ON INFRASTRUCTURE
The big event that impacted financial markets in the last week was the announcement of a US$2.25 trillion infrastructure plan to be implemented by the Biden White House. The US stock markets gushed, racing to new record highs. The US Dollar surged.
Infrastructure building is an effective initiative to bring economies out of the doldrums. Or protecting their dynamism and resilience.
I was reading an interesting portrayal of how the Great Wall of China has long been a marvel of ancient human endeavour, not only because of its immense length and its snaking along remote and precipitous mountain spines, but also the way the durability of the bricks and cement have lasted hundreds of years, and the signalling capabilities of the watch towers.
This Wall has defined China. Outside of the Wall, it was for two thousand years, non-China. Those who lived beyond the Wall were barbarians. Inside the Wall, stretching for thousands of kilometers to the seas in the East and South and the Himalayas to the Southwest, the Chinese built the Middle Kingdom, an agrarian economy that supported a flourishing “civilisation state” with values and morals that are largely unchanged to this day.
Think of the Great Wall of China as essential infrastructure, built and maintained over two millennia. It protected the ancient Chinese economy, which prospered for that length of time and also hosted the largest population in a single homogeneous country on the planet.
There were other great infrastructure projects within the Middle Kingdom. The Grand Canal, the Yellow River dikes, or the ports that launched the massive Ming fleets are examples of effective economy-boosting infrastructure.
More recently, the infrastructure building in China has extended to dams, highways and roads, sea-crossing bridges, high speed rail, vast solar and wind farms, even a South-North water diversion system. These have been engineering achievements not seen before in human history. The result has been a booming Chinese economy. In one generation of just over 30 years, they have helped to eliminate poverty, which once plagued 99 percent of the entire population in 1950, the starting point of the New China, under the CCP.
Infrastructure construction works.
The same is true in the West. During the 1930s, Germany built the Autobahn system which helped to reverse the Great Depression. FDR’s excellent federal highway system and projects like the Tennessee Valley Authority’s dams and power projects, created the impetus to revive the US economy in its time. In the 19th Century, the British Empire built a series of ports at chokepoints on the world’s major trade routes and flourished as the greatest maritime empire of all time. Including that sliver of water in the news all of the last week – the Suez Canal. That infrastructure project brought a lot of wealth to the world over one and half centuries, and a few days of blockage caused multiple billions of losses…
With that perspective, the Biden Administration’s attempt to launch a US$225 trillion is a promising venture. It is very likely to be successful, if it survives Congress without much of it being slashed to pieces by partisan politics.
On its implementation, the prosperity of the American economy from infrastructure construction will reduce the angry energy wasted on who is manufacturing more or less, against China. The Biden plan is all good.
There is another aspect of infrastructure that may be of interest - financial infrastructure.
On Friday, there is the following article circulating on social media:
“Commentary: If China changes its exchange-rate regime, the US dollar is in trouble" - written by Kenneth Rogoff, a former chief economist of the International Monetary Fund, is Professor of Economics and Public Policy at Harvard University.
Reading this article is like looking at a map of South East Asia, and pushing the idea that the Straits of Malacca is far too crowded for existing and future shipping and a canal can therefore be built across the Kra Isthmus to bypass some, if not all of the congestion, further south. The Port of Singapore would inevitably suffer.
This Kra Canal project has been discussed for many decades. It has not happened. It does not mean it cannot happen, but the point is that what looks obvious on a map does not take into consideration the myriad complex issues that are embedded in such projects. Some infrastructure just cannot be built because existing infrastructure is already working well. If there had been nothing there before, such as if Singapore Port does not exist, a Kra Canal might have worked. But that is not the case.
Even ardent proponents of the Kra Canal would look at the cost and benefits of building such an infrastructure project and obviously, there has been no financial case for going forward.
Similarly, the case for replacing (or reducing) the role of the US Dollar in the global financial infrastructure that has been in place for a good three quarters of a century must be based on a future international payments infrastructure being more efficient (ie profitable) for most of its users. For everyone involved in international trade and finance to look to the Chinese Yuan as a replacement for the US Dollar, they will have to consider the cost and benefits of switching out of a dollar payments system to do so. Here are some thoughts that while it might happen, it will be like watching grass grow.
1) There is of course a strategic competition going on between the US and China now. This is motivated by politics. And history has shown that political attitudes can change over time. In 1953, the Americans and the Chinese were at each other’s throats in a bitter life and death struggle in Korea, and by 1972, the Americans were happy to have their President visit China. An ideological war based on, with the benefit of hindsight, incorrect assessment of realpolitik, ended peacefully without another shot fired after the Korean war ended. Today, we are nowhere close to the circumstances of the Korean war, and it is a relatively congenial contest between the US and China.
2) We don’t know if in a couple of years, this contest may escalate or just die down. Changing the dollar payments infrastructure is a big deal, and as Mr Rogoff said, it will take a long time. Whether the change, even if inevitable, will come before a realignment of political interests, is impossible to predict. The political infrastructure is not stable enough to suggest a change is imminent.
