Emerging-market organizations will define the future of global trade, often controlling large segments. As commodity prices rebound in the next two years, albeit slowly, the actions of sovereign-wealth funds, commodity producers from emerging-market economies, the crony capitalists running those producers, and Chinese state-owned banks will influence much more the global economy and the large role played by commodities. Key signals that this could happen include the emergence of sovereign-wealth funds with their vast financial sums to invest around the world, the growth of crony capitalists in emerging-market countries, the current global monetary disorder, the declining influence of Western foreign aid and London as a financial center, and the recent rebound in commodity prices after the commodity markets collapse.
Recent Signals of Change
Recent disruptive, big, and out of the ordinary changes affecting global money flows and ownership include:
- Fueled by commodity prices, particularly oil exports, sovereign-wealth funds—financial vehicles owned by governments—doubled in size from 2007 to 2015 to $7.2 trillion. Since 2007, the number of sovereign funds increased by 44 percent to 79, many in Africa and Asia. Nearly 60 percent of sovereign wealth fund assets are related to energy exports.
- Many sovereign-wealth funds, including most likely several from the Middle-Eastern oil exporters, came to the aid of the Russian Direct Investment Fund when US and European sanctions restricted business between the Russian fund and Western companies. Sovereign funds don’t behave like traditional institutional investors that typically invest only to produce returns. Sovereign funds often answer to top government officials and may invest not only to produce returns but also to push economic-development or diplomatic initiatives.
- Developing economies account for 43 percent of global GDP but 65 percent of crony wealth. Crony capitalism is where an individual’s wealth stems from a special relationship with the government. Since globalization took off in the 1990s, the wealth of billionaires in high-crony industries, like natural resources, real estate, construction, telecoms, and defense where there’s a lot of interaction with the state or are licensed by it, grew substantially in developing countries. The Economist’s crony-capitalism index indicates billionaire wealth in crony industries in developing countries has fallen—largely because of the fall in commodity prices—from 7 percent in 2014 to 4 percent in 2016. Russia’s crony industries represents approximately 18 percent of Russia’s GDP.
- Large commodity traders, like Glencore and Trafigura, have been buying parts of the commodities supply chain. Margins in commodities trading have been shrinking as the efficiencies of the supply chain have improved and data become more abundant, and trading firms are seeking opportunities to take advantage of their commodity insights. Except when commodity prices are volatile, like over the last two years, the trading firms are looking to take advantage of global trade flows.
- As of July 2016, it appears energy and materials commodity prices hit bottom in 2015 and now are steadily recovering. The commodity fuel (energy) index of indexmundi.com is up approximately 45% since the beginning of 2016, although it’s still 23% down from the highs of a year earlier. Noticeably, private equity firms are beginning again to invest in oil opportunities. The metals price index of indexmundi.com is up 10% for the year, but still down 15% from a year ago.
- Chinese commodities exchanges are shaping the world’s commodity prices. China accounts for three of the top five trading exchanges for future contracts. While essentially closed to foreigners, the Chinese commodities markets are the world’s largest and drive short-term price fluctuations in the world.
- Large increases in the issuance of catastrophe bonds are transferring the risks from the insurance industry to capital markets. Currently $72 billion of bonds are outstanding representing a loss of 12 percent of the reinsurance business.
- London’s role in capital markets and financing sector is falling. UK banks are no longer global leaders. The average global rank of HSBC, RBS, Lloyds, and Barclays by Tier-1 Capital fell from 8.8 in 2004 to 15.5 in 2015. After Brexit, London will likely no longer be Europe’s financial center.
- Emerging-market banks are now the biggest banks in the world, feeding on the borrowing binges in those markets. The world’s four largest banks are in China, and more than a third of the world’s biggest banks have their headquarters in emerging markets. While banking standards and regulations in emerging markets are improving rapidly, the countries are becoming increasingly leveraged: Bank lending in emerging markets has increased from 77 percent of GDP in 2007 to 128 percent in 2015. In India, non-performing or restructured loans now account for 14 percent of the assets of public banks.
- Africa’s banks are in serious trouble. Africa’s financial firms did very well after the financial crisis in 2007/2008 as the world demanded the continent’s commodities. In Nigeria, 25 percent of local bank loans went to oil land gas wells. Today with the oversupply of commodities worldwide and sharply lower prices, many African-bank loans are non performing. At Nigeria’s second largest bank, First Bank, 18 percent are non-performing.
- Global monetary disorder! An array of exchange-rate mechanisms executed by governments around the world for various political and economic reasons is creating more volatility, currency mismatches, and persistent imbalances. A number of governments are intervening in foreign-exchange markets to manipulate currencies to gain export advantage. Two outcomes of this chaos are uncertainty for international businesses—and less investment—and political backlash against global trade.
- Foreign aid just isn’t efficient: Instead of going to poor, well-governed countries, it is more likely to go to middle-income countries that are poorly governed. While more transparent in the 21st century, the “system” of foreign aid is still failing. Official development aid from more well off countries is still a tool of foreign policy. New cures for poor foreign aid practices continue to be promulgated, often contradicting earlier cures. Official aid is worth about $130 billion a year—a very large sum—but it’s hard to imagine much positive direct impact given the problems it must avoid: Crooks siphoning the money or goods, weak bureaucracies administering the monies, imported goods distorting local markets, and aid monies propping up governments of dictators and prolonging civil wars.
