TLDR: US Yield Curve is inverted, indicating recession, massive quantitative easing /money printing has plunged the value of the US dollar in real terms due to increased inflation, while interest rate hikes have artificially propped up demand relatively. As the world's reserve currency, the US has control over money printing and refinancing debt, but the increase in US debt raises global economic risks. BRICS nations are considering creating their own reserve currency due to their combined GDP potential by 2030 and getting joined by Saudi. Russia and China have increased their gold reserves, a safe haven asset, as a solid foundation for a new currency. In due time if US asset-debt-inflation bubble pops, it will be the death knell for petrodollar backed US fiat reserve currency hegemony and usher in a new global economy.

The US Treasury Yield Curve is currently inverted, meaning short term interest rates are moving up, closer to (or higher than) long term rates. This unusual occurrence, called a yield curve inversion, has historically been a very reliable indicator of an upcoming economic recession. Since World War II every yield curve inversion has been followed by a recession in the following 6-18 months, and recessions are naturally correlated with decreased stock market returns, unemployment and reduction in GDP and other productivity metrics.

US Money Printing

The US has printed a large amount of money by inflating its M1 money supply, causing a decrease in the value of the US dollar compared to other currencies like the Indian Rupee and the British Pound. The supply of the US dollar has increased, leading to a decrease in its value. However, all other currencies are being impacted more severely due to the simultaneous rise in US interest rates which is offers a better risk adjusted return now compared to say that of a emerging economy like India. Majority of the world debt is denominated in the US dollar, USA has a lot of debt, which is similar to India and China, but being the world's reserve currency has massive benefits.

The US has the ability to print money and refinance its debt, which is not possible for other countries like India and China. Reserve currency is the apex currency, giving US complete control over how much currency they can print and withdraw from the market for example by printing quantitative easing or investing public money into defaulting big banks to prop up the economy. 60% of the world trade happens in the US dollar, so countries like India are required to hold a certain number of US dollars, even if they don't want to take debt in it. Foreign countries hold ~$7.5T worth US treasures as of July 2022. The more the US decides to print money, the more its debt increases, which raises the risk in the global economy. This increase in risk affects emerging economies the most, as they become more vulnerable to financial instability. When the world takes on more debt and the risk of the global economy increases, investors start to search for safe haven currencies to put their money in, which becomes the US dollar. This is why we have seen instances of foreign institutional investors withdrawing money from markets such as India, due to rising global risks from events like the Russia-Ukraine conflict and the COVID-19 situation.

According to a recent study, the reversal of quantitative easing (QE) by central banks has led to a vanishing of liquidity in financial markets. The study, which was presented at the Federal Reserve Bank of Kansas City's Jackson Hole conference in August, shows that the financial sector has become dependent on easy liquidity due to QE, which may make it difficult for central banks to reverse. During QE, central banks buy long-term bonds from the private sector and issue liquid reserves in return. Commercial banks hold these reserves and finance their own asset purchases with short-term demand deposits that represent potent claims on their liquidity. Additionally, to create additional revenue streams, commercial banks offer reserve-backed liquidity insurance to others, such as households, asset managers, and non-financial corporations. Speculators, including pension funds, have also been affected by the low returns on long-term gilts induced by QE. They have increased their risk profiles and taken on more leverage, which has generated margin calls on their derivative positions. In the event of a shock, such as a government-induced scare, the financial sector generates substantial potential claims on liquidity, which can become a big problem if there is a shortage of spare liquidity. The study also finds that, in the case of the United States, QT makes conditions even tighter, as the financial sector does not quickly shrink its claims on liquidity. This makes the system vulnerable to shocks and can cause massive dislocation in financial markets. The onset of the pandemic in March 2020 was a large liquidity shock, which prompted central banks to flood the system with reserves. In conclusion, the longer the duration of QE, the greater the liquidity that financial markets become accustomed to, and the longer it will take for central banks to normalize their balance sheets. Monetary policymakers find themselves in a difficult position as they may need to raise rates to reduce inflation while also supplying liquidity to stabilize government bond markets. The study co-authored by Rahul Chauhan and Sascha Steffens highlights the interdependence between central banks, commercial banks, and financial markets and the importance of monitoring the effects of QE and QT on financial stability.

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Western Hypocrisy

The West, specifically US and EU, are considering implementing a carbon border tax. This is being done with the aim of leveling the playing field for their products in the international market, as other countries may have less stringent environmental regulations, leading to cheaper goods being produced. The carbon border tax would be imposed on goods entering the EU or US from countries that do not have the same level of carbon regulations.

This move is being criticized as hypocritical as the developed countries, who are now imposing the tax, have emitted a significant amount of carbon during their own development phase, and are largely responsible for climate change. The imposition of a carbon tax on developing countries, such as India and China, is seen as unfair as they need economic fuel to grow and are still in their developing phase. The carbon border tax is being viewed as a way for the developed countries to maintain their dominance in the international market and prevent companies from moving to countries with less stringent regulations.

