One lazy weekend this past summer, I took my laptop out to the backyard to indulge myself in some reading. There had been an email from Ray Dalio’s www.Principles.com website, highlighting that the latest chapter of his forthcoming book “The Changing World Order” was available to be read online. Once I read through the chapter, I could not stop thinking about it for days.
I am a firm believer that Mark Twain was right when he said: “History does not repeat itself, but it often rhymes”. The reason being, I believe, that humans live short lives before a younger generation takes over who have never had the chance to personally learn the lessons of the last world war, depression, enlightenment or renaissance. Some of those lessons are carried to the next generation, but there is a good amount of broken telephone and youthful stubbornness, so that a lot of hard-earned knowledge is lost. In addition, regardless how much our future seems special and unique to each of us, many of the answers about the future can be found through studying history.
This is the chart that stopped me in my mental tracks:
Source: https://www.principles.com/the-changing-world-order/#chapter4 , retrieved on November 26, 2020.
A few things jumped out at me immediately:
• No empire has ever been as powerful as the US Empire was after WWII, not even the British Empire in its heyday
• China is rising fast, and set to overtake the US if you extrapolate
• How lucky I am to have lived my whole live in a time without major wars!
For someone like myself who loves numbers and graphs, this was mind blowing. Having lived and raised my children in Hong Kong over a period of 12 years I was already well aware of China’s rising power and influence, but this chart snapped everything into laser focus. It put numbers, and speeds of change, on China’s long decline, America’s spectacular rise, and China’s rise again.
Having seen this chart, I could not un-see it given how thought provoking it was in the context of being a father, steward of my own capital, and most importantly as someone whose clients pay him for long-term financial advice.
While one can never predict the future, I am quite confident about the following:
• China and the US will have more friction between them. These last few years have seen the low-temperature economic war start to play out. Tariffs, interference in each others’ political systems, the fights over Huawei and 5G telecom hardware, are a few examples. Ray Dalio’s research tells us the military shooting war typically starts around 10 years after economic conflicts begin. Hopefully that is not true this time around, but if it is, then Taiwan is a very likely flash point.
• China will continue to be the most important growth engine for the world. And growth is what makes assets appreciate. If profits or rents are not rising, neither are the assets connected to those things. To have real capital growth (after inflation) in your investment portfolio, you need to be invested in the parts of the economy that are growing. And a lot of that will be related to China.
Take this difficult year of 2020 as an example. As we know all too well, it’s been a year of tragic deaths and sickness, lockdowns, businesses permanently disappearing, unimaginable numbers of people becoming unemployed but being saved (mostly, so far) by enormous government handouts. Yet, despite all that, in the place where the virus first appeared, China will be the only significant economy to have positive growth this year! Data* from Morgan Stanley Research show that China’s real GDP in 2020 grew 2%, while all the other major economies shrunk: the US shrunk by 3%, Europe by 7%, Japan by 5% and India by 6%. Serious investors cannot ignore that growth engine.
• Currency exposure will be an important driver of returns. History shows that you want to have exposure to the world’s reserve currency and reduce that exposure before it gets replaced by its rival. This was true when the British Pound replaced the Dutch Guilder, and again when the US Dollar replaced the Pound.
What is different this time with regards to the Chinese currency (the Renminbi, which literally means “the people’s currency”), is that the Chinese government wants to control all the major aspects of their country, including who is allowed to hold their cash and equities and in what amounts. The Chinese government enforces this by essentially requiring an investor get permission before buying shares in Shanghai or Shenzhen, and every purchase and sale has the investor’s identification number attached to it. As well, there are currency controls on the Renminbi, meaning cash cannot be easily moved outside of China. The Dutch, British and Americans cared about this control over investments much less, or not at all. This makes it difficult to see the Renminbi replacing the US Dollar as the world’s preferred safe haven, store of value, unit of accounting, and medium of trade.
While China might be half a world away, and there are reasons arguing both for and against the country’s financial future being globally dominant, its importance to investors and stewards of capital will certainly be increasing as we head into the future.
*Forecasts of GDP growth are rounded to one digit. Source: 2021 Global Strategy Outlook, Morgan Stanley Research, November 15, 2020.
By: Wayne Edelist