FX Markets after Globalization

June 23, 2021 | 09:30 CET | Online Zoom Event

GUEST: The guest for our second show was Michael O’Sullivan, former CIO of Credit Suisse and author of “The Levelling, What’s Next After Globalization”. Michael is a world-renowned speaker and commentator on geopolitics.


TOPIC: We discussed what happens to FX markets if globalization is in retreat, trade flows, whether the supremacy of the US Dollar might be at risk, the rise of cryptocurrencies and more…


You can watch the video here.


[00:03:33] The balkanization of FX markets
[00:17:05] The future of the US Dollar as the World’s reserve currency
[00:20:36] The rise of cryptocurrencies and their impact on FX markets
[00:23:33] The feasibility of Central Bank Digital Currencies


Barry: [00:00:17] Hi, everybody. Welcome to our second ever episode of Talking Hedge. I’m your host Barry McCarthy. This morning, I’m honored to introduce our guest today: Michael O’Sullivan. Mike is a former Princeton professor and CIO of Credit Suisse. He’s the author of a fantastic book called The Leveling: What’s Next After Globalization, and other books. If you haven’t read it, it’s a brilliant analysis of the transition in world economics, finance and power as the era of globalization ends and gives way to new power centers and institutions.


Mike, welcome. Maybe we’ll start off by, for those that don’t know you, just to give a little bit about your background and what brought you to where you are with this book, The Leveling.


Mike: [00:01:04] Thanks, Barry. I suppose, given you’re an Irish company, I’ll start with Ireland. Ireland is interesting because it never, until the 1990s, had much of an economic history. It was a history of underperformance. Then in the ‘90s, something changed and you began to get big multinationals setting up in Ireland. Interest rates fell, the economy took off, and very soon people started talking about the word ‘globalization’ – which effectively means a world where everything is interdependent and interconnected. Ireland was the poster child of that, and governments in China and places send people to study the Irish miracle, which we know soon collapsed.


Around the time I was fascinated by this. I wrote a book on Ireland and globalization, soon after wrote another book called What Did We Do Right, which was trying to pull out the good things of the Irish miracle. I’ve kept an interest in globalization since then. The recent book then is really about globalization on a much bigger stage, and the fact that it’s coming to an end. Many of the forces that have driven economics, trade, migration in particular, trust and collaboration between nations, are beginning to come to an end. I had this view before COVID. COVID I think has dealt a fatal blow to globalization as we know it.


The book is trying to think about some of the options as to where we go on. In history, we’ve had globalization once before in the late 19th century, that ended very badly, of course in the wave of economic crisis, protectionism, WW1. I’d probably sell more books if that was my view and I was more alarmist. I don’t think that’s what’s ahead of us. What I think is ahead, is a world where instead of having one system, one dominant currency, you get three or four big regions. It’s the multipolar world. Europe will be one of those, China will be another, the States, and then maybe the region of India to Dubai could be another one.


The balkanization of FX markets


Barry: [00:03:24] When we talk about globalization, just to keep it simple for our listeners, what do we mean by globalization?


Mike: [00:03:33] Globalization, if you picture a globe and all the flows: the flow of trade, the flow of finance, banks in the UK lending to people in China, the flow of people, migration, and the flow of ideas; in the last 30 years there was lots of flow and lots of interconnectedness. In Ireland, England, people’s diets changed, ideas were exchanged, we got new technologies, and all those flows. You can measure, most of them are now slowing down.


I’ll give you a couple of examples. For me, globalization began with the fall of communism and the rise of democracy in Eastern Europe. The other bookend to that now is the end of democracy in Hong Kong. Hong Kong, if people know what it is, it is an exciting thriving dynamic city but its democracy and its unique way of life is being snuffed out. You can see there’s a curtailing of financial flows. There’s certainly curtailing of migration, and the curtailing of ideas.


I’ll give you one more example, which is probably clearer if you take the internet. In the middle 2000, Google had about 30% market share of the Chinese internet space. Now it’s got zero. The internet has gone from being a global public good to being one that’s looked at very differently in the big regions of the world. In the States, you’ve got these huge, big dominant internet, social media companies. Microsoft, Facebook, Apple, they’re together 25% of the stock market. It’s a huge chunk of the market and economic sphere.


In Europe, we don’t have those. But in Europe, the attitude is that you have to protect consumers from the forces in the internet. Europe focuses on regulation. China is very different. China you have a massive e-commerce sector, but also China is totally in control of its internet. It’s walled off its internet. You can’t use your Gmail if you go to China, and there’s massive social control through social media in China.


Barry: [00:05:57] What’s your opinion on the benefits versus negative outcomes of globalization? Do you think globalization is a good thing or a bad thing on balance? I know it’s not an easy question to answer. I’m just looking for your personal opinion.