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‍THE BRICS CURRENCY

The BRICS nations (Brazil, Russia, India, China and South Africa) are considering creating their own reserve currency, the BRICS currency, due to the potential of controlling 50% of the world's GDP by 2030. The challenge of creating a currency through multiple nations is complex and would require a central bank to regulate it. The issue is that each nation would want to exert its own dominance over the currency and their political structures and growth goals are very different.

With a combined population of over 3 billion people, the BRICS countries represent nearly 42% of the world's population. In terms of gross domestic product (GDP), the BRICS nations account for over 23% of the world's total economic output, with China and India alone contributing over half of the group's total GDP. Trade between the BRICS countries has also been on the rise, with their collective trade volume reaching nearly $7 trillion in 2022. The BRICS nations have been working towards increasing economic cooperation and integration, with initiatives such as the BRICS Trade Fair and the New Development Bank, aimed at promoting trade and investment among the member countries.

In recent years, Russia and China have been increasing their gold reserves with the aim of creating a new gold-pegged reserve currency as part of the BRICS nations. The BRICS nations, consisting of Brazil, Russia, India, China, and South Africa, have been considering creating their own reserve currency in light of the potential of controlling 50% of the world's GDP by 2030. According to figures from 2022, Russia's gold reserves had increased by nearly 20%, while China's had increased by over 50%. The increase in gold reserves is significant, as gold is widely considered a safe haven asset and is expected to provide stability in times of economic uncertainty. Gold is widely recognized as a valuable currency, and having a significant amount of gold in reserve provides a solid foundation for a new currency. US fiat currency based on trust is being misused by US to print away their problems by reducing their debt burden in real terms while simultaneously exporting inflation to the entire world. The creation of a new gold-pegged reserve currency could have far-reaching implications for the global financial system, by replacing US hegemony, reducing misuse by printing money, providing stability and reduce the vulnerability to economic and financial shocks, give BRICS nations greater control over their financial futures and provide an alternative to the IMF's Special Drawing Rights. This currency would be a basket consisting of the Chinese Renminbi, Russian Ruble, Indian Rupee, Brazilian Real, and South African Rand, thus expected to be more stable and semi-decentralized. The introduction of a currency backed by gold has not been seen in half a century and if the BRICS nations are successful, it could become the most valuable currency in the world.

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SAUDI and China Angle

China is motivated to end the dominance of the US dollar as the world's reserve currency due to the two major advantages it gives the United States. Firstly, the US has the "exorbitant privilege" which allows it to spend more than it earns due to its status as the issuer of the world's reserve currency. Secondly, the US can harm its enemies by excluding them from the dollar-based international financial system, which restricts their ability to buy crucial imports and get new loans. China has seen this play out with Russia, where US banks were forced to stop doing business with Russian banks, and a large chunk of Russian foreign currency reserves were frozen. These factors have motivated China to come up with a plan to challenge the dominance of the US dollar.

In order to make the Chinese currency, Renminbi, more attractive to traders and countries outside of China, there are three main steps that need to be taken: improving spendability, investability and liquidity of the currency.

Spendability is how easily the currency can be used for transactions and purchases internationally. Currently, the US dollar is the most widely used currency for international transactions, while the Renminbi is only the eighth most traded currency. To increase the spendability of the Renminbi, China has promised full Renminbi settlement in oil and gas trade, which would make the currency more widely accepted for payments. Additionally, China has also promised to deepen digital currency cooperation and advance the multiple central bank digital currency project, which could make it easier for people to use Renminbi for international transactions.

Investability is attractive it is for people outside of China to save their wealth in Renminbi assets. Currently, European banks and brokers do not offer access to financial markets in mainland China, making it difficult for people to invest in Renminbi assets. However, in recent years, big banks in places like London and New York have started offering Renminbi accounts, and big investors have been pouring money into China. However, China still heavily restricts access to its financial markets for foreigners, which makes it difficult for big global companies and countries like Saudi Arabia to invest in Renminbi assets.

Liquidity is easily a currency can be obtained and traded in the market. Currently, the US dollar is the easiest currency to obtain and trade in foreign exchange markets, while the Renminbi is not as widely available. To increase the liquidity of the Renminbi, China will need to make it easier for foreigners to obtain the currency and trade it in the market.

The recent prospect of Saudi Arabia joining BRICS is an interesting one, as it could bring significant benefits to the group. With its large oil reserves and strong economy, Saudi Arabia could play a crucial role in supporting the economic growth of BRICS and strengthening the group's position in the global economy. Additionally, the addition of Saudi Arabia could provide a boost to the BRICS currency, as the country has expressed interest in using the currency for its international trade and investments. Saudi Arabia selling to the United States gives them a $7T dollar advantage due to petrodollar recycling.  Under a currency exchange agreement as part of BRICS however, BRICS countries, particularly India and China who are the largest oil consumers, would no longer have to buy oil in dollars. This shift away from the dollar would be a significant blow to the American economy, as bank interest rates would skyrocket.

China alone owns one trillion dollars in U.S Treasuries, and without the need to buy oil in dollars, they may choose to sell those bonds, causing a significant dent in the American economy. In contrast, China has already developed a alternative to the current SWIFT international payment network, known as the M-Bridge prototype, which is essentially an alternative to the Swift system for making international transactions using a Central Bank digital currency.

