Stocks are leading indicator of the economic activity. Hard to digest? Let me explain this to you through a story. The story of world economy, rise and fall of empires controlled this economy and how it is related to stocks. So this article is purely about history and economy. If you are not interested in neither of the above, feel free to skip!
This article is inspired from the works of famous American Investor Ray Dalio.
The world economy, without exception, was controlled and dominated by different empires during various periods in our history. The decline of one empire eventually light the way to rise of next one. But what and how these happened? We are discussing a time frame ranges from 16th century to the present. Yes, that’s well above 400 years but we can break down it into 3 parts. The era of Dutch Empire, British Empire and US.
In the 1500-1600 period the Spanish empire was the supreme economic empire in the “Western” world where as the Chinese empire under the Ming Dynasty was the most powerful empire in the “Eastern” world. When the Dutch became powerful enough in 1581, they overthrew the Spanish and went on to eclipse both the Spanish and the Chinese.
How a country or empire manages to dominate the world economy?
Race to the Top
Strong education, Technological innovations, Order in society, Respect for rules and laws are the key made these empires stand-up on the top. Military strength, competitiveness and World trade benefit them to maintain their empire.
Would you believe if I say, quarter of all inventions happened in the world during 1600s was contributed by Dutch empire! This includes invention of ships, introduction of capitalization and Amsterdam stock exchange – World’s first stock exchange.
How World Reserve Currency is derived?
When a country emerge as trading empire, their currency become superior and worthier. That currency will be considered as the preferred global medium of exchange. As it become most used, people around the world want to save in it. Now you know why US Dollar is considered as current preferred store of wealth and world reserve currency. In 1600s, Dutch Guilder was the world reserve currency. This results in empire’s growing economic output and rising share in world trade. But nothing lasts forever, right?
With the decline of Dutch East India Company in the middle of 1700s, the entire Dutch empire collapsed too. Their downfall paved way to the emergence of British Empire and later in history, the collapse of British Empire gave rise to the start of American dominance.
First one is – Each era had a global economic hub like Amsterdam during Dutch Empire, London during the British Empire and New York during the American.
Second one- During each of these periods Guilder, Pound and US Dollar are the World Reserve Currencies respectively.
Beginning of the End
Being reserve currency, that country will get the luxury of printing more money as much as they want. They also have the luxury to borrow more compared to other countries. Since every country would prefer to store that currency, these empires can print currency as much as they want. But printing more money and enjoying the luxury of being the super power also have consequences.
Gradually people become lazier and live in comfort hoping this prosperity will last forever. But still the economic gap between rich and poor will grow slowly. Along with these internal issues, cost of maintaining and defending the empire becomes greater. But there comes a stage where, their spending become massive compared to the income or revenue they generates. Thus borrowing increases and gradually having an empire become unprofitable.
Is it any different with USA?
We all know US are spending trillions in foreign countries to defend their military bases. They have spent trillions in countries like Iraq and Afghanistan during the last two decades.
Richer countries slip deeper into debt and borrow money from smaller countries that save more. According to Ray Dalio’s latest book, this started in US in 1980s when they had per capita income 40 times more than china and started borrowing from Chinese who wanted to save in dollars because dollar was reserve currency.
Nothing Lasts Forever – The Collapse
Once this empire run out of borrowing, the people who hold the money will obviously start selling and save the money in other currencies which they consider safe or in gold or why not Bitcoin?
When this financial bubble bursts and it lead to a situation for the empire to choose defaulting on their debts or print more money. At first gradually and then massively. This will accelerate the devaluation of their currency. Thus the inflation rate of the country surges.
For Dutch empire these debts and inflation rate accelerated with Anglo- Dutch war.
In case of British, it all started with First World War and accelerated during the Second World War.
For USA – this was the Dot com burst, Mortgage crisis and now Covid pandemic crisis. Printed money.
Would you believe if I say 40% of all US Dollar was printed by Central bank in last 12 months?
The Future of US Empire
Now America haven’t reached ‘The Collapse point’ but,
- They have massive debt.
- They are spending more than they earns,
- They funds this empire with more borrowing and printing huge amount of money.
- Internal and external conflicts are also in the corner.
The big sell off in dollars haven’t yet begun but it is a possibility! The fall of an empire doesn’t happen in one day. Usually it will take happen slowly, let’s say 30-40 years.
Ok, I will explain you how.
When living standards start to decline and there will be large gap btw rich and poor.
At that time taxes on rich increases and they will seek for a way to get out of tax burden. At that time they move their wealth to places or assets they feel safer. This will lead to reduce tax revenue hence the entire revenue of country. Gradually Democracy fails and rich will try to kick poor to redistribute the resources. It can lead to some form of civil war or revolution. Hence collapse of the empire will be the final result. Remember Russian revolution, Chinese revolution and French revolution?
The Yield Curve Inversion
Have you noticed the yield curve inverted in US treasury spread! In a normally functioning world the yield curve is upwards. I cannot explain you what that is, considering the length of the article. But I can tell you this – Yield curve inversion means a recession could be on its way. The yield curves predictive power has made it a crucial metrics for investors and traders like me. It is an incredibly accurate predictor for recession signs and that’s why we watch it closely!
US and Dollar dominance will not end tomorrow but the push against it has begun. For one empire to rise, another must fall.
You can see this now as US and China are roughly comparable in their economic output and shares of world trade. As I mentioned earlier, no empire can lasts forever. The decline is inevitable! Reversing a ‘sudden decline’ or extending the dominance is difficult but possible. That depends on their leaders and the measures they come up with.
But one thing I am sure about is – If an empire falls, it have consequences in the world at least for some period of time since their currency is considered as the World Reserve Currency. Since all other currencies in the world are backed by US dollar, when Dollar falls every currency devalues.
Now my question is, what currency or store of medium have positive growth against US dollar. What is the best medium of storage in long term? What is the best inflation hedge?
I will discuss more about this in my next article but I have to mention that everything I have written here is purely for educational and entertainment purposes. Nothing I have mentioned in my articles are financial advices. Do your own research.