Commercial Real Estate News / Insight / The Theme Behind World Events And What It Means For Portfolios

The Theme Behind World Events And What It Means For Portfolios

Published: 10-27-22 Category: Insight

MyEListings' markets and economics editor and creates content about global macro events and their impact on US commercial real estate.

TLDR;

The US is no longer interested in or able to act as guarantor of world shipping security
As such, and because it is now energy-independent, its interests are realigning
In the past, when core US interests have shifted, it has had the effect of global wholesale change and forcing the world to conform to its machinations
Examples include US responses to Germany and Japan in WWII, the launching of the space program in the late 50’s and the retooling of the US industrial and educational base that ensued.
As the US pulls back from the world, this should enable greater focus on the big issues that are actual US interests such as eliminating the CCP, overseeing the dismantling of the Russian government and balancing power in the middle east to its liking.
The ways in which it pursues these aims will be strategic
‘Strategic’ implies economic/monetary machinations are on the table
This suggests global coordination regarding interest rates and monetary policy, at least to some degree, and this in turn means that from now until early 2023 could see a respite, however brief, where rates correct some of their recent rise, allowing injured property deals some breathing room.

In 1949, the US got together with its allies at the Mt. Washington Hotel in Bretton Woods, NH, and produced an alliance of sorts, intended to overcome the sets of circumstances that had led the world into two consecutive, extremely destructive wars. Among these circumstances were the concepts of empire and the mercantilist economic system that accompanied it.

Empire and Mercantilism

Empire is a form of political organization wherein a powerful country exclusively invests resources into a few less powerful ones, with the tradeoff that it receives an agreed-upon share of the new colony’s resources and production.

Mercantilism was the dominant economic system that emerged around this shape of political organization. Under it, horizontal trade was extremely limited between nations. States got their resources from their own networks of colonies and vassal states, not by trading with each other. This was done out of fear, and the grasps at control that are often borne of it; England did not share scarce resources with France or Spain, but got them from its colonies, and vice-versa.

Scarcity Invites Conflict

Empires necessarily consumed vast amounts of resources, leading to scarcity. The empires that made it into the 20th century successfully, namely the Ottoman, Austro-Hungarian, Japanese, and remnants of the British, Dutch and French empires, demonstrated the sub-optimality of these systems. World War I dismantled the Ottoman and Austro-Hungarian empires, and the world’s response was to try to organize a League of Nations, and to punish the losing belligerents so viciously they could never prosecute war again.

World War II was what resulted from this fiasco of uninformed attempts. In it, the Japanese empire could no longer source oil from its colonies at the rate its ambitions required, so it invaded China to source fuel and attacked Pearl Harbor to attempt a decapitation strike on the US Navy. This act had grave consequences for the Japanese people, as the US punctuated its ultimate response with two very destructive doses of ‘yeah, that’s what I thought.’

A New Way Forward

At the end of World War II, the US had the only navy left standing, as well as the only economy. It could see how empire and mercantilism had led to these destructive outcomes systematically and sought a new way forward, subject to the constraint that the threat of the burgeoning USSR be held in check. The Bretton Woods Agreement created global institutions - the IMF, the World Bank, established a system of fixed currency exchange rates, and allowed signatories to trade freely with each other and anyone else, with the US’ blessing. The US would facilitate global trade by offering its physical protection for trade shipping.

This would prove to be the single most prosperity-inducing act the world has known, to this day. More than one-third of the world’s current population has been lifted out of poverty since the US undertook this endeavor, and the prosperity it unleashed can be traced directly to this newly-permissioned trade.

Flash Forward: The US No Longer Cares

US interests were at the heart of Bretton Woods. It essentially paid the tab for alliance members to prosper, with the quid pro quo being that they agreed to oppose the Soviet Union and to stand in front of the US to that extent. Two things emerged from this: The US retraded some of the stipulations once it became clear they were ripe for abuse, instituting floating currency rates in place of fixed, eliminated the fixed gold exchange rate and the US dollar became the defacto global reserve currency, used by the majority of countries for interstate trade in place of their own currencies. One key driver of the adoption of dollars for international trade was the petrodollar, which the US and Saudi Arabia agreed to in 1945. It essentially meant Opec would denominate oil trade in dollars, and this would be imposed by Saudi Arabia as the defacto leader of the cartel. The resulting ubiquity of dollars in global trade benefit the US in too many ways to count, and it is for this reason that certain countries today seem to believe they can replace the dollar in global trade, if not with a single other currency, then a basket of them.

