The Return of Anarchy

The world has changed irreversibly in important ways.

This is a problem for an industry that relies on past performance to gauge future outcomes. But it is what it is.

There are many consequential developments with which investors should grapple.

I will highlight three.

1. Path Dependence and Bad Outcomes
Vladimir Putin launched his abhorrent war with maximalist objectives. 

He miscalculated. Ukrainians’ tenacity, coupled with a zealous response from the G7 and others, have dramatically increased Russia’s costs and reduced the likelihood of its ability to attain maximalist ends.

De-escalation and dialogue are necessary. The Ukrainians must determine whether negotiations can lead to acceptable terms, whether Putin will adhere to them, and whether the costs of continued conflict are bearable (and if so, toward what ends). 

My worry is that a modus vivendi with Putin is unlikely.

The destruction and isolation of Russia’s economy is tragic for the Russian people, and it’s unclear how the sanctions will be unwound. The prospects for Russia’s economy are so bleak that the world undoubtedly faces increased risks of proliferation. 

Russia is weak, and Putin’s multi-year clampdowns on civil society and political opposition add to its weakness. Zealous calls for regime change evoke the disaster of De-Ba’athification in Iraq in 2003. Who fills the gap?

The performance of Russia’s military so far implies that strategic weapons are their only viable recourse in any broader European conflict. Given Putin’s revanchism, this is bad.

The world does not need more weak states with nuclear weapons, but that is what we face.

2. The “Rules-based Order”
Putin’s invasion of Ukraine — with the tacit support of Xi Jinping — is the opening of a contest for the future of the international system.

The invasion of Ukraine happened, in part, because the post-WWII system had already failed.

This may be uncomfortable for many Americans to read, but the United States has played a role in fanning the flames of entropy. Over the last 30 years it has gone from stewarding order and the international system to exploiting its dominant power position to change the governments and conditions of sovereign states.

In brief, the “unipolar moment” led to calls from foreign policy thinkers in both parties to seize an historic opportunity to shape the world in the United States’ image — from “Democratic Enlargement” in Somalia, to the “Freedom Agenda” in Iraq, to the “Responsibility to Protect” in Libya.

The underlying thinking was that, given its preponderance of power — and the perceived universality and moral justice of its ideals — the United States need not be constrained by the rules of the system.

The ends would justify the means.

Alas, all of these military actions culminated in a period in which the United States sought a breather from acting as the “world’s policeman,” and aimed to husband its power after having changed the rules of the game.

And U.S. power was in relative decline precisely as the global environment was becoming less benign, and peer competitors were becoming more aggressive toward their neighbors.

It was hard to reconcile the scale of the changes with the slow pace of historical processes in real time, but it has been manifest for many yearsthat anarchy was in the ascendant.

3. Central Bank Reserves and the Dollar
Last month, the world’s governments learned that property rights do not apply to foreign reserves.

Recall that before Putin’s invasion of Ukraine, the U.S. government froze $7B of the Afghan central bank’s U.S.-based assets.

The U.S. government partitioned the assets into two tranches: $3.5B earmarked for humanitarian aid in Afghanistan, with the balance reserved to cover potential claims from U.S. plaintiffs who have sued the Taliban for losses due to terrorism (including the 9/11 attacks).

The stewards of the largest economy in the world — GDP of $21 trillion in 2020 — seized the assets of a country with a gross national income per capita of $500 (World Bank, Atlas method).

According to UN Population Division estimates, ~21 million Afghans were between the ages of 0 and 19 in 2020 out of a total population of ~39 million. 

In other words, more than half of the country’s population wasn’t even alive on 9/11.

Two weeks after the seizure of Afghanistan’s assets, the EU, Japan, Switzerland, the UK, and the United States froze the Central Bank of Russia’s assets.

The implications of this decision will take time to understand fully. However, some immediate conclusions may be drawn.

Since the Asian Financial Crisis, reserve accumulation has been a core tenet for many EM policymakers, China above all. 

From 2000-14, EM FX reserves grew from ~$400 billion to ~$3.3 trillion, 66% of which were in USD. Over that period, EM’s share of the world’s total FX reserves grew from 26% to 49%.

This voluminous accumulation of dollars helped depress U.S. interest rates, and supported America’s credit- and consumption-driven economy.

Global reserve accumulation continued at an 8% CAGR from 2014, with total allocated FX reserves reaching $12 trillion as of Q3 2021

Given the state of America’s finances, countries have sensibly been diversifying away from the USD, which has declined from 71% of reserves in 1999 to 59% in Q3 2021.