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USA Inflation and stock market:

‍‍While SP500 Total Returns has grown 58% in the last 5 years, adjusted for the massive money printing, it has given a real return of just 4%.  Almost losing 7% of money to inflation per year or 0.59% per month. At this rate, in 10 years over 50% of money has evaporated.

The Federal Reserve has two mandates: to minimize unemployment and control inflation. Currently, inflation is at an extremely high rate of over 8 percent, which is the highest seen in decades. The high inflation is a result of various factors including supply chain issues due to COVID-19, pent-up demand from the pandemic, $5Teconomic stimulus, the Russian-Ukraine war, and historically low interest rates.

The main tool the Fed has to combat inflation is raising the federal funds rate, which is the rate at which banks and financial institutions lend to each other. When this rate increases, it becomes more expensive for consumers and businesses to borrow, resulting in less spending and potentially lower prices to attract customers. This decrease in demand and supply can eventually lead to a decrease in inflation. If inflation goes up, value of currency goes down which translates into people and businesses spending money as soon as possible which increases the demand over supply and thus causes more inflation and the cycle continue which if not controlled can lead to stagflation, with high inflation and unemployment with low economic growth or even hyperinflation.

However, many believe that the Fed's plan to raise interest rates until inflation comes down, as stated by its chair Jerome Powell, will lead to a recession. The hawkish stance by the Fed has already resulted in investors selling riskier assets, leading to a bearish cloud over the markets. A recession is usually defined as two consecutive quarters of declining GDP growth. Additionally, according to a study done by larry summers and alex domash the combination of greater than five percent inflation and unemployment of less than four percent makes a recession. The first quarter of 2022 saw a 1.5 percent decline and the second quarter saw a 0.9% along with employment rates of 3.5% suggesting USA has begun its recession.

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Effect on India

Recession in US along with rate hikes is a big deal for the Indian economy as this has a direct impact on several inflows.  Firstly, currency carry trades. This affect the value of our currency which then takes a toll on our Imports because Imports become costlier profit margins become thinner in every import dependent industry as a result the cost of the products go up eventually causing a ripple effect in the economy. The currency carry trade is a trading strategy in which an investor borrows money in a low-interest rate currency and invests it in a high-interest rate currency, with the aim of profiting from the difference between the interest rates (known as the "carry"). This strategy can be risky, as changes in currency exchange rates can wipe out the potential profits from the interest rate differential. America hiking the rates means money flows out from India to America and additionally increasing demand for dollars against INR which depreciates the currency further.

Secondly, IT industry is crucial for India, contributing 8% to the country's GDP and employing 5 million people. Indian IT companies largely rely on the US and Europe for their revenue, with 86% coming from these regions in FY22. In the event of a recession in the US, the Indian IT industry may be impacted as expansion by foreign companies to utilize more IT services from India will stop as they halt their expansion plans in their operating markets. The Indian IT industry may face a growth slowdown, but will thankfully not completely shut down. Infosys, for example, saw an increase in revenue during COVID-19 but a drop in operating margins from 25% in 2015 to 21% in 2020, due to the high attrition rate in the industry. While a recession may affect the salaries of IT professionals and operating margins, the importance of software in business will ensure the industry continues to operate.

Thirdly, the merchandise sales and garment sector are expected to experience a significant impact due to the presence of large clients in Europe and the US. The US is the largest export destination for India, accounting for 16-18% of total exports. A recession in the US would directly result in a decrease in exports from India.

Lastly, another significant challenge that the Indian markets will face due to a potential US recession is a decrease in start-up funding and an increase in layoffs. Investors are now placing a stronger emphasis on profitability for start-ups, and companies that are unable to achieve this are either cutting jobs or going bankrupt.

It's not all bad news during a recession. One potential positive impact is a decrease in oil prices. If oil prices fall and the government takes advantage of the situation, fuel costs could go down, acting as a counterbalance to inflation in the country due to reduced transportation and goods costs, especially when India spends ~$80B annually on oil imports. This however in the short term seems to be unlikely as Saudi has leveraged the Russian oil supply cut to reduce its own supply too thus inflating the prices of oil in an attempt to profit as much as possible something which they haven’t been able to do since 2015 until now. Additionally, commodity prices are expected to drop further. If the depreciation of the rupee is kept under control which the RBI has already taken steps to by increasing Indian interest rates and selling forex dollars in exchange for rupees and there is no further impact on prices, India could benefit from low-cost imports.

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Sources:

https://youtu.be/HofmLFn6MTo

https://youtu.be/iIxKhF6ZLOs

https://youtu.be/rfZ7u-ecfEg

https://youtu.be/owWUyOm7SBE

https://wap.business-standard.com/article-amp/economy-policy/statsguru-from-india-to-us-six-charts-show-rising-global-inflation-122041700808_1.html

https://youtu.be/aAYziRy3kJ8

https://youtu.be/49iLl-V4xos

https://www.stern.nyu.edu/experience-stern/faculty-research/where-has-all-the-liquidity-gone

https://www.sascha-steffen.de/updates/why-shrinking-central-bank-balance-sheets-might-be-an-uphill-task

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