By Michele Ocejo


Why should secured finance providers and those in their network be concerned with geopolitics?

ZEIHAN:  The short version is that the world as we understand it is coming to an unceremonious end and anything that is cross border at all is going to go through some sort of upheaval as the adjustment process kicks in. Now, of course, when you’re talking about secured credit you’re talking about people on the lending end and the borrowing side.

Let me lay some baseline stuff down first. Number one, there are two big sources of financial sourcing. The first one comes from, to be perfectly blunt, private savings, primarily retirement savings. People who generate this are the people who are roughly age 45 to 65. The kids have started to move out, they’re at the height of their careers, their home is mostly paid for and they’re accumulating capital. They have to invest that capital, that eventually makes it into the world of lending. So that’s the number one big source.

The opportunity that we have right now is that, globally, this demographic, 45 to 65, is now the largest it has ever been, both in the aggregate and as a percentage of the population. It’s a moment in time that won’t last, but for right now, we are in the most capital-rich moment in human history because of it. The problem is that it all ends in three years because in the year 2022, the majority of the world’s baby boomers all move into retirement, and they go from being capital providers to capital absorbers. And so we know that the available- capital generation is going to plummet even as the need for that capital is going to skyrocket. That’s piece one.

Piece two has to do with the global order. We’re probably getting a little ahead of ourselves, but with America withdrawing from the world, everything that is cross border has to go through a period of readjustment, assuming it can survive. In order to have a global system you need two things. Number one, you need a consumption base, that’s going to become harder and harder to do as everybody ages out of that consuming category. And second, you need global security so that people don’t shoot at each other’s cargo.

The U.S. Navy has about ten times, maybe we’re down to nine times now, the total offensive capability of all other Navies combined. And so, if you remove the Americans from that equation, there’s no coalition of countries that can step in and guarantee safety on the sea. In addition, the country that is aging most slowly is also the United States. So, if the U.S. takes its market and its guns and just goes home, nothing about the rest of the system is sustainable.

As we all know, it’s easier to move a bunch of money than it is to move a bunch of people. As global trade networks break down, as financial networks break down because of the demographic situation, people will vote with their money and they’re going to send it someplace safer, and it just doesn’t get safer than the American market. Throughout most of the world, you have rapidly shrinking volumes of capital on top of capital flight, on top of the skyrocketing need for that capital.

In the United States, you’ve got the most gently graying of the Baby Boomer generation, so we will be seeing tighter markets, but not ridiculously so, and the U.S. is going to benefit from the capital flight that’s coming in.

This is going to turn some markets inside out. In the United States a lot of that capital flight is going to be looking for a relatively safe asset that, ideally, is a hard physical asset, ideally has a rate of return, and ideally has a quasi-government guaranty. And the three pieces of the market that appear to be most favorable for at least two of those three categories are T bills, shale bonds and residential real estate. And so we have seen, I don’t want to use the word bubbles, but certainly a lot more energy, in those three markets than a lot of the others.

You describe a new world order that has evolved over 75 years since Bretton Woods. This is the same time that our association, SFNet, was formed in order to align and promote the interests of its members. As with Bretton Woods, those interests have evolved over the years, our borders are now more fluid, there are more actors in our network, we have other trade associations we compete with, other lenders, and they all constitute a global network that relies on formal and informal relationships. From your experience working with associations, how do you see their role evolving in all of this?

ZEIHAN:  I think you would agree with me that you saw a big quantum leap in interconnectivity in the number of players and associations around the end of the Cold War. Bretton Woods is definitely where to put the post in the ground because that is when we got our first truly global system. The deal that the Americans basically struck with everybody was “we will defend you and you can access our market if, in exchange, you side with us against the Soviets.” That was the first true phase of globalization; everything before that had been a series of imperial expansions and competitions and a lot of people shooting at one another. It’s the first time we had cross-border connectivity and trade and connections without having to be part of an imperial network.

