Markets Sometimes Do The Work That Armies Can’t

#CKStrong

The instant immiseration of a big economy [by sanctions] is unprecedented and will cause alarm around the world, not least in China, which will recalculate the costs of a war over Taiwan. The West’s priority must be to win the economic confrontation with Russia. Then it must create a doctrine to govern these weapons in order to prevent a broader shift towards autarky. – Economist

1997 Asian Financial Crisis Forces Indonesia’s Dictator From Office

During the 1997 Asian Financial Crisis, Indonesia was hit hardest. The economic and political chaos that ensued forced Indonesia’s Suharto government from power in May 1998,  after ruling unopposed for 31 years. Something that domestic political pressure and periodic military unrest could not. 

Suharto consolidated his power in 1967 after the 1965 military coup, which is the basis for the excellent Australian movie,  The Year of Living Dangerously

Massive capital flight from Indonesia coupled with its current account deficit caused the rupiah to lose 80 percent of its value against the dollar from August 1997 to January 1998.   

By 1998, Suharto became increasingly seen as the source of the country’s mounting economic and political crises, and prominent political figures began speaking out against his presidency…Rioting and looting across Jakarta and other cities began over the following days…On 20 May, there was a “massive show of force” from the military, with soldiers and armored vehicles on the streets of Jakarta. Facing a threat of impeachment from Harmoko, and having received a letter from 14 cabinet members rejecting the formation of a new cabinet, Suharto decided to resign. — Wikidpedia

Unlike Putin, Suharto didn’t have a real external enemy to deflect blame for the country’s economic woes, though the Malaysian Prime Minister Mahathir Mohamad did single out Geroge Soros.  Sound familiar? 

The hard-right scapegoating of George Soros for all the world’s ills is now commonplace, but Mahathir did it a decade before Sean Hannity and two decades before Laura Ingram hit the airwaves at Fox News. 

However, not himself personally, Soros’ firm did go after the vulnerable Asian currencies, as did Morgan Stanley and almost all the big Wall Street firms and hedge funds. But that is what they do.  As one trader told me during the period, “these economies are so out of balance, it was like shooting fish in a barrel.”

Moreover,  Indonesia was in a current account deficit and highly dependent on foreign capital. Russia, by comparison,  runs a large current account surplus and is hardly dependent on the “hot money” foreign capital as they were, which led to their infamous 1998 default.

The head of Russia’s central bank, Elvira Nabiullina, is one of the world’s best, so we doubt the ruble is heading the way of the rupiah during the 1997 crisis though it’s too early to be sure. 

Will Putin Go The Way Of Suharto

It’s too early to speculate, and the two countries couldn’t be more different. 

Russia and Indonesia during 1997 are two very different situations.  Indonesia collapsed due to market forces exploiting the country’s economic vulnerabilities.  Russia’s case, however, is similar to what happened during the first few quarters of the pandemic when the world’s policymakers flipped the global economy’s lights off.  Similarly, Western government sanctions are flipping off Russia’s outside lights, and the darkness is rapidly spreading to the domestic economy.  

Short-term Putin’s fate most likely depends on the support of his inner circle, the heads of the intelligence agencies, for example, which will be dependent on how the war unfolds.  

How will Russia’s population react to being cut off from the West, such as  Apple’s announcement they will stop selling products to Russia?   

Who knows, it’s way too early but we are highly doubtful the younger population will have much patience as they watch their country morph into another North Korea.  Time will only tell. 

One Last Thing – China 

The Economist also writes, 

Autocracies will be most nervous: they own half of the world’s $20trn pile of reserves and sovereign wealth assets. While China can inflict huge economic costs on the West by blocking supply chains, it is now clear that in the event of a war over Taiwan, the West could freeze China’s $3.3trn reserve pile…Over the next decade technological changes could create new payments networks that bypass the Western banking system.u

…Some of this fragmentation has become inevitable. But by applying sanctions to ever more countries over the past two decades, and now also raising their potential severity, the West risks pushing more countries to delink from the Western-led financial system than is desirable. — Economist

Will China Dump Its Treasury Securites?

The primary reason why nominal interest rates, and real rates, for that matter, are so low in the United States is that central banks, who are price insensitive, own 53.2 percent of all outstanding coupon Treasury securities as of the end of last year.  The Fed held $4.9 trillion (29.4 percent) and foreign central banks $3.9 trillion (23.8 percent).  In other words, similar to housing, there is an engineered shortage of coupon Treasuries relative to the amount of money in the global financial system, distorting interest rates. 

Of the total foreign holdings of Treasuries, China is the second-largest, just behind Japan, owning over 27 percent of the foreign-held.  The data are illustrated in the chart below.

The latter three, UK, Ireland, and Luxemboug, most likely reflect the individual county’s status as a  financial center or tax haven.  For example, we speculate close to half of Ireland’s holdings reflect Apple and Microsoft’s corporate portfolio.  We could be wrong, and if you have better information, please email us or comment at the bottom of the post. 

We also suspect leaders in China are getting very nervous after seeing the West’s harsh sanctions on Russia, including the freezing of its central bank assets

Is China Still Comfortable Holding Treasuries? 

Seriously, folks,  do you think the regime in China is as comfortable as it was at the beginning of the year, holding almost one-third of their foreign reserves in U.S. Treasuries after the events of the past ten days?  We doubt it. 

Watch This Signal

I began my professional career in the private sector, negotiating the sizeable commercial bank sovereign debt restructurings.  If negotiations hit a snag, as they often did, we would watch the government’s action regarding their foreign reserves held in custody in the United States.  If they began to move them out of the country, it was a signal they may be preparing to declare a debt payment moratorium and suspend payments to gain leverage in the negotiations — the nuclear option. 

If, say, China begins to dump their Treasury holdings rapidly, it could very well signal they are preparing to take Taiwan.  Just a theory and a hypothetical, or it could be they are becoming more politically risk-averse and hedging after observing what happened to Russia’s central bank.     

If our speculation is correct, U.S. interest rates will be moving closer to a market-driven price. That is,  much higher or forcing the Fed to step in to keep a lid on interest rates, which cause inflation to move higher.  

The more they [sanctions] are used, the more countries will seek to avoid relying on Western finance..It would also lead to a dangerous fragmentation of the world economy. 

…Today it is hard to park trillions of dollars outside Western markets, but in time more countries may seek to diversify their reserves by investing more elsewhere. – Economist

Dayam, the current world situation is starting to read like a Tom Clancy novel. 

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…the second phase of the Japanese offensive: an economic attack, where Japan engineers the collapse of the U.S. stock market by hiring a programmer who is a consultant for an exchange firm to insert a logic bomb into the system, which when triggered blocks the storage of all trade records made after noon on Friday. They also assassinate the President of the Federal Reserve Bank. – Wikipedia

The Times They Are a-Changin’.   

Here’s to hoping the policymakers have thought this through and have a contingency plan.

Only sweat the things you can control.

Stay frosty, folks. 

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23 Responses to Markets Sometimes Do The Work That Armies Can’t

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  22. Carlos says:

    What does Dayam mean?

    Good article.

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