Like A G7

By Benjamin Picton, senior macro strategist at Rabobank

“Like a G6” was a hit song by the ‘Far East Movement’ that spent 3 weeks at number 1 on the Billboard charts back in 2010. Over the weekend, we saw movement in the Far East, with the G7 leaders meeting convening in Hiroshima. This was the latest in a string of engagements where the White House has been attempting to shore up alliances with other democracies, particularly in the Asia Pacific.

The Communique reads like a greatest hits list for Western foreign policy. Some highlights include:

• Support Ukraine for a as long as it takes in the face of Russia’s illegal war of aggression;

• Coordinate our approach to economic resilience and economic security that is based on diversifying and deepening partnerships and de-risking, not de-coupling;

• Support a free and open Indo-Pacific and oppose any unilateral attempts to change the status quo by force or coercion;

• Strengthen our partnerships with African countries and support greater African representation in multilateral fora;

• Strongly opposing any unilateral attempts to change the peacefully established status of territories by force or coercion anywhere in the world and reaffirming that the acquisition of territory by force is prohibited;

• Strengthening the rules-based multilateral trading system and keeping pace with the evolution of digital technologies.

Russia is explicitly called out here, but much of this is obviously pointed at countering the regional ambitions of a certain unnamed Asian power. I think you might be able to guess who that might be!

This Daily noted on Friday that a deal had been struck on the sidelines of the summit for US-based semiconductor manufacturer Micron Technologies to work with the Japanese government to develop next generation chips in Japan. On Sunday, China responded by banning Micron Technologies chips, with the Cyberspace Administration of China noting that they “posed significant security risks to China’s critical information infrastructure supply chain”. In the Great Game, semiconductors are increasingly shaping up as the new oil, and this Chinese ban comes after well publicised moves by the USA, Japan and the Netherlands in recent months to restrict China’s access to critical chip technology. The timing of the Chinese retaliation is more than coincidental.

Indeed, the events of the weekend could not have better illustrated the creeping bifurcation of the global system. While the G7 democracies met, Russian forces finally succeeded in capturing the Ukrainian city of Bakhmut. Despite lacking any real strategic importance, the city had become a kind of Ukrainian Stalingrad in that it assumed a totemic quality as a symbol of Ukrainian resistance. The capture of the city is a propaganda victory for Vladimir Putin, even if it comes at a very high cost for the Russian armed forces. Strategists have questioned whether Putin’s fixation on taking Bakhmut may have again placed Russian forces in a vulnerable position against potential Ukrainian counter-offensives in the coming months, but much will depend on the resolve of Western allies to stay the course in providing the Ukrainians with arms and other aid. The ”as long as it takes” language of the G7 communique could not have been more clear regarding the West’s intentions in this respect.

The G7 meeting was supposed to roll into a meeting of the Quad in Sydney this week, but President Biden had to fly like a G6 back to Washington to attempt to defuse the debt-ceiling bomb. House Speaker Kevin McCarthy sounded confrontational, accusing Biden of “want[ing] a default more than he wants a deal”, while the President said that “it’s time for Republicans to accept that there is no bipartisan deal to be made solely on their partisan terms.” This sort of language doesn’t do a lot to engender confidence, considering that Janet Yellen has been warning that the US Treasury could run out of money in a mere 10 days. Even if the two sides do manage to come together and strike an agreement, it will take some time to pass a bill through Congress, so the potential for miscalculation can’t be completely discounted. The Administration is now busy in contingency planning around which bills to leave unpaid, while also considering controversial workarounds that could include invoking the 14th amendment (“The validity of the public debt of the United States… shall not be questioned.”) or asking the US Federal Reserve to mint a trillion-dollar platinum coin.

The debt ceiling issue is hardly new. The US and other national governments have been poppin’ bottles gettin’ slizard on cheap debt for many years now, ever since Nobel Laureate Ben Bernanke saved capitalism by ending the free market for long-term interest rates. Every time the hangover arrives we tell ourselves that this was the last time, but the events of the G7 highlight that spending pressures are only growing, not receding.

Aside from the increased urgency of new military spending, there is also the urgency of new spending measures to address climate change. The G7 also considered this at length, and made new commitments on investment and supply chains for critical minerals and technologies. Increasingly, climate and defence are becoming linked. President Biden provided sweeteners to Australia that would allow Australian firms to apply for US subsidies under the mammoth Inflation Reduction Act, as well as being designated as a ‘domestic source’ of manufacturing for critical sectors like defence, critical minerals and clean energy technology.

While all of this was going on, Bernanke himself spoke alongside current Fed Chair Jerome Powell on Friday. In response to questions, Powell largely read from prepared remarks where he noted that endogenous credit tightening from the recent banking crisis meant that there was less need for the Fed to increase interest rates, and that the Fed had time to assess the data now that policy was at a restrictive level. The dovishness of those statements sits well with our Fed Watcher Philip Marey’s expectation that the May rate hike was the last one for the cycle.

Comparing the current banking crisis to the crisis of 2008, Bernanke helpfully noted that this time is different. Revaluation of US treasuries is not as a big a problem as illiquid mortgage-backed securities, he said, because you can always find a price for them and there is an in-built counter-cyclical nature to Treasury prices because the price of those assets tends to go up in a crisis. The only problems with that line of reasoning is that it assumes a well-functioning market where those securities are not being defaulted on, and it also assumes that the Fed will aggressively cut interest rates in a crisis. Can that be done with core inflation still more than double the Fed’s target?

While this discussion on the various crises was going on, my wife suggested to me that building the world banking system on top of securities at risk of systemic default was a bit like building the Death Star with an exhaust shaft where a well-placed missile would blow up the whole thing. Twice.

Hard to argue with that.