Sailing Withhout an Anchor!
RECENT HISTORY - Up until the early 1970's, our planet followed the Bretton Woods agreement of international monetary management. This system sought to secure the advantages of the gold standard without its disadvantages. The US dollar was linked to gold at the rate of $35 per ounce of gold and other nations pegged their currencies to the US dollar. At this fixed rate of US$35 per ounce, foreign governments and central banks were able to exchange dollars for gold. Bretton Woods established a system of payments based on the dollar, in which all currencies were defined in relation to the dollar, which was itself convertible into gold. The U.S. currency was now effectively the world currency, the standard to which every other currency was pegged. As the world's key currency, most international transactions were denominated in dollars.
During the 1960's, the US accumulated massive deficits and when the French demanded gold in exchange for US dollars, the US refused to redeem its dollars in gold. On 15 August 1971, US President Nixon shut the "gold window", thereby removing gold from the monetary system. The result was inevitable - currencies started floating against each other and without gold as the anchor, nations gave up on their monetary discipline. A fabulous new era of "endless prosperity" had arrived! Central banks became obsessed with monetary inflation, world-trade benefited and the world's foreign exchange reserves exploded. Figure 1 captures this development in all its glory. In 1971, the non-gold reserves of all countries were worth US$100 billion and today these have grown to roughly $4.3 trillion - an alarming 43-fold increase in 35 years!
Figure 1: Explosion in global non-gold reserves!
As the amount of money within the financial system increased due to the absence of gold, prices within the economy started rising. Once currencies were no longer linked to gold, the global economy became a ship without an anchor, floating from one "boom and bust" cycle to another! Rampant monetary inflation fuelled by the growth of credit turned the capital markets into one giant casino as punters worldwide (often loaded with credit) searched for the next opportunity to make a fortune.
In the 1970's, this excessive liquidity churned out by the central banks found a home in commodities as the price of raw materials went crazy. During the 1980's, investors piled into Japanese assets as stocks and real-estate soared. And in the 1990's, when we were ushering in the new millennium, our world fell in love with the technology, media and telecom sector. Each of these booms was accompanied by rapid credit growth, heavy speculation based on unrealistic expectations and unfortunately they all met their common fate - the eventual bust!
Since the "tech wreck" in 2000, this excessive capital floating around the system has found a refuge in real-estate. Today, the public's money is predominantly in property and everyone is convinced that the current boom will last forever. "What me worry? Nah, real-estate always goes up!" seems to be the common argument. Allow me to share a secret - no asset-class goes up in a straight line and property investors may be in for a rude shock if interest-rates continue to rise, which in my view is inevitable.
History has shown that rising interest-rates have always been bad news for stocks, bonds and highly-leveraged properties. Will this time be different? I guess we'll find out!
THE FUTURE - I must admit that I don't have a crystal ball, but wait, neither does anybody else. In the business of investing, we're always dealing with change and all we have in our arsenal are probabilities based on the ongoing developments around us. At present, I'm most certain about the following mega-trends, which are likely to intensify over the coming decade -
- Transfer of wealth from the West to the emerging world
- Transfer of capital from financial to tangible assets
I base my above forecasts on the fact that due to globalisation and the opening up of China and India, 2.3 billion people have now entered the workforce and these people are hungry for success and a better quality of life. After having lived in dismal poverty for decades, the middle-class in these developing countries has now "tasted blood" and it is determined to catch-up with the West.
To be perfectly honest, China is much more developed and its infrastructure far superior than India's. In fact, I would argue that China probably has the best roads in the world. I might as well add that the same can't be said of its drivers!
Last week, I traveled to Suzhou (2-hour drive from Shanghai) for a meeting with an extremely successful Chinese businessman. Mr. Wong is the new breed of entrepreneurs and represents modern, capitalist China. He established his manufacturing business 10-years ago and today his annual turnover is US$240 million. Mr. Wong is in the process of building another factory; he has just bought a luxurious Mercedes and his children study in exclusive schools in England! Moreover, I was amazed to learn that one of Mr. Wong's friends had just built a 5-star luxury hotel in Suzhou by paying US$30 million upfront in cash! Welcome to communist China!
Let's face it, the 21st century will belong to China. Shanghai is a phenomenal city with countless skyscrapers, huge shopping malls, great restaurants and an energetic population. Even a small town like Suzhou is home to massive factories, modern buildings and its people have an incredible work ethic. You really have to visit China to see what's going on in the world's fastest growing economy! For sure, its vast majority is still poor and the wealth divide is getting bigger but I am very excited about China's future. If my assessment is correct, the world's oldest civilization has a bright future.
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