I was winding down a cliffside road in Cape Town with my wife in an Uber, shooting the shit with the driver.
"Canadian and Russian! Wow! That's quite the difference! And how do you guys make that work?"
"We're forging international relations!"
Then he had to start asking about who's winning the war. I just told him no one can really tell because it’s impossible to see through the fog of propaganda these days.
"Well I don't care man, I support anyone that opposes the West!"
I’ll admit that I was at least a bit surprised to hear someone say that so blatantly, even though I’ve been watching the changing tide of sentiment in global foreign policy for months now.
But this isn’t the first time I've heard this opinion. I was chatting with a guy from Ghana in the airport a few weeks back who was telling me how most Africans are much happier doing business with the Russians and the Chinese now because they are fed up with the value extractive Anglo-Saxons and Europeans meddling in their economies. For far too long have we come and taken their resources and given them little in return.
I got to thinking about this change in sentiment, and it brought to mind a particular S-curve diagram about disruptive tech. As a platform grows over time, its relationship with 3rd parties slowly moves from cooperative to competitive. Once passing a certain threshold of adoption, a platform needs to extract value from its users to maintain dominance.
"When they hit the top of the S-curve, their relationships with network participants change from positive-sum to zero-sum. To continue growing requires extracting data from users and competing with (former) partners." — Chris Dixon
Now let's take this model and extrapolate it a bit:
Rome: Forged alliances with neighboring cities and nations such as the Latin League, Carthage and Egypt in their early days to protect their interests, trade and share culture. As they grew in size, they fought wars with neighbors to expand territory and control trade routes, imposing their language and culture.
Ottoman Empire: Expanded through a policy of cooperation and tolerance towards other cultures and nations, allowing non-Muslims self-governance and religious freedom. Once their influence grew, they became engaged in more conflicts across the Balkans and Eastern Europe to protect their territory, such as the wars with the Habsburg monarchy.
British Empire: Benevolently fostered trade relations across the globe through entities such as the British East India Company until... well you get the point.
If there's one thing I know for sure after years of being whipped around in the markets, it's that sentiment rules all. If sentiment is starting to shift, you do not want to be on the wrong side of that tidal wave.
What we are witnessing now is the slow and steady buildup of sea change, not just on the macro level but the geopolitical level as well.
And the main subject of that change is dedollarization. However, it's not so easy to dethrone a currency that the majority of global trade and debt is denominated in. People have been calling for the end of the USD for quite some time now, but there has been no viable alternative. Nothing... disruptive enough.
Now a lot of the dedollarization rhetoric is very polarizing, like the one about the USD's collapse in 90 days, Bitcoin will go to a milly, we'll all be using Yuan, etc.
(to be fair duration is the hardest bet—just look at Michael Burry's track record)
But behind all the smoke and mirrors I see a lot of hubris. A lot of "this could never happen to us" rhetoric which pretty much sounds like "we're culturally and economically superior so nations around the world will forever be groveling at our table for Lincoln scraps."
"But they are so afraid of each other, these other nations! They would never form an alliance against us"
Remember, these emerging powers are still scrambling their way up the S-curve. Adversity is still a recent memory. Russians remember the early 90s when they were lining up for 2 hours or more to get staples as inflation peaked at nearly 2500%. Chinese people remember the same era when over half the nation was living below the poverty line.
I’m sure many of these nations are ok with setting aside their differences for the time being to get a bit of a foothold on the world stage: China “opening a new chapter for China-Russia relations”; the Middle East looking to create “the next global renaissance”; China calling for “a new paradigm of all-dimensional energy cooperation” with the Gulf Cooperation Council; China brokering peace between Iran and Saudi Arabia… who knows, they might even step in between Russia and Ukraine as well.
And at this point it's a pretty classic enemy of my enemy type scenario. They’re incentivized to cooperate and lots of other nations want in as well.
But in the meantime, many fintwit pundits are busy convincing themselves that this isn't a threat because most international debt is dollar denominated, no one will want to use the Yuan as reserve currency because China has economic problems of its own (they’ve been recalling loans and rolling back growth targets), China's been doing trade in local currency for years so this is no different...
These are all valid points but it is missing the forest for the trees. Certainly there is no compelling single alternative to the USD—trade in local currencies is not so much fun when you're left bagholding an illiquid minor currency that no one else wants.
The problem here is that these economists are approaching the problem like economists, when in fact we are facing an entirely different problem.
Disruptive technology.
The USD became a reserve currency after WWII with the establishment of Bretton Woods. It was only logical for emerging economies in that era to leverage the most liquid financial market with the most reliable international payment infrastructure (the SWIFT network).
However, if your nation is no longer strategically aligned with the country that controls this currency, and if a new option for frictionless cross-border settlements emerges, why would you go on financing an economic war against yourself? If there’s a promising new technology that enables nations to trade with each other faster and cheaper than ever before…
CBDCs.
Central Bank Digital Currencies, when employed by an alliance of unfriendly nations, have the collective power to disrupt USD dominance a lot faster than we all would like to imagine.
They could very readily set up a network of DeFi-like infrastructure that incentivizes nations within the alliance to do trade with each other. Create a liquid pool of currencies, e.g. Yuan, Ruble, Rupee, Dirham, Rial, etc. that can easily be swapped out for each other, and then value each individual currency relative to the others according to how much trade that nation commits.
Your rupee gets more buying power the more you commit to do trade with us, which means you get cheaper commodities than the rest. And if you feel like reselling those commodities to those Westerners for a premium, go for it!
Sergey Glazyev, Minister of Foreign Economic Relations of Russia, has already telegraphed his strategy to create a commodity-backed currency that is “issued by a pool of currency reserves of BRICS countries, which all interested countries will be able to join. The weight of each currency in the basket could be proportional to the GDP of each country . . . its share in international trade, as well as the population and territory size of participating countries.”
The 60% dominance the USD currently enjoys could decrease pretty quickly when a big enough swath of the rest of the world employs new technologies and new incentive mechanisms (providing of course that they are able to cooperate with each other long enough to execute on this vision).
The point I’m getting at here is not that we are on the verge of a dollar apocalypse, but the dedollarization trend could accelerate sharply without warning. Put simply…
more nations are looking for alternatives, either for political or economic reasons
previous alternatives were inadequate in terms of liquidity and interoperability
a CBDC enabled pool of member currencies provides better trade incentives
The world is moving from unipolar to multipolar. As the cumulative GDP of BRICS surpasses that of the G7, we can no longer count on them doing it our way. It’s only a matter of time until they develop the technology and systems of their own to manage their own economies without having to depend on US dollars.
The big question that any holder of USD should be asking is, if the United States goes on spending while nations go on pivoting, who’s going to be buying the debt?
Capital has no loyalties. It is impartial, unsentimental, always chasing the optimal risk/reward ratio.
There’s no telling how long the buildup lasts until the wave finally comes crashing down. It could be quite some time now until trust in CBDCs is sufficient for states to fully pivot. But once a few countries demonstrate a viable use case, adoption will be exponential.
Now there is one important caveat to all of this. An AI renaissance could drag us out of the debt hole and usher in an entirely new era of economic productivity. It might, just might spark off another boom to make up for the gap from the rest of the world not buying dollars, and save us from the debt issuance vacuum that’s poised to nuke equities.
But are we far enough along in the product cycle to justify such valuations? Is AI capable of solving enough problems yet? That’s a topic for another day.