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Fed’s ‘Ghost Of 1994’ Is Haunting Asian Markets

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Asia will always have complicated feelings about Alan Greenspan.

In the mid-to-late 1990s, the then-Federal Reserve chairman was a bona fide celebrity. His photo was showing up in People magazine, Entertainment Tonight and the style pages of national newspapers. Greenspan’s command of the globe’s biggest economy earned him a glowing Bob Woodward biography titled Maestro.

Yet Asia mostly remembers the Greenspan era for precipitating the 1997-1998 Asian financial crisis. It was the Fed’s 1994-1995 tightening cycle—doubling short-term interest rates in just 12 months—that set the stage for Asia’s reckoning.

As the dollar surged and capital raced toward the West, officials in Bangkok, Jakarta and Seoul could not maintain currency pegs to the greenback. The resulting waves of currency devaluations also pushed Malaysia toward the brink and nearly dragged Japan into the mix.

In late 1997, extreme market turmoil claimed a major prize: the then-100-year-old Yamaichi Securities, one of Japan’s fabled big-four brokerages. Its collapse panicked officials in Washington. Both the U.S. Treasury Department and the International Monetary Fund worried not that Japan was too big to fail. They thought Japan’s economy might be too big to save.

All this explains why Jerome Powell’s comments on Aug. 26 spooked Asia so viscerally. Suddenly, the region is fearing what former Bank of Korea Governor Kim Choong Soo calls the “ghost of 1994.”

Over the last decade this fear sprung up from time to time. In 2013, when the Fed “taper tantrum” was stalking bond markets, Bank of America strategist Michael Hartnett warned of a “repeat of the 1994 moment.” Lloyd Blankfein, then the CEO of Goldman Sachs, admitted that “I worry now as I look out of the corner of my eye to the 1994 period.”

Hence the impact of Powell warning about the Fed’s hawkish turn persisting “for some time” and necessitating “some pain” for households and businesses. It comes against the backdrop of the most aggressive Fed tightening moves since the 1990s.

In fact, one even wonders if Powell is pulling his rhetorical punches as inflation increases the most in 40 years.

The yen is already on the verge of 140 to the dollar, a level that New York University economist Nouriel Roubini, “Dr. Doom” himself, warns could force the Bank of Japan to “change policy” in ways that intensify global turmoil.

Over the weekend, Isabel Schnabel, a member of the European Central Bank executive board, spoke for many when she talked of the “great volatility” challenge to come. Already, she said, “the pandemic and the war in Ukraine have led to an unprecedented increase in macroeconomic volatility.”

Now comes the threat of powerful central bank tightening. The burning question, Schnabel said, is “whether these shocks, albeit significant, will ultimately prove temporary, as was the case for the global financial crisis.”

The bottom line, Schnabel warned, is that the “challenges we are facing are likely to bring about larger, more frequent and more persistent shocks in the years ahead.”

Nowhere more so than Asia. The downward pressure on Asian currencies as the dollar rallies like it did back in Greenspan’s day will cause plenty of chaos. Already, markets are buzzing about a “reverse currency war.”

Over the last two decades, governments from Seoul to Singapore preferred weaker exchange rates to boost exports. Now, as Russia’s Ukraine war boosts prices of oil, food and other vital imports, Asia fears importing inflation via low exchange rates.

The capital flight problem is real, too. One of Asia’s big frustrations is it’s in many ways paying the price for Powell’s failures. An early one: bowing to former President Donald Trump’s demands for lower rates in 2019, even though the economy didn’t need support.

In 2021, Powell failed to put any tightening moves on the scoreboard. He bought into the inflation-is-transitory argument a bit too enthusiastically. By the time the Fed began hiking rates in March 2022 it was too late. Now, as the Powell Fed plays catch-up, Asia will be collateral damage.

The Fed swinging from quantitative easing to “quantitative tightening” has Asia directly in harm’s way, says economist Tan Kai Xian at Gavekal Research.

This accelerated austerity, he says, “coming on top of further interest rate increases at a time when the U.S. Treasury has finished reducing its cash balance will amplify the liquidity squeeze already under way. Moreover, U.S. commercial banks are tightening their lending standards, and so are unlikely to offset this liquidity drain. This is likely to weigh on U.S. equity prices, and as real borrowing costs rise and choke off demand, it will increase the probability of a near-term U.S. recession.”