Mike: [00:06:11] I think in terms of how globalization has affected many people’s lives, they will recognize the effects. But when they think about globalization, it’s a very lofty, philosophical concept. I think part of the problem is that there’s no office or ministry for globalization. It’s just out there in the ether, and there’s no one in a way to blame.


I think globalization has been a huge positive. In saying that, I remind people that we often in Europe or the States or wherever else, we forget about the rest of the world. Globalization has been the force that’s lifted emerging markets, and it brought an end effectively to poverty in many emerging markets. It’s seen the emergence of a huge wealthy middle-class in China, it’s brought infrastructure technology to the emerging world. That’s been a huge force for positive.


It’s also, from an economics point of view, compressed transaction costs. It’s made business much more effective. We have all these new kinds of organization of business structures now. On balance it’s been a great positive. It’s associated, I think, with things like the rise of democracy – which is now slowing down; generally, the spread of progressive values and the spread of openness – again, that’s been curtailed in some countries.


The problem for globalization is that it’s a gift. The amplitude of the gift depends on how countries use it. Ireland is a good example. Ireland has used globalization to great effect. We have created lots of employment, lots of innovation. There is a wave of Irish companies, yours in one, Stripe is a great example, of people who’ve harnessed tech and know-how. The Irish tax system as well, corporate taxes are very low, but the Irish personal tax system is quite redistributive.


What’s interesting is that the countries who are the most globalized in the world, Sweden, Switzerland, the Netherlands, Ireland, they all have average or low levels of inequality. Inequality is something people talk a lot about today. For me, they prove the fact that globalization doesn’t have to be associated with inequality.


Barry: [00:08:45] On that point, I want to differentiate between correlation and causation. You made a statement there, you’re linking lower levels of inequality to higher levels of globalization. Is that correct?


Mike: [00:09:02] No. What I’m doing, I’m saying that small advanced economies, again, Belgium, Netherlands, Sweden, Ireland, they have open economies. They’re harnessed, they’re hitched to globalization. They have the choice and the problem as to how do you take globalization and digest it, and spread its benefits to many people? Most of them have done a good job because they have tax systems that redistribute a lot of the benefits of it.


What I’m saying is that globalization is there, and that there’s a whole bunch of countries who have recognized that they’re small countries so they have to think strategically about what’s happening in the world and deal with the side effects. There are other bigger countries, the UK and the US is a much greater example, who are part of the globalization story. The US is the engine of globalization, the UK was in the 19th century. They haven’t done a good job of spreading the benefits. That’s one of the reasons why you’ve had all this political volatility in the States and also in the UK.


I’ve gone back in time and looked at periods in history when you’ve had extreme inequality. Wealth inequality today in the States, even the difference between the pay of a top CEO in the States to his entry-level worker, that’s more extended than the relative differential between I think the Roman Senator and a Centurion or a servant or something like that. It’s on a scale we haven’t seen in ages.


Maybe just to add in one thing, why globalization is coming to an end is that it is beginning to produce lots of side effects that we haven’t been very good at dealing with. If you were to draw a big chart going back a thousand years of economic history, you look at debt to GDP in the world, it’s pushing on to levels now we haven’t seen since the Napoleonic wars. If you looked at the average temperature of the world today compared to its long-term average, that’s also at an extreme. Wealth inequality in the States is at an extreme.


There’s a sense that things are bubbling very hard, and globalization has created forces that humanity hasn’t been very good at curbing, and the reckoning of these will be somewhere down the line.


Barry: [00:11:39] That’s very interesting. Your book was written in 2019, which was before recent pandemic related events. We’ve all seen a huge structural shift in the way we do meetings, the way we do business. There’s been the rise of the digital economy. All sorts of businesses now have been created in the digital economy. They’re not thinking about national borders, they’re thinking globally. Would you change anything in the book if you wrote it today, from when you published it in the light of what’s happened with the acceleration of the digital economy and the way we use technology as an enabler of globalization?


Mike: [00:12:28] On that question, there’s nothing I would change. I think that companies today, first of all, more of them are thinking about some of these long-term issues. The way companies are reacting to climate change and the ESG debate, they’re certainly more reactive to it. I think that companies are becoming more susceptible to geopolitics and this cleavage in the world of the US and China and then maybe Europe.


I’ll give you two examples. One is HSBC, which in terms of its top management structure has always been a British company, almost with a colonial foreign office type feel to it, even though 80% of the business is in China, Hong Kong. They’ve recently made the decision to take, I provocatively say, the side of China. They’re moving their headquarters to Hong Kong, they have very publicly refused to criticize any of the recent developments in Hong Kong, which recognizes that the future of that business is in China, not the UK.