It first started with the United States and the United Kingdom and Canada, then it expanded all over Western Europe, brought in Japan, and the Koreans and the Taiwanese, and eventually even the Chinese. And then the Cold War ended and all of a sudden the entire rubric of security of guns for butter went away and the Americans never updated their system so they kept providing all of the benefits of globalization, global security and market access, but they stopped asking for anything in return. Countries that weren’t necessarily part of the family, could then join, such as Saudi Arabia, Russia, Brazil, countries that tried to sit out the Cold War, countries that were on the other side of the Cold War. And so we have, for the first time in history, a globalized system in which politics, at least on the surface, doesn’t matter. And I don’t think most people recognize just how truly revolutionary that was and I’m positive that most people don’t recognize how unsustainable that is.

These massive expansions and connectivity that we have seen since 1992 almost never works. It’s a unique moment in time and that moment is nearly over, which means that if your business is dependent upon frictionless trans-border activity, I’ve got news for you: that’s going to change.

It will affect some of your members more than others based on what subsectors they’re in and how dependent they are on foreign capital or foreign borrowers. We’re moving into a simpler, more brutal system where national borders matter again, and where you sit determines where you stand.

There’s a lot of very scary stuff that’s in process right now. I would love to give everybody some hope and, for the United States, I think there is a lot of hope, but even if this all ends up okay for the United States, the road from here to there is not a straight one and every sector is going to have their own ups and downs and implosions and explosions as we sort out what the world is going to look like. We just have the advantage here of suffering the least, having the longest time to make the adjustment, being in the driver’s seat on the security issues and, at the end of the day, still having a robust growing market within North America for almost everything that we normally would like to do. It’s not perfect, but in relative terms it’s about as good as you can get.

Having a large number of Millennials and their spending power seems to be unique to the U.S. How do these demographics favor lenders?

ZEIHAN:  As a rule, if you’re roughly age 18 to 45, that’s when you are going to do most of the consumption in your life, raising kids, going to college, buying homes, buying cars, and Millennials are square in that category. With the definition that I use for the Millennial age group, they’re currently aged 19 to 41. We still have at least another four years of that consumption left before they start aging into middle age.

That means that the United States is sort of recession-proof for now. It’s got some great ballasts in the system because of the Millennials. What most people forget is that there was a global baby bust that started around 1970 to 1980 based on where you are, that affected almost every country in the world. The only other two countries that have a relatively Millennial-rich population are France and New Zealand, and that’s just not enough to carry the water.

The same bust has happened in the developing world, first and foremost in China. We’ve all heard of the one-child policy, but we’ve never really done the math as to how bad it is. The average American is now younger than the average Chinese citizen. That’s been true for almost two years. They are now, based on how you do the math, the second, third or fourth fastest-aging society in the world. Europe has basically aged to convalescence already; Japan is there already; and Korea doesn’t look very good. Even in the “young countries” of the developing world, say Mexico and India, the baby bust still happened, it just waited until the year 2000. So, we’ve got a rapidly graying population followed by what is going to be a rapidly contracting population with the exception of the United States, France and New Zealand, and then some developing countries that are just 20 years behind.

If you’re in finance, ultimately, you need someone to borrow, and if you don’t have Millennials, the only thing you can borrow for is corporate expansion and government activity. And since more and more government activity is going to be focused on serving pensions and healthcare costs for retirees, the costs of servicing that debt is going to skyrocket because that’s not exactly a growth generator. If you’re looking for traditional finance that’s consumption based, you’re down to three countries.

You write about capital deficiencies. What are the implications to lenders and do you foresee more capital demand in the U.S.? Will more foreign capital flow into the U.S.?

ZEIHAN:  Yes, when the Chinese tried to liberalize the capital accounts about two to three years ago, a trillion U.S. (in currency equivalent) flooded out in less than six months. That tells you everything you need to know about what the Chinese think about their own system; they can’t wait to get out. The general breakdown of the Chinese system is going to generate one of the biggest capital outflows in history. I would expect the majority of it to come to the United States.