That will boomerang back Asia’s way. Though the region has made progress weaning itself off exports, building more vibrant services sectors, any drop in U.S. demand would hit China and the rest of Asia hard. Scary, indeed.

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Banks Are About To Face The Same Tsunami That Hit Telecom Twenty Years Ago

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I fear global bank regulators are about to make a decision that will unintentionally “obsolete” the banks, by prohibiting a coming tech pivot. Making this mistake would guarantee that the tech industry continues going around the banks, right as internet-native payment technologies are starting to scale.

The telecom sector offers a cautionary tale: When Voice-Over-Internet-Protocol (VOIP) was invented in 1995, most people disparaged it as a technology that couldn’t scale and wasn’t a threat to the telecom giants. Then, circa 2003, the technology to scale VOIP arrived – broadband – and within a flash, most of the telecom industry’s copper-wire networks became obsolete. Useless relics.

Bitcoin is a “Money Over Internet Protocol,” as is Ethereum, potentially. Just as VOIP moves voice data around the internet natively, Bitcoin and Ethereum move value data around the internet natively. Most people disparage Bitcoin, Ethereum, et al. as protocols that can’t scale and can’t possibly threaten the incumbent financial industry, just as they denigrated VOIP. But the scaling technology is now here – it’s called the Lightning Network, which is a Bitcoin layer 2 protocol. Its throughput capacity roughly equals that of Visa, and payments made over Lightning cost virtually zero. There are other scaling technologies, too. If I’m right and scaling technologies for internet-native money protocols have arrived, then many legacy systems operating in the financial system today will be obsolete within a handful of years.

As CEO of a new breed of bank – a dada-bank (“dollar and digital asset bank,” defined as a depository institution authorized to handle both and pronounced like “databank”) – my company lives with the problems inherent in the banking industry’s antiquated legacy systems every day. Culturally, banks have a history of building complex, “walled garden” IT systems. Fintechs sprang up in recent years to provide efficient front-ends that act as “middleware” between antiquated back-end systems and the user experience demanded by customers. Culturally, fintechs build the opposite of banks’ IT systems – fintechs generally build their systems to be as open and “low-walled” as possible to create network effects. Had banks done this, fintechs wouldn’t need to exist! But, until “Money Over Internet Protocols” came along, banks still had a role because fintechs still needed to partner with a legacy bank to settle their customers’ US dollar payments.

“Money Over Internet Protocols” at scale are truly a threat to traditional banking because they enable money to move outside the traditional, antiquated payment rails. To date, the US banking industry has lost roughly $600 billion, or 3% of its deposit base, to the crypto industry – and that happened before the “Money Over Internet Protocols” scaled! Despite all the legal, regulatory, accounting and tax problems faced by their products, and all the criminals and fraudsters running rampant (who should be in jail), the tech industry has proven its ability to go around the banks.

It will take Lightning a few years to lay down that proverbial broadband (scaling) infrastructure before the “Money Over Internet Protocols” hit their tipping point at scale. But make no mistake, it’s happening. The proverbial undersea cables that scaled VOIP are being laid before our very eyes.

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But the “aha!” of these “Money Over Internet Protocols” isn’t cost or scale. There are two “ahas” that matter far more: integration speed/cost and developer communities.

  • Integration speed/cost: Anyone in the world can become members of these emerging payment networks in the span of a few hours, using equipment that costs a few hundred dollars.

Banks’ IT systems will never be able to compete with that.

It’s not even a question whether legacy technology architectures can compete with these emerging protocols, for the simple reason that it’s fast, cheap and easy to join these networks. I recall a recent conversation with a B2B payments company, whose executive was very proud that his team whittled down to only 3 months the time required for its business customers to integrate with its system. In the legacy world, 3 months is impressive. But the paradigm has shifted: payment system integration time is now measured in hours, not in months or years – and in a few hundred dollars, not a few million dollars. It’s obvious which approach will win.

  • Developer communities: Open, permissionless protocols have huge developer communities, which compounds the speed of their ecosystem development and network effects. Network effects are all about compounding. The code libraries and developer tooling available for Bitcoin and Ethereum are critical infrastructure that banks’ proprietary systems cannot replicate. Moreover, these developer communities organically create interoperability. Banks’ “walled garden” systems with closed groups of developers will never be able to keep up with their pace of innovation.

