TDI Podcast: Economic Indigestion (#991)

29:13That can be true. And if you talk to European officials or Asian officials, they will tell you they're at work. But at the same time, it can be the case that developing these alternatives takes time. and until they are more fully developed, the dollar will continue to be the central currency in the global monetary and financial system. But there's been an ongoing discussion. The BRICS were going to come out with this dominant alternative to the dollar and China was going to press this and Brazil was going to get in there because they had the oil and they were the ones that were going to really be the petrodollar really governing body because everybody was, I guess, aggravated or disappointed or bothered the fact that everything, commodities are priced in dollars, not all, but commodities are priced in dollars.

30:04That's changed a bit over the years. But I guess the question is that, you know, who, where is, where is the play on this? And I guess, is there an alternative that you found that would be reasonable? Yeah. So at the retail level, the answer is things like fast payment or instant payment systems like PIX in Brazil and UPI in India. These are now being linked across borders so they can be used to exchange local currencies directly for one another without having to go into the foreign exchange market and first buy U.S. dollars in order to buy the counterparty currency. So Singapore and Thailand, Singapore and Malaysia have linked their systems.

30:58India and Brazil are pursuing linking their respective systems. So that is happening on the retail front and on the wholesale front. In other words, for the big transactions done between banks, we have blockchain and various initiatives that not only the banks, but Visa and MasterCard and Swift are pursuing to tokenize bank deposits and other assets, create digital representations of them that can be exchanged directly for one another on a distributed ledger, on a blockchain, without having to go through the U.S. correspondent banking system. So the retail part is going faster than the wholesale part, but I think they're both underway.

31:46What they're telling us is that digital technology is opening up alternatives to the traditional dollar-based, US-based correspondent banking system-based system. It's unbelievable. I mean, obviously what's happening is retail's pushing, wholesale doesn't want to do it because there's still a lot of bucks in it for them. I mean, And that's probably what I'm thinking is going on in behind the scenes. Does that somewhat ring true? Yeah, no, that rings exactly true. And if you ask, what about other currencies that might become meaningful rivals to the dollar on the international stage? The euro is the most obvious candidate, I continue to believe.

32:31But those in entrenched incumbent interests, banks, investment funds, and others in various European countries don't want to see a deeply integrated liquid euro security market, which is what the euro area needs in order to compete with the US and the dollar. Now, you've argued, I would say rather persuasively that, and you'll have to fix my words if I don't get this exactly right, but dominant currencies are often damaged from within rather than displaced by a rival, right? And I guess the question is, with that being the case, if that was something you believe and you've talked about, is Washington and our current administration or not even current, let's forget the current administrations, a bigger threat now than, let's say, Beijing?

33:28That is exactly what I conclude in my book, Money Beyond Borders, that if there is a threat to the continued global role of the dollar, it's coming from Washington, D.C. It's the United States of America shooting itself in the monetary and financial foot by issuing large amounts of public debt that the markets come to view as unsustainable through threats to the independence of the Federal Reserve, which are deeply demoralizing to international investors. We've moved from a situation 10 years ago where foreign investors held the majority of U.S. Treasury securities. Now they hold a minority. We can't count on them to the same extent to hold our assets and finance our deficits.

34:22And then, you know, there is the political noise around Washington, D.C. at the moment. I think questions about rule of law, separation of powers, control of corruption, all of which make foreign holders and users of dollars think twice. Yeah, because there was a time when we were all freaked out about, oh, my God, what if China sells? What if Japan sells? And the fact is they've been diversifying for a while. And, you know, this then goes into some of the discussion about how Washington, again, writ large, the whole batch of them, whatever department you want to look at, is creating, I think, a question in terms of the, you know, the old America, right?

35:09You know, was the country, there is a de-America or migration away from America in so many things. And when you look at what happened recently with Besant, which I call Besant's big bond blunder, we saw this coordinated intervention, first of all, the week before with Besant. Remember that little notepad that he had so conveniently out with only by, what was it,$10 billion of the yen that was sitting out there for all reporters to take a picture of? And the yen did, in fact, move. And then the week later, we have a situation with him doing an Operation Twist. But let's go back to this whole Yen situation.

35:51How abnormal or maybe problematic do you see it or not that Besant went in, or at least they said they're going to do this, with the Yen, somehow this global intervention? What is that signaling and what are your thoughts on that? Well, I think Besant was sympathetic to the Japanese cause. The Japanese were worried about the sharp depreciation of their currency, which reflected weaknesses in Japanese economic growth and Japanese finances. But fundamentally, he didn't want more pressure on the U.S. Treasury market. He didn't want large sales by the Bank of Japan of its reserves of U.S. Treasury bonds.