The Euro Zone is definitely in its final years. When that breaks down, you’re going to have thrashes of financial collapses across the European space. I would expect a majority of that capital to find its way to the United States. There will be a bit of competition from Australia and New Zealand for that, but you just have to keep it in perspective.

The Canadian economy, for example, is about one-ninth the size of the American economy, but if you ask any citizen of the world if they prefer the United States or Canada, more than one-ninth of them say they prefer Canada. So Canada will get a disproportionate chunk of this, which will have all the normal effects on their property markets and their currency that you would expect. But still, the vast majority is going to come here and with every month that passes that the Brits cannot figure out how the hell they want to handle Brexit, more comes here because, normally, Britain being a big financial center and London being a big financial capital, would absorb a big chunk of this, especially from Europe. But it’s completely off the table until they figure out what happens after Brexit. And they haven’t honestly even started that conversation yet -- three years out and they haven’t started it.

We do have many members and a chapter located in the UK. What is your take on Brexit and the effect on our members?

ZEIHAN:  There was never, ever going to be a negotiated exit for Brexit. The way foreign-policy making works in the EU is that each individual state has full veto rights over all big decisions. Brexit is a big decision, which means that there was never any version of any deal that would satisfy Ireland and Spain and France and Germany and the Netherlands and still be able to make it through Parliament. So, it was always going to be a hard crash out.

The longer the Brits take to just come to terms with that simple fact, the worse it is for London, the worse it is for the United Kingdom banking sector, and the better it is for the United States, because it means that the Brits are wasting away every little bit of financial, economic and strategic leverage they have in a fight with themselves. When this is all finally done and the Brits start to pick up the pieces, they’re going to look to the United States as the only country that it can get a trade deal with, but they have nothing to offer anymore. The U.S. will give them a trade deal, but as payment we will take the entire London financial district.

I’d say no more than a quarter of it is going to stay in London, maybe a quarter of it will get scattered across the EU for those who have a really myopic view of Europe and just can’t see the writing on the wall and the rest of it is going to come to the United States.

Tariffs have a real impact on our members’ borrowers, as increased costs impact financial viability. Are tariffs here to stay or is this just a speed bump, and what industries will be most affected?

ZEIHAN:  The tariff level we have today is the lowest it’s going to be for the rest of our lives. I personally bet that Trump is going to get reelected (Editor’s Note: This interview took place on September 10), just looking at the candidates and the power structures as they are right now and what’s going on with parties. But even if he loses, look at the people who he’s running against. All of them say that he is being too soft on China. So, the degree to the trade war is here, it might be fought a little differently, but it’s not going to let up and it’s not going to end until the Chinese system is crushed. That means the tariffs are here to stay. They may move a little bit on the edges and some specific tariffs may come and go versus other countries as the Trump administration or its successors  hammers out a series of trade deals to replace the American order, but that is only going to be a very short list of countries: Mexico, Canada, Korea, Japan, United Kingdom and that’s it. And that’s half of our trade portfolio, so it’s not like that’s insignificant.

But for everyone else, if they want access to the American market, or if they want access to the American security umbrella, they have to bring something to us. And I think the best example of that going down right now is what happened with Japan and Korea, both of which sought out talks with the Trump administration knowing that the guns-for-butter deal of the old global order had now reversed and they have to come up with shiny concessions just to start talks.

At the beginning of this year, people were talking about how Japan never does trade deals, which is true, and how Japan would never concede on anything, but that ignored the fact that the rules of the game had changed. And it’s no longer the United States trying to court Japan in order to get a security deal; it’s Japan trying to court the United States in order to get a security deal. And that meant the Japanese had to give in on every economic issue that the Americans cared about. And that’s why the talks are almost over, they probably have agreement on 90 percent of the stuff already. It will definitely be signed by the end of the year.


About the Author

Michele Ocejo
Michele Ocejo is editor in chief of The Secured Lender and director of communications for the Secured Finance Network.
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