So, what could be the role of banks in the world I’m describing? Answer: banks become software application providers, providing access-controlled applications that run on top of the open, permissionless protocols and to make them accessible even to unsophisticated users, just as the telecom companies do with VOIP. I’ll bet very few of us use the command line interface to make a phone call – even though we could use it if we wanted to, most of us pay to use telecom providers instead because they make the user interface so easy.

That’s what banks will do, too: provide access-controlled applications to ease the use of “Money-Over-Internet-Protocols.” Huge, successful businesses have been built exactly this way – as access-controlled applications running on top of open, permissionless internet protocols. Auto companies are just one of many examples – they’re software companies now, albeit providing software that runs on a different type of hardware.

What about central banks? What would be their role in the world I’m describing? No different. They’ll become providers of a software application for issuing fiat currency that runs on top of open, permissionless protocols, too.

That brings me back to my fear that global bank regulators (specifically, the BIS) are about to make a decision that “obsoletes” the banks. Why? Because the BIS is proposing bank capital treatment that would effectively block banks from interacting with open, permissionless protocols. If they do that, they are guaranteeing that the tech industry will just keep going around the banking sector.

The biggest concern of global bank regulators with banks using open, permissionless protocols, I suspect, is compliance. But banks don’t need compliance to be built into the base layer of their IT systems. Compliance can be built into applications that run above the base layer, and which control access. In fact, that’s what banks are already doing today with TCP/IP. Every bank uses TCP/IP, and yet strictly controls access to their online banking platforms. Criminals and sanctioned countries use TCP/IP today too, but banks have the tools to block them from using banks’ applications. Same thing with Bitcoin and Ethereum – banks have the tools to block illicit finance from using their applications. It’s easier to police illicit activity on open blockchain systems than it is in legacy systems.

At its pivotal juncture telecom was a heavily regulated industry, just like banking is today at its pivotal juncture. How, then, did the telecom companies pivot to become software companies and avoid obsolescence? Answer: regulators enabled them to make that pivot.

That’s what banks will become, too – software companies – but only if bank regulators enable banks to make the same pivot. If they don’t, then it will be obvious, looking back 10 years from now, why the tech industry won.

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Will Putin’s Military Mobilization Mean The End Of His War?

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Could Elvira Nabiullina be the next Russian President?

Last Monday evening I was driving along the contours of Cork harbour, not far from East Cork. The area has many claims to fame – for example, a local (Edward Bransfield) is credited with having discovered Antarctica in 1820. Less triumphantly, some local villages like Whitegate, Aghada and Farsid lost one third of their male populations during the Crimean War.

At the time, a great number of soldiers died from disease and the lack of basic medical procedures – whilst the French and British armies fought side by side against the Russians, casualties were far relatively far higher on the British side because of inferior medical equipment and practice – hence the acclaim with which Florence Nightingale’s techniques were greeted.

I thought of this recently when I read a post on the very different medical kits supplied to Ukrainian and Russian troops, respectively. Setting aside propaganda and donations from the West, the Ukrainian kit looked modern while that of the Russian soldiers could well have come from a museum or horror show. In that respect, the apparent wilting of the Russian army is not surprising.

Filaytev Diaries

More supporting detail on this comes from the 140 page long diaries of Pavel Filyatev, a career paratrooper in the Russian army who, driven to despair by the chaos within his regiment (in Kherson), wrote a long account of his experience in the Russian army. Armies are not pleasant places but his account of the systematic mistreatment of the Russian soldiers, their undernourishment, disorganization in battle and embarrassing under-equipment is telling, not just of the Russian army but of the Russian state. Needless to say, he is now in hiding beyond Russia.

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In that context, the mobilization of largely experienced soldiers to start with, and the co opting of prisoners into the Russian army, opens up many risks – for both Ukraine and Russia. Additionally, the coming referenda on the accession to the Russian Federation of the Luhansk, Donetsk, Zaporizhzhia and Kherson regions is a sneaky, deadly moving of the geopolitical goalposts. Any attempt to liberate these areas of Ukraine would now, in the eyes of the Kremlin, an attack on Russia itself, and it has the right to respond as it sees fit.

From a military point of view, this elevates the risks around Ukraine, and in particular heightens the probability of a strategic mistake or tail event (i.e. such as the destruction of a NATO satellite or an attack on a Baltic state). Putin’s move also increases the risk of socio-political risk within Russia. As I am not a military expert but prefer to write on economic development and the rise and fall of states, I will focus on that.