36:40So he did two things. Number one, he supported the yen directly, taking pressure off the BOJ by selling euros in accounts of the U.S. Treasury. And number two, he used open mouth operations to encourage the Fed to expand the repo line that it had with the BOJ. So the BOJ could mobilize its other dollar assets without having to sell them into the market. It could repo them to the Fed. Instead, the message was that to foreign central banks, I think it was that your treasury holdings, your dollar reserves are not as liquid as you thought they were. We are not going to be happy in the Treasury Department if you actually sell them as central banks normally do when they intervene to support their currencies.

37:38So that message, once it's fully processed, I think will lend additional momentum to the reserve diversification that we have seen. And do you consider this, both of these things probable, whereas we'll continue to see the momentum for interest rates moving higher due to the fact that we have a strong economy here? I heard today or recently something about our nominal GDP is like 7 % last quarter and or the coming quarter. That's the expectation, I guess. And at the same time, you look around the world and you see there's a lot of pockets of strength. But are people going to say, well, we're going to sell the dollar into that?

38:22Is it because of, it's not because of our economy. It's got to be something else. Well, you know, higher interest rates, other things equal, make holding dollars more attractive for foreign central banks and corporate treasurers. I think one of the reasons we saw gradual but continuing reserve diversification in the decade that ended with COVID was that U.S. interest rates were near zero for a long time. So the fact that they're now back up to historically normal levels ought to be dollar supportive. The question is whether those higher interest rates are going to be matched going forward by higher inflation and dollar depreciation, which would offset their impact, or whether the Fed will be serious about hitting its inflation target, in which case where interest rates go will depend, as with the stock market and many other things at the moment, on the AI financing boom.

39:29I think, you know, budget deficits are part of the high interest rates, not only budget deficits here in the U.S., but in Europe and Japan and elsewhere. they will probably continue indefinitely into the future. The big unknown, I think, is whether the trillions of dollars of data center and related borrowing and investment continue to push up interest rates. That's going to be that and the debt issuance out there, the$40 trillion debt that we have as a country here, all that probably is a big part of it as well. So, but, but, you know, we'll see. this is the great experiment, isn't it? This is the next level of debt financing that we'll see if we can actually come out of.

40:17Because I remember for years, we all scoffed at, look at Japan, look at Europe, look at Greece, look at the pigs, right? It was all this whole story about, we're so much better, we're so much cleaner, we're so much, you know, we have our debt to GDP, and all this stuff was like, and then now it doesn't matter. I was like, we'll just rack it up. Who cares? Nobody ever has to really pay for it. But I want to talk about your book. In Money Beyond Borders, Global Currencies from Croesus to Crypto. Did I say that right? Croesus? Croesus. Croesus. Croesus. Silent O. Silent O. Croesus. All right. So now this is a history of about 2 ,500 years.

40:58I want you to take me back and all of us back about 2 ,000 years. Rome had the denarius and the aureus, I think it was called China had something called the, the Wuzhu, Wuzhu, I think it is. And they have all strange names here. And back then there was really no single reserve currency. It seemed like it was more like whoever was the strongest power out there was like, okay, this is what it's going to be. So back then, when you go back there, was there, or what, I don't know if it was there. And if there was, what it looked like from an international monetary system. Was there something out there before it was the dollar was at the center of it?

41:41Yeah, there was typically something out there. So in the period of the Roman Republic, Roman gold and silver coins circulated everywhere from Scotland in the northwest of Europe into the Middle East, into Asia, into what today we would call Persia, Afghanistan, India. They have even China. They have even been found in Japan, although they probably got to Japan at a later date. The Romans paid their legions in these silver coins that came into local circulation everywhere. Julius Caesar, when he crossed the Rubicon with his troops, carried a mobile mint with him to pay the legions, keep them loyal.

42:29But the fundamental was that Rome was a formidable trading power. It was Athens was the leading trader. I'm sorry. Rome was the leading trader of its day. It had that formidable military. Being able to defend your trade routes and your ships against pirates is part of being a commercial power. And from being a commercial power flows the status as a financial and monetary power. So those factors go together historically. And on the downside, if there are factors that tend to weaken checks and balances in the political system when Rome moved from the republic to the empire, And Nero started spending on himself, building a 300-room mansion, if you will, engaging in more foreign military adventures.

43:36That was followed. What we would call today budget deficits gave way to currency debasement and the end of the denarius as a global currency. So I think we've seen this life cycle before. So it's kind of like when you spend$900 million maybe to rebuild the White House and you spend recklessly and all this, that's when the downside of your currency could possibly happen is what you're saying. Yeah, I didn't give you the example of Nero and his palace randomly. Yeah, no, I think of that. I got that. So I just want to go back to something because I'm kind of curious. you know, you're schlepping along with all your gear and your camels and your horses and all that.