- Economic migration is so widespread that remittances back to developing economies from workers abroad are now worth twice as much as foreign aid. Remittances are worth 10 percent of the Philippines’ GDP and 42 percent of Tajikistan’s. The cost of remitting money however is quite expensive. On average the cost to send the funds is 7.7 percent. Technology is developing to increase the competition and reduce the costs but regulations to prevent money laundering and financing of terrorism are increasing the risks and costs.
- Cross-border money payments are a target of cyberattacks. In May 2016, the Society for Worldwide Interbank Financial Telecommunications (SWIFT), the global payments system most banks around the world use to move money, described recent some spectacular cyber bank thefts out of Bangladesh, Vietnam, and Ecuador. Each of the thefts involved re-routing transactions through the SWIFT network.
- Energy-producing nations of the Persian Gulf are setting records in issuing bonds to offset the revenue declines from lower oil and gas prices. The Gulf Cooperation Council states of Saudi Arabia, United Arab Emirates, Bahrain, Kuwait, Oatar, and Oman together have raised $18 billion in 2016.
Plausible Developments in the Next Five Years
The goal of this analysis is to highlight possible outcomes in the next five years that could be very disruptive. The recent signals of change above suggest we could see the following.
- Sovereign-Wealth Funds. Sovereign funds will grow in importance in global finance. They will be the means for holding commodity-export monies anywhere in world and using them for whatever purpose.
- As commodity prices recover, the assets of sovereign funds will likely rebound and grow larger than they were in 2014. The funds will become more intertwined in the global financial system.
- The investment policies of most of these funds will remain largely obscure. Key investment criteria will most likely continue to include the foreign policy of the sovereign governments and crony benefits.
- Sovereign funds will become an even more important source of capital for large multinational companies, competing with regulated banks and public capital markets to provide that capital. The new key financiers of the world could be the investment-authority executives of commodity export countries. How might they influence the management of those companies? Might California Public Employees’ Retirement System (CalPERS) decide to exit many energy investments to be replaced by Saudi Arabia state-owned investment funds?
- Sovereign funds of commodity-export countries may become the financiers of last resort for illiberal governments and organizations subject to international sanctions. Dark money.
- More schemes by government officials and cronies to siphon off monies of the funds, like the recent case of Malaysia’s 1MDB, will become public.
- Sovereign funds will experience large volatility in their asset values and performance. A new financial disaster could occur if several large funds simultaneously collapse in some way.
- The US Justice Department and US Treasury Department will emerge as the primary check on sovereign-wealth fund abuses. No other government organization or international agency will develop the capability to identify and effectively pursue illegal actions involving the global financial system.
- For the next couple of years emerging-market currencies will remain low relative to the dollar until commodity demand and prices rebound more.
- The US dollar will remain the strongest currency and global benchmark in the foreseeable future.
- But the Chinese Yuan will establish itself as the primary alternative.
- After all the dollar-denominated borrowing by crony commodity-export producers leading up 2015, taking advantage of the low interest rates of the US dollar, many producers will struggle in 2016 and 2017 to cover the dollar interest charges with falling local currency.
- High inflation, stoked by the currency devaluations, will continue in many countries—Russia, Brazil, Venezuela—until commodity sales improve.
- Commodity markets. Commodity prices in general will rebound slowly, and the crisis is over except for the radical restructurings of many bankrupt and financially stricken producers.
- An oversupply situation will continue for several years for most natural resource categories.
- Commodity producers will continue to perform poorly financially for a couple more years.
- Large producers will continue to close or divest expensive supply assets, but excess supply will remain in place for several more years.
- Commodity sellers. But as commodity prices increase, we will see the emergence of powerful crony producers in the next five years and a decline in market share of the multinationals.
- For the next couple of years, non-state international producers will attempt to lower their costs significantly by restructuring internally and by merging or acquiring other producers and restructuring some more.
- Some producers, particularly those state-owned, will use extend and pretend practices, trying to sweep problems under the rug.
- In desperate efforts to develop new business, international corporations will pursue relations with large commodity exporting countries wherever they can, for example Russia, Iran, and Somalia. If they are Western companies, they may pursue opportunities that are against the will of their home governments.
- Commodity producers from emerging market countries will continue turning into large international competitors as they diversify and grow. More Chinese companies will become international competitors.
- As a result, multinationals from North America and Europe will lose market share to the new players. State-owned commodity producers from China are already significant players in North America, South America, Africa, and northern Europe.
- Non-performing loans and solvency of emerging market banks.
- Many emerging-market banks will likely fail in the next two years, particularly in Africa.
- If a restructuring of the banks in the different emerging-market countries doesn’t occur, then the rebound of their commodity markets will be delayed.
- China’s state-owned banks involved in Russia, Africa, and Latin America will take advantage of commodity-export countries’ need for capital.