Surely the weaponization of central bank FX reserves will accelerate the move away from the U.S. dollar-led system.

Many people persist in believing this is unlikely for lack of a viable alternative. After all, the EUR sat at ~20% and the RMB ~3% of allocated reserves last year.

However, the probability that an alternative will be found has gone up considerably.

The issue isn’t what assets are available to absorb reserves in, say, China relative to the United States today; it’s that the shift determines which countries will benefit over the decades to come.

Two thoughts:

The Petrodollar — What if oil exporters and importers agree to price the commodity in another currency? Why wouldn’t they?

Regardless of net-zero targets, the International Energy Agency projects that EM and developing economies are going to drive increased oil demand of 12+ million barrels per day under most scenarios through 2030.

The West’s imports of oil flatlined over 40 years, while China’s have grown at 18%, India’s at 6%, and non-OECD Asia and Africa at ~3%. 

These are the markets where the people are.

Setting aside the question of who will secure the shipping lanes, is it any surprise that palaces in the Gulf aren’t picking up the phone?

The Bancor — Rather than looking around for an existing alternative, what if a group of commodity-exporting countries and large buyers took up Zhou Xiaochuan’s 2009 proposal to resurrect Keynes’s Bancor?

Beyond the implications for the dollar, the emergence of a Bancor-like currency could carry the potential to radically reshape world trade from an open system to one of preferential market access / spheres of influence. It would also be likely to constrict international capital flows. 

There are numerous implications of governments moving away from the dollar and seeking direct custody of their assets — not least for investors whose long-term capital is tied up in markets that deem the United States an adversary (or vice versa).

A few for the United States: 

  • America would be compelled to abandon its debt-fueled, consumption-led growth model, with all the implications that has for returns on equity and the LBO model.
  • The elimination of the Petrodollar would likely reduce the outsized role of finance in the economy and in politics.
  • A weaker dollar could accrete to a revitalized defense industrial / manufacturing base.

There are other developments regarding China, crypto, and rearmament that merit thought and attention — and there is a world beyond Eurasia — but I’m going to stop here.

It’s all very fluid, but the contours are appearing.

We are transitioning from the age of globalization under American leadership to an era of autarky under anarchy.

Peace be with you.


The Power Law

Sebastian Mallaby has written a compelling history of U.S. venture capital (The Power Law). 
It’s a bit of a love-in for Sequoia at times, but it offers insightful interpretations of how leading firms adapted to the shifting landscape of tech (from hardware to software), and embraced (fueled?) the cult of the entrepreneur.
I sent Sebastian a cheeky tweet last December suggesting that the launch of his book might top-tick U.S. VC:

It was a fun back-and-forth.

In my view, if VC is meant to be a source of enduring economic growth in the United States, then it will need to pivot from its gamified approach to software startups and seek out genuine discoveries on the frontiers of science. 

The stories in Africa, Asia (ex-China), and Latin America are different.

Parenthetically, it does seem like the last 30 years have been a transition from:

the Power of Law → the Power Law → the Law of Power


Bain’s latest Global PE Report is out, and it’s a doozy.

A few takeaways that jumped out at me:

  • Global buyout deal value hit $1.1T, ~40% higher than the prior peak in 2006.
  • Average EBITDA multiples for U.S. LBOs hit 12.3x.
  • Technology companies accounted for 27% of global buyout-backed exits in 2021, up from 15% in 2015.
  • Sponsor-to-sponsor exits were up 108% compared to the 5-year average.
  • Asia-Pac accounted for roughly half of global venture and growth equity AUM in 2021.
  • Multiple expansion accounted for 56% of the value bridge for the median buyout deal between 2016-21, with margin expansion a mere 6%.
  • This chart in an inflationary environment:
Source: Bain & Co. Global Private Equity Report 2022

From the Bookshelf

Athenians: … we recommend that you should try to get what it is possible for you to get, taking into consideration what we both really do think; since you know as well as we do that, when these matters are discussed by practical people, the standard of justice depends on the equality of power to compel and that in fact the strong do what they have the power to do and the weak accept what they have to accept.

Melians: Then in our view (since you force us to leave justice out of account and to confine ourselves to self-interest) — in our view it is at any rate useful that you should not destroy a principle that is to the general good of all men — namely, that in the case of all who fall into danger there should be such a thing as fair play and just dealing … And this is a principle which affects you as much as anybody, since your own fall would be visited by the most terrible vengeance and would be an example to the world.

Thucydides, The Peloponnesian War, Book V, Chs. 89-90 (Penguin Classics: 1972)

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