It may come as a big surprise but exchange rates and the state of the country from which they derive are not always a straight forward cause and effect system. For example, pegged and controlled exchange rates may be fixed by a Government for a time and as a consequence, the gap between reality and rate can become so wide that it explosively corrects as market forces reassert themselves.
Meanwhile, free markets are all about supply and demand. These may also depart from long-term economic reality as they are driven not by causal logic, but rather mass, unconscious, herd-like behaviour like all other free markets. After all price is a perception not an absolute.
China has operated a semi-managed hybrid currency with the objective of keeping its currency relatively undervalued (like Germany within the Euro) favouring its exports. However, the pound is a free-floating currency where this systematic manipulation is not possible. Indeed, there are lessons from the recent decline of the pound post-Brexit; whilst it was used by the MOD to explain away their budget overspends, it also boosted UK manufacturing significantly as orders flowed in from abroad. This gave us a hint of what would be possible if the pound could be artificially suppressed. However, with a free market currency, this is not possible so we will have to look for more realistic solutions elsewhere. Indeed, as we shall discuss later we expect the pound to rally significantly in the short term which will kill off any traditional manufacturing revival in the UK.
In order to derive lessons from China’s success for Britain to harness going forward, we must go right back to a more basic construct. In my book ‘Breaking the code of History’ (BTCH) I describe the concept of long empire cycles that have five phases: Link to summary of the five stages of the empire model
In essence the Western world which I described as the ‘Super Western Christian Empire’ (SWCE) is in terminal decline, with America as the last of the great component empires. Trump is doing all he can to reverse its downward trajectory. Meanwhile, Britain is the sole sub-empire to have started a new cycle, expanding from its 1970 base and thus in the stage of regionalization. Its’ Brexit vote was not a random accident but an expression of collective aspiration commensurate with its ongoing development and growth.
The vacuum caused by the decline of the SWCE is being filled by the rise of an ‘Asian Super Empire’ (ASE) currently lead by China. Now strangely enough when comparing China to Britain, China as a nation is well ahead on the cycle as it is now in the second stage of expansion to empire. Adding to its momentum is the fact that it is also part of a bigger super empire that is also expanding; the forces of internal growth and adaptation are far stronger than in Britain, if not resonant with a similar energy.
One of the key drivers behind the economic rise of China in 1990 was its cheap labour rate applied to its manufacturing industry. Much of what America had done before benefited from a cheap labour rate, especially compared to the SWCE. However, as local labour costs increased, America and all other western nations driven by market forces exported their manufacturing to China. Exacerbating this process over the past 20 years is the development of automation which has superimposed itself into the mix. Using the revenue flowing to their factories the Chinese have invested in larger and more efficient automated factories which further enhances their advantage over the west. This advantage even carries over to other emerging market nations who have cheaper labour, but cannot compete with the investment required to create large-scale automated manufacturing. The reality is that China, like America before it, is the most powerful manufacturing nation in the world today and for the foreseeable future. Thus, that race has been won. Unless a new global paradigm unfolds to change this situation by introducing new elements to the competition, China will continue to lead as the most powerful manufacturing nation in the world.
Manufacturing and the global economies are entwined very closely thus before we talk about the future of British manufacturing we must have a view of the global economy going forward. Last year in early 2017 I created what I called the Arkent Scenario as the sequence in which I expected markets to roll over into global economic trauma. The Arkent scenario was a roadmap to follow markets and prepare for the worst.
It articulated the following signs in this specific order:
• Dollar declines:
The first sign of the roadmap was that the dollar index would commence a decline to new lows over 2-3 years. This call was made in March 2017 when the index was at 104. It is now at 88.80. The new lows on the index would be sub 71. Additionally, we called for sterling to be the strongest currency against the dollar during this phase and specifically the low in the region of 1.20 and we are now at 1.40. We expect this dollar trend to continue over into 2018 as the trade war scenario grows and the Trump administration encourages a weak dollar policy to revive their manufacturing base. This prediction was first made in October 2016: Link to blog titled "Brexit Part xxii - Brexit and Sterling"
• G7 bond markets: The second sign was that the G7 bond markets broke their 20 plus year uptrend in March 2017 and we expected all bond markets to start a significant decline that would end in a western debt crisis before 2019. Since then price action has supported this scenario and is indeed accelerating.