44:24And you've got some kind of a mobile mint. What does that even look like? Well, you know, a mint meant basically a place where guys with hammers could use a template and they had lumps of silver and they could pound out an image with the emperor's profile on it or something like that. That's awesome. So it wasn't a mint building like that. No, it wasn't obviously a thing with paper money coming through. I know that. But I just kind of was interested in, you know, it's obviously had some kind of smeltering operation or some kind of to heat it, pour it, and engrave it, let's call it, stamp it. Exactly.

45:08Cool. So when you look back at all these different things that happened in the history of international currencies, Was there kind of like something like, wow, that's pretty cool, that's pretty wild that that happened? Or maybe something that was just super interesting that you can bring to us from the centuries worth of material that you studied? Well, an example of an international currency whose importance I didn't appreciate until I went into this project was the Spanish pieces of eight. So when, you know, Spain colonized much of the Western Hemisphere, they discovered big silver deposits in present-day Peru and present-day Mexico.

45:57They established mints, which churned out these Spanish silver pesos or dollars or pieces of eight. You know, a silver coin that was cut up into eight slices resembling the slice of a pizza to make small change. That was the first true global currency. It circulated throughout the Western Hemisphere. Spanish pieces of eight were legal tender in the United States until 1857. Is that right? Until we discovered enough gold in California and silver in Nevada to actually get Alexander Hamilton's mint fully up and running. But they were also the legal money in China for three, the leading money in China for 300 years.

46:44The Manila galleons, which sailed from Acapulco to Manila, silver was then trans shipped to China. That was the money with which China did business internally and with the rest of the world. It was the main monetary circulation in Europe and in the Middle East. So it was Spanish silver, which was the first true global currency, I think the most direct predecessor to the dollar. So in the book, you also, I think, well, and from your discussions and what I know of you, you kind of go deep into crypto and maybe not so much crypto in the area. I guess as a sidebar is central bank digital currencies, much different than crypto conceptually, right?

47:37But I mean, it has some of the similarities. But generally speaking, there's a differentiator between the two of those. So either of those, in your opinion, have any kind of ability to challenge some of the traditional national currencies that we have now? So I go into crypto and to all things digital, because one of the things you see in the 2 ,500 years of history is that states or kingdoms or nations that are able to capitalize on new financial technology, new monetary technology, those are the states whose currencies take on a leading global role. So now we have blockchain. We have distributed ledger technology.

48:23That's a new, fundamentally different financial monetary technology. It's a set of payment rails that can be used to complete all kinds of international transactions. So the question is, what will the unit be that runs on those new rails? What will the train that runs on the rails be? Will it be stable coins, crypto tokens designed to be linked one to one to a fiat currency like the US dollar? or will they be the tokenized bank deposits that I mentioned before? Will they be tokenized central bank reserves, central bank digital currency? As I, you know, we know that the United States is taking a bet on stable coins following passage of the Genius Act last year, reflecting, if you will, the political sway.

49:20I'm using my, choosing my words carefully of the crypto. lobby, whereas the Europeans and now the Chinese are betting on a combination of tokenized central bank money and tokenized commercial bank money. But doesn't that just bring us back to the same thing? We're fighting over their tokenized money, our tokenized money. Isn't the same thing just a replacement of a baseline currency to begin with? So these are updates of the kind of monetary transactions that we are accustomed to. But the question is, which ones will be gaining market share at the cost of the others? The view in the United States is that the future lies in stable coins.

50:04And because we are the first mover, 99 % of stable coins out there at the moment are linked to the US dollar. This digital revolution will cement the dollar's role as the leading global currency and repel the challenge it's facing from other units. And Europe and China view the prospects in exactly the opposite way. So there's always a competition between actual and prospective international currencies. And the question is, how will the digital revolution tilt that competition? Yeah, because right now we have a major fragmentation in the current monetary, on a global basis, right? The current monetary systems that everybody's pushing and pulling and wants their own.

50:55And obviously, you know, there's threats. And I think there's a lot of concern. I think there's a lot of fear out there from central banks about the currencies and what's happening. And I think, you know, right now everybody is overwhelmed and overloaded with debt. And so nobody looks good. I mean, if you just take each one individually, if you put them all together, it's like, ah, everybody's about the same. It looks terrible, right? But if you put them individually, you say, well, that's really bad. And I wouldn't want to even really refer to that compared to everybody. But is this fragmentation of the global monetary system going to be, in your opinion, in a number of years too, is it going to be something that's going to be resolved towards a more unified global monetary system?

51:41And is that actually a good thing? I don't think it's going to be resolved in my lifetime. I think we have different countries and different economic and political blocks with different interests. They don't want to delegate control of their monetary and financial affairs to someone else or pool their prospects and control with other countries. We have not seen progress toward a BRICS currency because the BRICS are a very heterogeneous, diverse grouping of countries with different structures and different interests. They had such promise for a minute, didn't they? Like a minute. Just for that one moment and then just disappeared.