I think lots of other businesses are making investment decisions around Brexit and the future of the UK. Also, I think in Europe more and more European companies are now I think beginning to look very urgently at the fact that Europe doesn’t have good banks effectively. It doesn’t have big strong banks compared to the States. You see more consolidation in Europe. I think there’ll be moves afoot to create more national champion type companies in Europe.


I think that companies are beginning to react to this. I think China in particular is going to be a very sensitive topic for lots of American companies, and they will have to change how they do business there, the same with Japanese companies. Also Chinese companies now I think are being confronted by the fact that they can no longer, or they will face greater constraints in raising capital in the States.


Barry: [00:14:37] Moving on from this point, if your theory is correct, what does that mean for the US dollar supremacy and all the other major currencies? Where would you be positioning yourself? This is a show about hedging after all, I want the listeners to get the benefit of all your years of experience in this, and have some key takeaways on the US dollar, the Euro, and some other major currencies.


Mike: [00:15:10] The back the backdrop I’m beginning to paint is one where there’s unfortunately in a world of less collaboration, more rivalry, more strategic rivalry, and currencies are going to be part of that. There’s all this talk about US and China confronting each other in the South China sea and the power of their militaries. The fact is that the area where the US is most powerful is in its currency. It is totally dominant. I think 60% of all transactions worldwide are in the dollar, 3% are in the renminbi. I think that at the margins that will shift, but will shift slightly. It will be marked by efforts by both of these countries to try and get the emerging world to adopt their currency. The emerging markets world is already effectively dollarized across the board and in different ways.


What I’m seeing, talking to business people in Africa in particular, is that in projects and transactions where they have the Chinese as a counterpart, there’s a greater push now by the Chinese to get them to transact in the renminbi. That will continue. The Chinese, for me, are being really sensible on how they’re managing their economy, compared to the West where countries are running up huge deficits, where central bank balance sheets are ballooning. The Chinese are being very sensible. They’re trying at the margin to limit speculation, to limit cryptocurrencies. They are trying to cool areas where there’s a lot of debt and allow private investors to go bust. It’s almost like a textbook capitalist policy menu from the 1990s.


The future of the US Dollar as the World’s reserve currency


Barry: [00:17:05] What’s the takeaway on the US dollar? Where do you generally see that going relative to other currencies?


Mike: [00:17:10] I think from where we are today, the dollar will remain stable to slightly lower. The lower, in the long-term, the size of the US economy in the global economy and its power. When empires begin to shrink, their currency always shrinks. From here, I see the dollar’s place in the world economy shrinking slightly. At the margin, I think the Chinese currency will pick up in value. The biggest thing that can help that would be a deepening of financial markets in China. Chinese financial markets relative to the States are not deep yet, in terms of people using the Chinese government bond market as a safe haven.


If they can achieve that, and I think this will come after the next Chinese recession, then that’s where the scope is in China, to really build out the scope of the renminbi.

We shouldn’t forget about Europe. I think the big issue in Europe again, is that the single currency is now there to stay. I dismiss anyone who thinks the Euro is going to fall apart. But there is now a choice to build out a banking system and a proper capital markets union that can generate a bigger portion of the Euro in terms of the global system. That obviously means that some currencies will lose out. I’m long-term very positive on the Swiss Franc as a small quality currency. I think some of the scandies may suffer at the same time.


I think the role of the pound will come into question again with Britain’s place in the world. To me, there’s no clear plan for Global Britain. I don’t see a massive rebound on the UK economy. I think that the pound will be one of the major currencies to suffer.


Then there’s other companies who are stuck in between these big regions. Russia is an example. Russia is I think slowly disengaging itself from at least the Western system, if not the global system. I think currencies like that will begin to suffer.


Barry: [00:19:41] What about emerging market currencies? What would your thoughts be there in the next five years?


Mike: [00:19:49] I think what’s going to happen, some of the bigger emerging market currencies, the Won, the Rand, will continue to be liquid and viable. The really big wild card for me is what happens to currencies in places like Bangladesh, Africa, and whether there’s any move to peg currencies either to local currency benchmarks (renminbi example), or an Africa to the dollar, or you see some digital currency across Africa. I think that’s going to be one of the big battle zones.


The rise of cryptocurrencies and their impact on FX markets


Barry: [00:20:36] This is really fascinating, Mike. I just wish we had more time. We’re pretty much out of time in the next few minutes. One of other things we wanted to bring up, and you alluded to it a few minutes ago, the whole rise of crypto. It’s something that I’ve been following as a trader for years.


