday, March 19, 2015

In the closing months of 2014, Germany faced a difficult dilemma. Although its own economy was holding up well, incoming data showed that the rest of the Eurozone was rapidly slipping into recession. As a result, the calls for the European Central Bank (ECB) to unleash its own quantitative easing campaign grew louder. However, the policy had always been unpopular in Germany, both among high financial officials and rank and file Germans, where a strong euro has been prized. But in the end, Berlin was ‘persuaded’ to drop its efforts to forestall a QE campaign that everyone else in the world seemed to want.
 
On January 22, 2015, Mario Draghi, president of the ECB, announced a QE program of 1.1 trillion euros. Such a move could never have occurred without the approval of the Germans. Larger than expected, it sent the euro down to $1.14. On March 5th, Draghi announced the program in more detail. This helped send the euro plunging further to close at $1.05 on March 13th, a 12-year low against the dollar, for a total drop of 20% since September 1st, 2014. The Germans may have started to wonder what kind of a deal with the devil they had made.
 
The Bank of Japan (BOJ) christened the term Quantitative Easing (QE) as a term to describe the creation of fiat money in order to buy bonds on the open market, thereby pushing down long dated yields, in an environment where short yields have already approached zero. Even as it launched this policy, primarily due to pressure from Japanese politicians, the BoJ doubted it would be “effective.” Fourteen years later, evidence indicates that they were right. QE appears to have worked for financial markets but not the economy.
 
Despite the evidence of failure in Japan, the U.S. Federal Reserve nevertheless came to adopt a $3.8 trillion QE policy when the American economy entered a deep recession in 2008. The results were met with mixed reviews, but many other central banks, including the Bank of England (BoE) followed suit. Only the reticence of the Germans prevented the ECB from joining the QE party. Their reasons are historic and particular.
 
Germany had suffered the rigors of wealth destruction, economic chaos and acute human suffering caused by massive currency debasement in the 1919-1933 Weimar Republic. In 1914, 4.2 German ‘gold’ Marks bought one U.S. dollar. By 1918, one U.S. dollar commanded 8.4 ‘fiat’ Reichsmarks.
 
In an effort to pay the massive French-inspired war reparations, Germany printed huge amounts of paper Marks. By November 1923, one German gold Mark was worth one trillion paper Marks. One U.S. dollar was worth 4,210,500,000,000 German paper Marks, or almost exactly 4.2 German gold Marks, the exchange rate of 1914! (sourced from Thorsten Polleit."Hyperinflation, Money Demand, and the Crack-up Boom", Mises Daily, January 2010. Referenced 2010-06-26.) There may be a valuable message here for those who continue to eschew holding gold.
 
With this experience burned into the German collective memory, the German government assured its people that it would drop the Deutsche Mark in exchange for the euro only if the euro remained a ‘sound’ currency and protected savings and retirement funds. It remains to be seen how angry German citizens will become if the euro falls much further. Perhaps the monetary authorities believe that monetary anxiety will be overcome by stock market euphoria, which inevitably follows the appearance of QE.
 
From mid-December to mid-March, the German DAX index was up a stunning 27%. Such performance may buy a lot of support inside Germany. But, looked from outside the fog of QE, the performance is not nearly as impressive. Over the same timeframe the euro has lost about 16% of its value, thereby blunting the magnitude of the stock gains. As happened with QE in the United States, much of the money in Draghi’s QE likely will find its way into stock and bond markets, boosting prices.
 
For the price of debasing the euro and boosting European share prices, the QE move by the ECB threatens to create global instability that may unfold over the medium to long term.
 
Clearly, non-Eurozone tourists will flock to Europe, boosting tourism. Conversely, the numbers of Europeans coming to tour America likely will drop. This will shake up the outlook for many very large public companies. In recent years, Eurozone countries and corporations have been tempted by low interest rates and a relatively strong euro to borrow from the vast pool of cheap U.S. dollars created by the Fed. If those borrowing costs increase substantially, it may lead to serious problems down the road, threatening even defaults.
 
Meanwhile, non-euro based corporations looking to buy European business assets likely will look quite aggressively for acquisition targets, boosting M&A activity.
 
It is not just the level of the euro’s fall, but also the speed of its fall which can prove to be so challenging. Even U.S. companies have been given little opportunity to hedge their euro-denominated revenues. As Jim Cramer said recently on CNBC, “You have to really steer clear from companies that are 35 to 40 percent Europe, of which there are a bunch”. Also, U.S. corporations, which for tax reasons hold an estimated aggregate of over $2 trillion worth of cash offshore, may now be faced with significant currency losses.
 
Clearly, a fall of twenty percent in the euro, the world’s second currency, is a most important event. If such a debasement proves successful in reversing the recessionary trend in the EU (in essence succeeding where Japan and the U.S. have failed), it could have a major positive impact on the attractiveness of investment in Europe and perhaps globally. Conversely, should Draghi’s QE fail, the world could be facing an increasing threat of a fiat currency crisis and a rising gold price.