Here’s the problem with that: To act as a global reserve, the issuing country can’t manipulate its value to bolster its trade figures. The US doesn’t care. It has every geographic advantage imaginable, and a few that aren’t. From these flow its economic advantages, one of which is that its currency alone has the ability to function as the global reserve. To do so, the issuer can’t care about its value vis a vis trade. The US is a net importer, and the largest one. Every other nation, especially big exporters, need access to the US consumer base. We pay in dollars.

To see the problem with literally any other currency, let’s look at the top 5 next largest currency bases.

The Euro - several years ago, the EU literally stuck its hands into citizens’ bank accounts in Cypress, and took their money, ostensibly to pay for a ‘bailout.’ This one thing precludes the Euro from ever being a global reserve currency, and the EU’s seeming need for ultra slow, never-resolved political action times their terminal demography only buttresses this fact.
The Yen - in an environment where interest rates are rising globally, Japan still keeps its short term rates at 0.25%, all but guaranteeing its value will unravel in the coming months. Japan is the oldest society on earth, meaning they cannot consume all their economy produces, and must thus export. See: that bit above about not caring about the value for trade purposes. No.
The Pound Sterling - say it with me: Absolutely not. See: BOE/UK Budget fiasco last week, plus we’ve tried this and found it severely lacking.
The Chinese Yuan - Ludicrous. Beyond asinine. China couldn’t manufacture a ball point pen until 5 years ago. They can’t open their capital account for fear of truly massive capital flight, which they’re already contending with despite a closed capital account. Their crazed economic machinations are matched only by their poor geography.
That’s really it. Everything else is just too small to matter. And let’s keep in mind that if your currency is awful on its own, a basket of others like it is just a basket of awful.

The Shale Revolution Changes The Game

The US shale revolution has allowed US producers to become the largest in terms of volume in just the last decade. That’s a feat in itself, but the real value in this lies in the natural gas that lies trapped along with crude, and exists in such truly massive quantities that it is essentially a waste product in the US. Nearly a quarter of what we bottle and store is flared off at wellheads while waiting for a pipeline connection.

What has happened in the US vis a vis gas production is that refineries, particularly inland refineries, have begun to retool their processes to create many end products from natural gas instead of liquid crudes and condensates. This is a largely unappreciated advantage.

This Is The Theme Behind World Events

What this means at day’s end is that the US no longer cares as much about its relationship with any Middle Eastern country, and since there is no other power capable of rivaling it geopolitically, its interests have shifted away from guaranteeing everyone’s shipping security and will continue to do so. So the US is no longer as interested in either the middle east or any other country’s trade with others.

And where the US has historically operated fairly strategically in the world, with these interests having shifted as they have, its interests now lie in denying access to its experience to other countries. That means the US will not sit by and allow Russia or China or any ally to usurp its relationships. The Kingdom of Saudi Arabia, for example, owes its existence, quite literally, to the US. And if they were to pivot to replacing the US with either of those countries, then we’d likely see the US’ disruption game on to full display. And if you thought the US was a force strategically, think about using that force to disrupt, destabilize and outright seize the very trade we were protecting before. This is the reality of having the only navy of any real heft on the planet. The ability to reach any geographic maritime chokepoint where others might possibly be able to reach one or two with an inferior force is a massive advantage, because it allows the US to simply deny enemies access to these choke points from well outside their defensive range.

What This Means For Dollar-Denominated Investments

As the world awakens to the new reality of US interests having shifted, many seem to have failed to recognize what its new interests are. They include protecting the value of the dollar, which is evident in the current spate of unprecedentedly sharp short term interest rate hikes, ensuring no rivals can gain the scale necessary to threaten the US’ role in the world, and using its demographic advantages to iron out domestic issues and establish a framework for global furtherance into the future, under continued US hospices.

US interest rates have risen to a point where they will likely subside a bit, as the yield curve metabolizes this series of hikes, and this should give everything from corporate bond issuances to CRE deals in need of retrade a bit of breathing room in the next few weeks to months.