I have the unfortunate quote in an Irish newspaper going back to 2015, that this Bitcoin bubble is just about to crash. I can’t get it off Google. I’m not the best guy on the whole crypto thing, but I’ve been proven wrong. Bitcoin rallied up as high as $60,000 in April. It’s come off a lot, it’s $33,000 at the moment, which for a string of cold is quite a lot. I’m curious to get your thoughts on this. I personally see a lot of value in crypto, but I don’t see the valuation in crypto. That’s my position. I’d be very keen to understand where your head is at on the whole crypto.


Mike: [00:21:48] I think finance is very interesting because you have all these new ecosystems. You have the retail trading ecosystem, the crypto ecosystem, et cetera. I’m very skeptical on Bitcoin as a money, as a currency. It’s just not viable, it’s not working, et cetera. For me, it’s a high risk asset. It has a highly debatable value. But people who trade it don’t push back on that, they’re happy to trade it as a risk asset.


I think there are parts of this whole field that are going to be very interesting. Digital asset management has a huge future, I think a big development. The really big picture issue is the clash of decentralized finance (which is the world of tokens, digital asset management, blockchain, et cetera) with the centralized financial system, which is effectively run by central banks (it’s money, as we know it, it’s the old banking system). Some companies are already on the meeting point of that.


What we’re seeing, particularly in China, are efforts by different kinds of regulators to curb Bitcoin and crypto activity. They’re doing so by trying to limit the actual infrastructure, be it mining farms or crypto brokers, et cetera. If you go back in history, look at any innovation and finance, the first couple of years are a bit lurid. They’re exciting, they’re ugly. People make money and lose lots of money. I’m not too focused or too carried away on Bitcoin.


The feasibility of Central Bank Digital Currencies


Barry: [00:23:33] Would you see a digital crypto US dollar in the next five years? Would that be something that you see as plausible?


Mike: [00:23:37] Yes. It wouldn’t be called a crypto dollar, it’ll to be called a digital dollar. It’ll be exactly the same as the dollar. Then you have these other things called stable coins. A stable coin is effectively a digital wrapper construct on a bunch of real world assets that are just away and stored away to give actual financial backing to this digital asset.


Barry: [00:24:03] It’s tied to the US dollar.


Mike: [00:24:06] Exactly. There is actually a bunch of gold bars in the vault in Switzerland, similar to the value of that stable coin.


Barry: [00:24:15] Like an ETF then, is it like an exchange traded form?


Mike: [00:24:19] Yeah, like a sensible EFT. It doesn’t have too much leverage or financial engineering. The value of all these things lies in a number of things. It lies in greater efficiency of trading, it lies in being able to set up these trustworthy contracts between parties to have certain networks where only certain people are allowed to trade.


The digital dollar, if and when it’s launched by the fed, it will give huge power to the federal reserve. How it would work is that each of us will have an account. Well, in our case with the European Central Bank or the Swiss National Bank, and if they want to do QE they may decide that all families with two kids would get a thousand Swiss Francs and they just plop the money into your account. We will be more connected than ever before to the system, which is the opposite of what the people who set Bitcoin up wanted to happen.


Barry: [00:25:19] Yeah, it would be very beneficial to the government. It would make crime very tough if they remove the paper, it would make tax evasion impossible. There are so many benefits.


If there was a digital dollar launched in the next couple of years, what do you think that would do the price of the other cryptocurrencies, like Bitcoin, etc.?


Mike: [00:25:40] You’re already beginning to see this, because in order for the digital dollar (in Europe, it’ll probably be the digital pound, the first one of the major currencies), what you’re seeing is that the authorities are trying to crash the crypto world in order to lay the ground for proper digital currencies. It will be a mixture of Y2K introduction of the Euro. Most people will be completely confused by it, because there’s a lot of tech involved and explaining it to people would be difficult. It will be a big communication job.


One area that makes me very uncomfortable, is it gives central banks an enormous amount of power over people. They can see right into your finances, there’s a risk that governments can come to mine this knowledge as well and have greater control. That’s one of the big worries that I have.


Barry: [00:26:41] Let me see, we’re running out of time now. We only have a couple of minutes left, if you can stay on for a few more minutes.


Mike: [00:26:51] Yeah, sure.


Barry: [00:26:52] Do you own crypto? Just to finish on this topic, I’m curious; or have you ever bought or would you ever buy it?


Mike: [00:26:56] I don’t own crypto now, no. One of the things I’m quick to launch is a FinTech portfolio. There will be companies in that which will have crypto exposure. What I’m trying to do is get a purchase on the companies who are – the old phrase is – the picks and shovels who are building the infrastructure.


Barry: [00:27:18] Understood. Okay, maybe we’ll finish up at this point, it’s just coming up to the hour. Thank you very much. I wish we had a lot more time to get stuck in. Maybe at some point in the future you’ll come back on again. Thanks again, Michael Sullivan. Much appreciated. All the best.


Mike: [00:27:43] Okay. Thanks, Barry.

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