3) Remember Jack Ma? He called the Chinese banking system antiquated. He is not wrong. For another 20 years, the Chinese banking system will not be able to become as efficient as the American system to have a network that can basically cover global trade. Chinese banks are largely state-owned, and they are not entrepreneurial in any sense of the word. They are controlled and beholden to the Chinese government. That is an institutional characteristic of the Chinese banking system. We also cannot ignore this restrictive structure of the Chinese financial system. The institutional infrastructure for a Yuan-based reserve currency that can facilitate trade simply does not exist yet.
4) And why would anyone expect Western countries to support the RMB as a reserve currency, that being the currency of a strategic competitor? There would be a “Huawei syndrome”.
5) The staff of Chinese banks have been brought up under generations of highly restricted practices, from foreign exchange control to interest rate control and have experience only in simple banking. It is not possible in a couple of decades for a new generation of Chinese bankers and traders to emerge in a short time to handle the requirements of international banking and forex trading. The human infrastructure is not in place.
6) Why does anyone assume that China wants to undertake the responsibilities of being an international reserve currency? It is the world’s manufacturing and export power, par excellence. Can it be the global financial powerhouse as well? I think not. To maintain its position as an exporter, it needs to never let its currency appreciate too much. The vital interests of China as it stands now is to maintain the status quo in the world of international trade.
7) Which is why the US Dollar also cannot depreciate too much. Imports and borrowing will become expensive. It is in balance right now. China has a high savings rate while America has a high consumption rate. They are two sides of the same coin. It is complementary. There is a lot of verbal gymnastics about which country’s currency is undervalued and overvalued but actually, the US and China are probably happy just the way it is. If the RMB appreciates too much, the exporter status of China is affected; if the USD depreciates too much, the US cannot import or borrow more. If the RMB becomes a reserve currency, it will likely mean a more robust currency value, affecting China’s competitiveness as an exporter and the US’ ability to import and borrow. Why would either country push for this? Right now, it is a system that benefits both exactly as is. Why change something that works? Forget the rhetoric. The system is actually working well.
8) As Mr Rogoff himself pointed out: “So, what is wrong with three world currencies – the euro, the yuan, and the dollar – sharing the spotlight? Nothing, except that neither markets nor policymakers seem remotely prepared for such a transition.” Developing a new global financial infrastructure is a massive undertaking that will involve every country in the world. We have seen how difficult that has been in solving a more critical problem – global warming. Even if the problems related to the Dollar as reserve currency were real, and not politicised verbiage, and the Chinese want to step up to offer the RMB as an alternative, it won’t happen easily due to the conflicting demands among 200 plus nation states. If 200 countries can ever agree on anything, it is better to be on the environment than on the reserve currency. Even the Euro has not succeeded to be a second reserve currency in 20 years. A third reserve currency? Forget it.
The chatter that is now pervading the English media on the weakness of the US dollar and “the end is near” syndrome is because it is in English and emanating from out of America. The Americans are suffering post traumatic disorder from the Trumpian years, and are still in the thick of reckoning with the most disastrous mismanagement of their economy since the Reagan administration started. In the last 40 years, the move towards “less government, more freedom for capitalism to work in the economy” has created the most unequal income and wealth distribution in modern society since feudalism ended. The vast majority of people including intellectuals are feeling the pain of being left out.
The effects of “less government” have created an ironic situation where people actually think government is at fault. Some want no government, no central bank, no treasury, and they see the financial establishment to be enslaving the downtrodden masses to a life of inflation and hence poverty. There is a culture of entitlement in America – of not wanting to pay taxes and enjoying the state welfare of the Europeans, the Canadians, and the Asians. That’s why there is fear of the future based on a Dollar that will be ravaged by debt and inflation. Higher taxes can actually solve the problem, but obviously one cannot have the cake and eat it too.
It has also led to the farcical promotion of crypto for Americans to free themselves of enslavement by government, which then puts them into the control of geeks plus a few whales.
Crypto is a uniquely American battle cry. At best, it is libertarianism. The rest of the folks behind crypto are really just speculators and manipulators. It is not the infrastructure for a new financial order. The finite supply of Bitcoin at 21 million units is trumpeted as financial discipline, until one remembers that are some 4000 plus crypto currencies, all trying to become the next Bitcoin and created faster than the government is printing dollars. It is hypocrisy.
If we go outside America, there is no such despair over the financial system. Chinese citizens are feeling more confident about their prospects than ever before in more than two centuries. Yes, they despair over inflation too, in the sense that some feel left out of an ongoing property boom in major cities. But they don’t blame the financial order and government.
If you look outside of the most dynamic countries in the world, there is no fear of dollar devaluation. Ask India, Indonesia, Russia, Brazil, Turkey, plus all the countries in Latin America and Africa (even East Asia countries including Japan and South Korea) making up three quarters of the world’s population. There is no dollar crisis. In the last ten years, the dollar has appreciated against ALL their currencies. By a lot. What crisis?
They don’t worry about an insidious reserve currency collapse and financial enslavement. They don’t need RMB or crypto; they just want US dollars.
In summary, the article by Mr Rogoff is to be respected, but it will not become policy within the short term. Just as it is not yet time to build the Kra Canal.
And as John Maynard Keynes said, in the long run, we are all dead anyway.
Wai Cheong
Investment Committee
The writer has been in financial services for more than forty years. He graduated with First Class Honours in Economics and Statistics, winning a prize in 1976 for being top student for the whole university in his year. He also holds an MBA with Honors from the University of Chicago. He is a Chartered Financial Analyst.
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