The Filaytev diaries say much about Russia. It is a country that until recently had poor levels of human development, especially in healthcare and life expectancy (which has been rising from low levels). In this context, Vladimir Putin’s vision of Russia as a superpower is hollow – unless a nation can sustain improving levels of human development (through education, good healthcare, freedom of thought) it will not sustain the core drivers of growth, such as productivity. This a lesson for China, the UK and the US to follow. In China and the UK (productivity is falling) whereas in the USA life expectancy had dropped sharply (below that of China).

Incompetence

In coming years, I am sure many will write about the surprisingly poor quality of the Russian army, and in the context of this note, it is simply another marker for poor quality development. This is perhaps one reason why when emerging market crises strike, they happen slowly, then very quickly. Incompetent institutions, poor rule of law and a prohibition on intelligent policy making can for some time be camouflaged by superficial growth, but all very quickly melt away in moments of stress.

The risk is that other institutions go the same way. As Putin announced the mobilization there were rumours that the highly regarded head of the Russian central bank, Elvira Nabiullina, had resigned (she had apparently tried to do the same in March). This has not been confirmed but raises the question as to the seaworthiness of the full range of Russian institutions in a stormy geopolitical climate. Increasingly, the pressure will be on Russia, and from multiple angles.

As a last word, I want to return to the Crimean War. It is not inconceivable that Corkmen from villages like Whitegate were shelled by Leo Tolstoy, at the time a young artillery officer. Tolstoy’s experience of war affected him greatly. In the context of Putin’s recent mobilization it is worth recalling some advice he gave to a young man ‘all just people must refuse to become soldiers’. Many young Russians are thinking the same today.

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World Will Have Nearly 40% More Millionaires By 2026: Credit Suisse

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The world will have nearly 40% more millionaires in 2026 compared with the end of last year, according to a report by the Credit Suisse Research Institute released on Tuesday.

The five-year outlook “is for wealth to continue growing,” said Nannette Hechler-Fayd’herbe, Chief Investment Officer for the EMEA region and Global Head of Economics & Research at Credit Suisse.

Higher inflation “yields higher forecast values for global wealth when expressed in current U.S. dollars rather than real U.S. dollars. Our forecast is that, by 2024, global wealth per adult should pass the $100,000 threshold and that the number of millionaires will exceed 87 million individuals over the next five years,” Hechler-Fayd’herbe said in a statement.

Buoyed by rising stock prices and low interest rates, global wealth increased global wealth last year totaled $463.6 trillion, a gain of 9.8% at prevailing exchange raises, Credit Suisse said in its annual “Global Wealth Report 2022.” Wealth per adult rose 8.4% to $87,489, it said.

All regions contributed to the rise in global wealth, but North America and China dominated, with North America accounting for more than half of the global total and China adding another quarter, the report said. In percentage terms, North America and China recorded the highest growth rates — around 15% each, it said.

The United States continued to rank highest in the number of the world’s richest with more than 140,000 ultra-high-net-worth individuals with wealth above $50 million, followed by China with 32,710 individuals, the report said. Worldwide, Credit Suisse estimates that there were 62.5 million millionaires at the end of 2021, 5.2 million more than the year before.

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By contrast, this year looks tough. “Some reversal of the exceptional wealth gains of 2021 is likely in 2022/2023 as several countries face slower growth or even recession,” the report said.

Rises in interest rates in 2022 have already had an adverse impact on bond and share prices and are also likely to hurt investment in non-financial assets, the Global Wealth Report noted.

Longer term, growth will recover, Credit Suisse predicted. “Global wealth in nominal U.S. dollars is expected to increase by $169 trillion by 2026, a rise of 36%,” from last year, it said.

The beneficiaries will be more spread out globally, the report predicted. “Low and middle-income countries currently account for 24% of wealth, but will be responsible for 42% of wealth growth over the next five years. Middle-income countries will be the primary driver of global trends,” Credit Suisse said.

Click here for the full report.

See related posts:

The 10 Richest Chinese Billionaires

Taxes, Inequality and Unemployment Will Weigh On China After Party Congress

U.S. Business Optimism About China Drops To Record Low

Pandemic’s Impact On China’s Economy Only Short Term, U.S. Ambassador Says

@rflannerychina

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