JUNE 2013                                                                                                               

The Unable to the Unwilling

Does the same ‘Great Power’ have to be the ultimate provider of credit and be in charge of the levers of war? If not, then what happens in a period of interregnum when the reins of finance and war are held by different powers? The last transition occurred when the American Republic eclipsed the British Empire.

In 1914 the Pound Sterling reigned as the global currency; London presided as the world’s moneylender; and Britannia ruled the waves.

America was a debtor nation with chronic financial panics; her central bank was only just assembled; and her military barely prevailed over Pancho Villa.  However, by the end of the Great War, the New Republic had replaced the beleaguered Empire as the global credit supplier, culminating in American military supremacy a few decades later. The globe was to experience a leadership interregnum between the new financial power (America) and the aging military power (Britannia); this vacuum left no responsible leader in command when global trade and asset markets wobbled. America was unwilling to lead and Britannia was unable to lead.

An Old Story

Pundits have identified China as the superpower of the future, with its gargantuan appetite for commodities and immense currency reserves. The argument goes that we are now seeing the rise of the East and investors should embrace this change today and invest in the suitably acronymed equity markets.

If we take this at face value then we have a situation similar to that  which existed between Britannia and America at the end of World War I.  There was a new creditor power (US) with limited military pretensions and the old military debtor (Britannia) with a still vast but vulnerable empire.

The duration of both these financial and military interregnums, the earlier one from 1920-1940 and the current one from 2000-2020, can be viewed through the lens of two simple indicators: asset market performance and the ratio of interest payments to warfare spending. What can we observe?

Similar Rhythm

The two charts below seem to show that there is a similar pattern to the financial transition periods. The Chinese equity market is following the same pattern as America during its changeover period, hinting that the asset pressures will, actually, be felt more acutely in China.

America is following the path of Britannia, its equity market recovered from its drawdown, but caution is advised as the equity market gives up all its gains by the end. Over the 20-year period the British Empire stocks essentially round trip back to the beginning. This would be a rather annoying outcome for all of us relying on a rising future American market.

A tell tale sign

The interest payments to warfare spending numbers suggest that like Britannia, the sun may be close to setting on the American Empire.

n 1914 warfare payments in the Empire comprised 21% of spending and interest payments represented 16%; by 1921 these levels had switched to 18% and 23% respectively. In 2012 American military spending was 18% of spending and interest payments were still at 2007 levels of 11%, even though public debt has increased by $6 trillion. Courtesy of the Fed, interest payments have remained steady. If interest rates rise 2%, interest payments would overtake military spending.

American debt diminishes its capability to lead. China shows little desire to take on the burden of leadership. The last interregnum allowed a ghastly set of actors to the forefront. This time round the unable and the unwilling need to provide a smoother transition.


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