What characterises a hyperpower?

Over the centuries, many hyperpowers, or empires as many prefer to call them, have effectively ruled the world. Persia (also known as the Achaemenian Empire), the Romans, the Ottomans and the Spanish to mention just a few. More recently, the British Empire ruled the world during the industrial revolution, followed by the Americans who took over from the British between the two World Wars. To this day, the USA is still the hyperpower of the world.

Being the hyperpower comes with certain obligations but also with plenty of benefits. Politically, you have enormous influence, but you are also expected to be the world’s policeman when trouble is brewing somewhere. Culturally, you have the ability to influence the beliefs, values, ideology and way of life in other countries.

Economically, you are large and powerful enough to control pretty much everything worldwide. Demographically, you have enough people to make a footprint in every corner of the world. Even more importantly, you have the resources, including human resources, to build a massive army which, in itself, results in plenty of power. And not to be dismissed, by sitting at the end of the table, you have access to plenty of natural resources to support economic growth.

Changing of the guard

For a while, I have been arguing that we are in the early stages of another changing of the guard. The US is slowly (very slowly) losing its position as the world’s undisputed hyperpower with China knocking on the door.

How do I know that? First and foremost, that’s what Exhibits 1a-b tell me. Both charts have been borrowed from Ray Dalio’s work on the topic. Secondly, a nation of 335 million people cannot forever hold back a nation of more than 1,400 million people, if that nation wants more power, and apparently it does. That logic is further strengthened by the fact that the average Chinese is currently enjoying a tremendous rise in living standards. It will prove impossible for the Americans to maintain its current position however hard they try; a situation not dissimilar to the years after World War I, when the British tried to prevent the Americans from taking over.

One of the great advantages of assuming the role as the world’s hyperpower is that your currency is likely to become the world’s preferred reserve currency. Today, no other currency is even close to the US dollar in terms of reserve currency status, and that brings plenty of advantages, which I shall come back to in a moment.

Before I go there, allow me to provide one more datapoint as to why I think the Chinese may push the Americans off the pedestal in our lifetime. Take a look at Exhibit 2 below. As you can see, US GDP doesn’t account for nearly as much of worldwide GDP as it used to, and the reason is simple – the rest of the world consists of almost eight billion people, many of whom are keen to loosen the ties to the US. Also, their living standards are, on average, rising much faster than the Americans’. Adding to that, it is also worth noting that the Chinese are better at building bridges to other fast-growing EM nations than the Americans are.

What does de-dollarisation mean?

British investors learned (the hard way) what the consequences are when your Prime Minister mistakenly believes that large-scale tax cuts can be financed with borrowings.  Liz Truss tried to do that in October 2022 and, within days, she was history.

You may wonder why the Americans can get away with such things when the British cannot, and the answer is simple. The Americans benefit from the US dollar’s reserve currency status, which means that foreign investors hold massive amounts of US debt but little UK debt.

Take a look at Exhibit 3 below. As you can see, the Americans haven’t exactly held back on debt accumulation in recent years. According to official data from the Federal Reserve Bank, US government debt-to-GDP now stands at about 124%.

However, financial markets don’t seem to care, and they probably won’t care for as long as the US reserve currency status remains unchanged.  Why do you think Donald Trump, at a recent rally, threatened to punish those countries willing to trade in other currencies than US dollars? See his speech here. Should large parts of the world decide to go off the US dollar when trading, the national debt level will suddenly matter to the Americans.

De-dollarisation is now an obvious objective amongst leading EM nations. More recently, Brazil, Russia, India, China and South Africa (jointly, the BRICS) have regularly traded in other currencies than USD when trading with each other.

The five BRICS countries have stated that the aim is to create a BRICS currency. And the net effect of all Trump’s threats to punish them with higher tariffs will probably only accelerate the process of de-dollarisation.

The expected impact on financial markets      

Since the GFC, central banks all over the world have bought government debt in large amounts, which has resulted in central banks’ balance sheets growing explosively. However, the rapid growth in balance sheet assets has also affected the performance of risk assets. As you can see in Exhibit 4 below, equity prices – in this case US equity prices – have risen more or less 1:1 with the rise in central banks’ balance sheets. In other words, recent years’ unprecedented growth in US government debt levels has had the effect of making holders of US equities wealthier.

Now, if the US dollar loses its status as the world’s #1 reserve currency, the US government can no longer assume that investors will tolerate endless amounts of government debt, and such a policy change will affect US risk assets negatively.

A brief look at history

If the penny hasn’t dropped yet amongst US policy makers, all they need to do is to look at Argentina. At the beginning of the 20th century, roughly at the same time as the Americans began to challenge the British for pole position, Argentina was, if not a hyperpower, a solid top-10 economy worldwide GDP-wise. If you fast-forward to the present, what is left is a poorly managed and deeply indebted country (Exhibit 5), constantly in need of help from the IMF and others.

I am not at all suggesting that the US is about to turn into the next Argentina. Nor am I saying that we are about to witness a repeat of the Liz Truss narrative. The US economy possesses so much talent and so many resources that an awful lot of bad decisions have to be made, before we are even close to an Argentina-like situation.

However, what I want to say with this is that the ongoing de-dollarisation will change the name of the game, and Americans had better realise that the rules are different, if you are no longer the hyperpower of the world.

Despite all Trump’s warnings, a change is underway. Leading EM nations are keen to reduce their reliance on the US economy, and expletives like the ones uttered by Trump recently (see the earlier link) will only serve to accelerate the process.

Final few words

Up to this point, this letter was written before the election on the 5th of November, as I didn’t want the outcome to affect my conclusions. I wholeheartedly believed, and continue to believe, that the ongoing de-dollarisation will continue to evolve whether R or D are in control on Capitol Hill.

As these lines are written, the Republicans have just won the House of Representatives in addition to their victory in the Senate. This means that Donald Trump and the rest of the Republican party will enjoy very wide powers at least until the midterm elections in 2026. Certain changes of law require a supermajority in Congress, i.e., not everything can be changed, but an awful lot can and will be changed in 2025 and 2026.

What Trump fails to understand (in my opinion) is that de-dollarisation is part of the natural lifecycle, and that there is little he can do to prevent it from happening. The train has already left the platform, and the only element of uncertainly is speed – i.e. how long it will take.

Finally, should you find this topic of interest, I suggest you get your hands on Ray Dalio’s 2021 book called “The Changing World Order”. Ray provides much more detail on the whys and whens than I am capable of in this letter.

Niels

2 December 2024