Thursday, May 21, 2015

Is the global financial system at risk of collapsing?

Many Western countries may well be facing a relatively bleak economic future, but I doubt that we are headed for anything like a global financial cataclysm.

Though I am no expert, it is important for me to have a considered view on these sorts of matters both for general and more practical reasons: general, because I'm curious about how our economic and political realities evolve; and practical, because of the impact impending events may have on personal investments etc..

I have been devoting serious attention to investing for almost twenty years now, and during this time my fortunes have fluctuated more or less in sync with global equity markets. My intention at the moment is to shift to a more conservative strategy (if only I could figure out what a conservative strategy might be in the current situation, when bond yields are so eerily low...).

Precious metals? I did hold some gold bullion years ago but don't currently own any. So-called gold or silver 'stackers' are often very naive and uncritical in certain respects but at least they perceive that something is seriously wrong with the current financial and monetary system and are seeking to take control of their own destinies.

In fact, some fairly mainstream commentators agree with their logic to a point. James Rickards thinks one should have about 10% of one's savings or investments allocated to physical gold; and Marc Faber and Jim Rogers both maintain a considerable proportion of their wealth in physical gold, held in an Asian country, not the US. (It is commonly thought that, in the event of a sovereign debt or currency crisis, Western governments would force private holders of gold to sell up at a low price, as happened in 1930s America.)

But moving and storing the stuff is always a bother (and an expense), and bullion pays no interest or dividend. More importantly, I don't see a collapse of the global financial system as being a necessary consequence of a loss of confidence in the US dollar. Why would a new system not evolve based (perhaps) around IMF 'special drawing rights' and the Chinese and certain other currencies not associated with over-indebted sovereigns? The Chinese are rapidly moving towards full convertibility for their currency and are already having considerable success in promoting use of the yuan in international trade. (It will almost certainly be incorporated into the IMF's SDR formula before the end of the year.)

More generally, what we are witnessing is a major wealth shift away from the U.S. and most of Europe and towards Asia (and specifically China).

Sovereign debt is a crucial issue here. Sure, there have been times in the post-WWII period when previously-prosperous countries have suffered from sovereign debt crises -- and have recovered. But, in the current situation, with sovereign debt at record levels in most of the major Western economies (as well as Japan) we have arguably passed a point of no return. Only extremely low interest rates are allowing this situation to persist without major financial, economic and political upheavals.

The fact is that major economies such as the U.S., Japan, the U.K., Italy and France are in decline and, given the state of their public finances coupled with low productivity growth, probably in terminal decline.

We are seeing a US-centred world financial system slowly being replaced by a multilateral system which -- increasingly -- will reflect the significance of the Chinese economy and the Chinese currency.

The Obama adminstration is hastening this process not only by sanctioning reckless monetary policies and virtually ignoring the looming crisis of US sovereign debt and entitlements but also by a series of geo-political and diplomatic blunders. One of the most cack-handed and significant of these was its recent -- and largely failed -- attempt to dissuade its major Western allies from joining (as founding members) the China-sponsored Asian Infrastructure Investment Bank.