52:27But, you know, China is making progress with its central bank digital currency and with a platform called Project Enbridge that enables exchanges of its CBDC with the CBDCs of other countries participating in that project. But the countries that are participating and will participate are politically aligned or economically aligned with China. The United States is not going to participate in a China-led project. So I think there will be a number of different schemes centered around different currencies to which other countries attach themselves. And then we'll have to see whether the interaction between those different currency blocks moves, proceeds smoothly or not.

53:20We had that kind of system before 1913 when the pound sterling, British pound sterling and French franc and German mark all played consequential international roles. That system worked smoothly. We had another such system in the 1920s, a dollar block and a pound sterling block. And that system collapsed in the Great Depression. So I think the lesson is if your policies and financial markets are stable, as they were before 1913, this fragmented system you described can work smoothly. And if not, not. So let's wrap it up with an exploration of the future. If you had to write one more chapter, a final chapter in your book, and let's say that it was, I don't know, 20 years from now or something of that nature.

54:13Let's go out that period of time. And by the way, I'm going to mention this again. The book is Money Beyond Borders, Global Currencies from Crisis. I got that hopefully right. To crypto this time. It's looking back 2 ,500 years of all of this amazing stuff that's gone on. But now if you were, if it was 20 years later and you have to like just modify, adapt this bestseller that you have. And you think about, well, what is it going to, what would you actually append to say about this period of time? Well, I would say this, the middle of the third decade of the 21st century was when the fate of the international monetary system was provided, was determined.

55:03It was when Washington, D.C., in its wisdom, took steps that effectively dethroned the dollar and gave rise to a system that was led by 20 years from now. Is it going to be the euro area in China or is it going to be Brazil and India? We don't know. or that 2026 and the surrounding years were when the United States and Washington got their act together and stabilized confidence in sentiment toward the dollar and the prevailing system lived on to see a couple of more decades. Might I say that part of that potential, your secondary and your review of the getting it together would probably be to have somewhat of a less self-serving group that is running the country.

56:04Again, I'm spanning a couple of decades here, right? I'm not just saying this particular administration, but the self-serving nature of what we have seems to be a really big problem. If they continue down that road, I don't have much faith in the fact that we can pull it off, to be honest. Right. This administration and its advisors think that international trade and international finance, what you and I have been talking about for the last half hour, are zero-sum games. Right. Either we, the United States, gain or they out there in the rest of the world, those nefarious Canadians gain where economists find large belief.

56:46That's code for I believe that it's a positive sum game and that everyone can benefit from trade as well as from the U.S. providing the global public good of a stable and liquid dollar. It's like a simple business, right? You beat everybody down. Who does that help? You build everybody up. We all prosper.

57:06Barry Eichengreen:That's as I see it, as simple as that. Barry Eichengreen, doctor, professor. Do we go by doctor, professor? I forgot what we call you. I'm sorry. Hair doctor, professor works on the instrument. I like it. Thank you so much for joining us. I appreciate it. Thanks, Andrew. Wow. Wow. That was pretty cool. I mean, the history that we look, We can look that far back and talk about currencies. It's pretty remarkable. Pick up that book, Money Beyond Borders. Hey, we're going to be back next week with some really interesting conversations as well. If you haven't done so already, make sure to go over to Instagram and follow Horowitz & Company.

57:46One word, Horowitz & Company. And of course, follow me on Twitter. Andrew Horowitz is my Twitter feed. We have been posting up some videos from this. You can see what we're saying because you can actually see what we're saying and hear us with a video. So make sure to hop on Twitter, follow us. And again, if you need any help, go over to thedisciplinedinvestor.com. I'm there for you. I'm here for you. And let's keep this going. Thanks so much for joining me this week and every week, and I'll see you again real soon.

58:21This podcast is intended for informational purposes only. and does not constitute personalized investment advice. Investing involves risk, including the possible loss of principal and past performance is not indicative of future results. The views and opinions expressed are those of the host and any guests and may not necessarily reflect those of Horowitz & Company, Inc., an investment advisor registered with the U.S. Securities and Exchange Commission. Registration with the SEC does not imply a certain level of training or skill. Advisory services are only offered to a client or prospective clients where Horowitz and Company is properly registered or is excluded from registration requirements.

58:59Any mention of third-party companies, products, or services is provided for informational purposes only and does not constitute an endorsement. Hypothetical scenarios or forward-looking statements are for illustrative purposes and should not be viewed as guarantees. Content is intended for U.S. residents only and may not be applicable in other jurisdictions. Listeners should consult a qualified financial advisor before making any investment decisions. Please visit our website for additional information, disclosures, as well as a copy of our form CRS. Advertisements are not related to the host or affiliates and are not considered recommendations by the host of the show or any affiliates of Horowitz & Company.