MacroVoices #505 Michael Every: Does Anyone Remember PMIs?

Key Concepts

• Economic Statecraft: The use of economic tools and policies as instruments of national power and foreign policy.
• Geopolitical Rivalry: Competition and tension between nations driven by geographical factors and political interests, particularly between the US and China.
• 2G World: A global order characterized by two distinct blocs, one US-centric and the other China-centric, rather than a single dominant power or a multipolar system.
• Ceasefire to Rearm: A temporary halt in conflict or tension that allows parties to rebuild their military and economic strength for future confrontation.
• Bifurcation: The division of something into two branches or parts, applied here to global technology sets, production supply chains, and commodity pricing.
• De-industrialization: The decline of industrial activity in a region or country, often due to offshoring of manufacturing.
• Onshoring: The practice of bringing manufacturing back to the home country.
• Capital Controls: Government restrictions on the movement of capital into or out of a country.
• Dollar Stablecoins: Digital currencies pegged to the value of the US dollar, with potential implications for global financial architecture and dollar hegemony.
• Secular Inflation: A prolonged period of rising prices that is driven by fundamental economic factors.
• AI Super Cycle: A period of rapid technological advancement and investment in Artificial Intelligence, driving demand for related components and services.
• Relative Value Trade: An investment strategy that seeks to profit from the price difference between two related assets.

Geopolitical Tensions and Economic Statecraft

Michael Every of Rabo Bank discusses the escalating geopolitical and economic statecraft, primarily driven by the US's efforts to redefine its global role, with China as the central focus. He highlights a series of "eyebrow-raising developments" over the past month, indicating a significant shift in global dynamics.

Key Developments and Examples:

• China's Rare Earth Export Controls: China announced further export controls on rare earths, restricting their use in military supply chains outside of China or its allies. This is seen as a "game-changer" as rare earths are crucial for advanced technology and military equipment.
• Dutch Seizure of Nexperia: The Dutch government seized assets of Chinese-owned chipmaker Nexperia, leading to a cutoff of chip supplies to the EU in response.
• Mysterious Explosions at EU Refineries: Three EU oil refineries processing Russian fuel experienced "mysterious explosions," suggesting potential economic warfare.
• US Military Aid and Sanctions: The US dangled military aid for Ukraine but pivoted to sanctioning Rosneft and Lucille, with physical enforcement being a key factor.
• Nuclear Testing and Regime Change: The US has restarted nuclear tests, and there are clear discussions about regime change in Venezuela.
• Trump's Foreign Policy Stance: Donald Trump has suggested potential interventions in Nigeria and Mexico, indicating a more assertive US foreign policy.
• EU Policy Shifts:
  • Former and current ECB heads have discussed majority voting in the EU's political system, moving away from unanimous consent.
  • The European Commission President outlined green tech policies implying non-tariff barriers, "made in Europe" public tenders (14% of GDP), capital controls for FDI screening, and tariffs/subsidies for key sectors.
  • Threats to use the "anti-coercion instrument" against China and potential overhaul of financial market regulation to a more centralized EU level.
• Trump's Asia Tour: Trump secured trade, FDI, and defense deals in Asia, focusing on rare earths and gathering allies like Japan and South Korea for shipbuilding support.
• Trump-Xi Meeting: The meeting resulted in a "ceasefire to rearm" rather than a long-term peace deal. Every anticipates a "2G world" with US-centric and China-centric blocs, with a potential year-long interregnum for rearmament.

Every argues that this is not an aberration but a fundamental shift driven by power dynamics, especially as the global hegemon (US) wobbles. He believes this process will be slow-burning and will play out for the rest of our lives, impacting all geographies, assets, and disciplines.

The US-China Rivalry and the Emerging "2G World"

The core of the discussion revolves around the intensifying US-China rivalry and its implications for the global economic and political order. Every posits that the world is moving towards a "2G world," characterized by two distinct, largely self-sufficient blocs: one centered around the US and the other around China.

Key Arguments and Perspectives:

• Power Dynamics: Every asserts that "everything is always about power at the end of the day." The current global instability is a consequence of the US, as the hegemon, beginning to "wobble," leading other nations to position themselves for the emergence of a new leader.
• Slow-Burning Process: This shift is not expected to be rapid but a "very very slow burning process" as neither China nor the US is disappearing. Both possess significant leverage and strategic options.
• Bifurcation of Strategic Sectors: While non-strategic goods might continue to be traded freely, "all the big strategic sectors which have direct national security, key industrial, energy, telecoms or or military implications" are already experiencing a bifurcation in technology sets and supply chains.
• US Vulnerabilities and China's Leverage: The US has historically outsourced significant productive capacity to China, leading to sole-source dependencies in areas like medications and rare earths. China leverages this by controlling access to these critical resources.
• China's Economic Weaknesses: Despite its manufacturing prowess, China faces challenges with weak domestic demand, over-investment, and significant private sector debt. This makes it reliant on exports, providing the US with leverage.
• US Strengths: The US retains control over the financial economy, high-end software, top-tier chips, and aircraft manufacturing. It also has the ability to influence global commodity flows through its alliances.
• The "Mexican Standoff": The current situation is described as a "Mexican standoff" where both sides brandish different types of weapons. China has rare earths and physical products, while the US has financial control and advanced technology.
• US Strategy of Disruption: The US is employing economic statecraft to disrupt China's access to resources and markets. This includes actions like regime change discussions in Venezuela and dollarization of other economies, which could impact China's trade partners.
• Military Statecraft: While direct military conflict between the US and China is considered unlikely, the US may increasingly use military statecraft to block China's resource imports.
• China-Russia Alliance: The potential for a closer China-Russia alliance is acknowledged, with Russia possessing natural resources and advanced weaponry. However, Every notes that China is "completely untested" militarily, and Russia has struggled against Ukraine, suggesting their combined military might might be overhyped in certain dimensions.
• US Response: Building a Block: The US response involves building a strong bloc of allies (Europe, UK, Australia, Canada, Mexico, Japan, South Korea, etc.) to counter China. This is framed as "America first doesn't have to be America alone."

Market Implications and Opportunities

The discussion shifts to the practical implications for markets and investors, with a focus on emerging trends and potential opportunities.

Key Market Trends and Predictions:

• Increased Statecraft in Markets: Market forces will play a diminishing role as governments increasingly intervene through tariffs, subsidies, and price controls.
• Capital Controls: The US is likely to implement capital controls, restricting where money can and cannot go, both inbound and outbound. This is seen as a logical extension of the US's efforts to re-industrialize and secure supply chains.
• Federal Reserve's Role: The Federal Reserve will become more involved in playing a "very, very different game" with significant market implications, especially with new management.
• Dollar Stablecoins: The legislative framework for dollar stablecoins is in place, and their widespread adoption could reshape the geopolitical and geoeconomic architecture, potentially reinvigorating dollar hegemony.
• Secular Inflation: Eric Townsend believes the market is in the early stages of a secular inflation, which is initially beneficial for stocks before feedback loops kick in.
• AI Surge and Inflationary/Deflationary Forces: The AI surge is seen as inflationary due to increased power and resource demand. However, AI's potential to replace human labor could also be deflationary, leading to massive corporate profits with fewer workers.
• Supply Chain Bifurcation: Expect a bifurcation in commodity prices, with separate benchmarks for Western and Eastern blocs, similar to what is already seen in rare earths.
• "Safari Park" vs. "Jungle" Markets: Markets are transitioning from a "jungle" where investors could roam freely to a "safari park" with defined areas of operation, implying more controlled investment environments.
• Trade of the Week: Fading the South Korean Tech Rally: Patrick Srezna proposes a pairs trade: long US tech (QQQ) and short South Korea (EWY ETF). His reasoning is that the South Korean market's rally is narrow, heavily reliant on memory semiconductors, and exposed to geopolitical risks. The NASDAQ 100, while concentrated in MAG 7, is more diversified.
• Opportunities in AI: AI is identified as a clear area of opportunity, with companies like Nvidia and Microsoft experiencing significant market capitalization growth.
• Uranium Market: The bull case for uranium remains strong, supported by government initiatives for nuclear power plants. However, a reversal of the AI trade sentiment could pose a risk.
• Gold and Silver: Both are viewed as structurally bullish, with current pullbacks seen as buying opportunities for a continuation pattern into a new bull move.
• Crude Oil: Seasonality suggests bearishness until February, with potential for further downside before a significant upside move.
• US Treasuries: The market is expected to trade in a range until more clarity emerges, with the December FOMC meeting being a key event.

Stablecoins and the Future of Dollar Hegemony

Brent Johnson's previous comments on dollar stablecoins are revisited, with Michael Every emphasizing their geopolitical significance.

• Geopolitical Tool: Dollar stablecoins are not just new assets but tools for creating a new financial architecture that will enable the US to re-industrialize and regain control over its financial destiny.
• Reinvigorating Dollar Hegemony: They have the potential to "reinvigorate the dollar's hegemony" by allowing the US to "wag the tail" of the global fiat dollar system, which has grown enormous.
• Shifting the Balance of Power: This new architecture aims to prevent the offshore fiat euro-dollar from dictating terms to the US, thereby reasserting US control over its currency and global financial influence.

Conclusion and Takeaways

The overarching theme is a fundamental shift in the global order, driven by geopolitical rivalry and the strategic use of economic tools. The world is moving towards a bifurcated system, with increased government intervention in markets, capital controls, and a redefinition of global supply chains. Investors need to adapt to this new paradigm, focusing on areas of strategic importance and understanding the interplay of political, economic, and military statecraft. The rise of AI and the potential impact of dollar stablecoins are key developments to watch. While challenges and disruptions are inevitable, opportunities exist for those who can navigate this evolving landscape.