• UK property markets: lead by London since the rules about beneficial ownership came into place in 2016, meant that the money laundering that fuelled the London property bubble went into reverse. As money launders can accept 30 to 40 pence in the pound this means that there is a massive overhang of property for sale that will drive prices down as low as 40-50% of the peak prices. Last year this trend accelerated and we expect it to continue to do so before spreading to all other areas of the UK.
• Commodities: We expected any rallies to be corrective, rather than the start of a new bull market. Whilst the upside moves have continued longer than expected in line with the US stock markets staying strong, the price action remains corrective and we would expect one more new low before a long-term sustainable bull market unfolds from 2019-2025.
• Gold: We remain bullish as it is one of the few stores of value during the challenges ahead.
• Stock markets: Stock indices were always going to be the last to fall in the above sequence. Within the stock spectrum, we viewed that the EU indices would be the weakest and the US the strongest. Indeed, this has come to pass with Euro Stoxx failing to exceed its highs three times since the start of 2018. Whilst the US stock market under Trump’s presidency has behaved bullishly in what can only be described as an excessive blow-off top. Such blow-offs are always reversed as fast as they go up, just like the bitcoin price action. What did catch our attention was that Trump in his interview with Pier Morgan, claimed that he had been a great success based on the stock market’s performance! This was a very risky statement that was full of market hubris. We would give quite high odds that this interview marked the high of the stock market rally. As such, although 2018 started very well we expect it to be all downhill in the stock land for the rest of the year. Ultimately over the next 18 months, we consider it very probable that we visit the 2008 lows in the US and below that in Europe.
So far, this roadmap is proving very accurate and as such should be taken extremely seriously. In summary, we expect the global economy to shrink dramatically in the next eighteen months before it re-inflates again after 2019/2020. Like our parents before us, who have seen great geopolitical and technological shifts change the economic landscape, we are now on the cusp of an economic dislocation of the greatest magnitude. This is the result of the collision between a rising and assertive China and the old-world power of America. An economic and military challenge is behind Trump’s trade war as he tries to slow down China’s growth. The heart of this strategy is to stop China’s manufacturing base from operating as it has been; freely in a globalized world with state-sponsored advantage. We should expect this trade war to soon bifurcate our globalized world much as the fall of the iron curtain once did: into the west and its’ allies, and China and its’ allies. However, this drastic scenario will have some silver linings as the result could be a resurgence of domestic manufacturing in the western world. Historically speaking if manufacturing were not about to change its very character, then Western economies would find and invest in emerging nation partners with low wage structures that it considered allies against its struggle with China, foremost of which is India. However, something else is on the horizon that could greatly benefit a post-Brexit Britain should we be prepared to grasp the nettle.
Up until now, manufacturing has been about scale which reduces costs, so big has definitely been better. However, with the advent of 3D printing, this is all about to change and the concept of decentralized automated manufacturing is now a very real prospect. A prime example is Britain's new aircraft carriers which carry only a few spares and the rest they print on the ship. Such a revolution could in itself bring manufacturing back to Britain and reduce costs to the point where the arbitrage of transportation versus currency valuation has less of an effect.
So how can we implement such dramatic policy shift that would once more place Britain at the forefront of regional manufacturing? Well there is some bad news and some good news. The US-Chinese trade war will in all probability end up in a debt war where western debt goes into free fall and the Arkent scenario becomes a reality. The dollar will fall, the euro will fall and the economics of the EU completely fail. https://www.davidmurrin.co.uk/blog-entry/the-impending-crisis-in-the-eu…
. However, the pound is currently set to rise significantly even before any such crisis as it will become a safe haven currency and capital will flow into Britain that will need to be invested. What better investment than in a new British decentralized and automated manufacturing base? Assuming that the government has encouraged funding that could make implementation a reality. Yes, there will be major challenges ahead as whilst this would create wealth, sadly it will not create jobs. There is a huge question about the need for a new paradigm for wealth distribution which I will save to discuss in another article.
Most importantly, today there is a double-red ‘storm warning’ flag flying.
Not only should we expect demand to drop sharply but in the short term current British manufacturing companies need to protect their order books by hedging their currency risk forward. If they don’t they are in for a very tough time in the next few years as sterling against the dollar could reach as high as 2 to 1 and similarly against the euro 2 to 1 to the pound. However, Britain should be using its newfound Brexit freedom to make plans for the inevitable crisis, so that it can minimize the damage and then rise ‘phoenix-like’ from the economic ashes faster than other nations around it and lead the next revolution of decentralized automated manufacturing.