Source: John Brownes Market Commentary

U.S. Isolated in Opposition to Chinese Bank

Our weekly commentaries provide Euro Pacific Capital’s latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.

By: 

John Browne

Tuesday, March 31, 2015

Over the past few decades while the economic power of the Chinese has grown exponentially, many observers have been surprised by the relative willingness of China to operate within the financial and economic framework established by the dominant Western order. But it should now be blatantly clear that Beijing prefers to act slowly, deliberately and quietly to advance its agenda. This is the case with the establishment of the Asian Infrastructure Investment Bank (AIIB), a Chinese-led lending institution which could emerge as an international rival to the World Bank and the International Monetary Fund. Such an institution could support Beijing’s political interests by controlling the flow of infrastructure financing that is vital for developing economies. As we all know, money can often buy loyalty.
 
Currently the regional infrastructure lending in Asia is led by the Asian Development Bank (ADB), modeled after the U.S.-dominated World Bank. Founded in the 1960s and headquartered in the Philippines, the ADB is headed by a Japanese appointee who enjoys the support of a 25% U.S./Japanese block vote, dwarfing China’s 6 percent. But according to 2013 figures from the World Bank, and excluding the European Union’s GDP of $17.5 trillion, China’s GDP, at $9.2 trillion, now is second only to that of the U.S. with $16.8 trillion. It should have been clear that China would not accept such relegation indefinitely.
 
In October of last year China and India led 19 other Asian and Middle Eastern nations in the formation of the AIIB, which was initially capitalized with more than $50 billion. The United States, angry at what it perceived as a clear threat to its domination, supported by European and Japanese interests, leaned heavily on its allies not to join. Notably absent from the AIIB launch celebrations were the important Asian nations of Australia, Japan and South Korea, all very close allies of the U.S. However, once China decided to yield veto power, some Western interests appear to have reconsidered their opposition.
 
The big blow came in mid-March when the United Kingdom (despite its ‘special relationship’ with the United States) decided to join. This in turn encouraged other powerful EU nations, including Germany, France and Italy, to jump in as well. On March 26th, even South Korea joined, bringing the total AIIB membership to 37 nations, including 9 non-regional countries. This clear move to support China’s campaign for greater regional power left the United States notably isolated. In response to the decision from London to lend its support, a US government official told the Financial Times, "We are wary about a trend toward constant accommodation of China, which is not the best way to engage a rising power.”
 
The strength of support for the AIIB could be another step towards the ‘de-dollarization’ that many expect to be the endgame of Chinese economic policy. The loss of the U.S. dollar’s coveted position as the international reserve currency would be a direct threat to America’s ability effectively to set world interest rates and to create seemingly limitless fiat dollars without the need to finance them in free markets. The AIIB represents one more indication that the ‘old’ order of dollar hegemony may be nearing an end to be replaced likely by a Chinese-led currency, perhaps even one linked to gold.
 
The ADB argues that there is an $8 trillion infrastructure gap in Asia and that investment there will yield true economic growth and wealth creation. However, the Japanese fear that China will try to tie and even annex Asian countries via a network of strategic pipelines, railways and roads. In all likelihood, China may use the newly established AIIB to do just that.
 
Under President Obama, America is appearing weak on many fronts, including defense and monetary affairs. Already a combination of Obama’s apparently inept foreign policy has led Chancellor Merkel of Germany to take a different posture over the Ukraine, exposing a potentially damaging split in the vitally important and longstanding NATO alliance. By leaning on its allies publicly, but ultimately ineffectively, to resist China’s AIIB overtures, Obama has exposed another level of increasing diplomatic and monetary weakness.
 
Clearly, the Obama Administration was angered by the UK’s reversal. Patrick Ventrell, a spokesman for the National Security Council, told CNNMoney that the White House had “concerns” over whether the AIIB will meet “high standards, particularly related to governance, and environmental and social safeguards.” He added, “This is the UK’s sovereign decision. We hope and expect that the UK will use its voice to push for adoption of high standards.”
 
In this column we have argued at length that China likely desires to replace the U.S. dollar with its own version of an international reserve currency. Doubtless, China wants to capture the massive financial and economic privileges and power that control of such a currency bestows on its host nation.
 
It appears that de-dollarization is progressing slowly but surely, with the formation of the AIIB being just a single but important and highly visible step in that process. If the U.S. dollar ultimately loses its reserve status, those holding dollars or assets denominated in dollars will feel the pain. Worse still, America will lose the almost total dominance over world monetary affairs she has enjoyed since Bretton Woods in 1944. As a result, the current era of extreme dollar confidence may in the future be considered a period of dangerous delusion and willful ignorance of world events. 


Source: John Brownes Market Commentary