• If hard evidence is needed that the global economy is in a “muddle through” situation, the latest data on global trade provides it. In the first quarter of this year, exports and imports from the G7 and the BRICs fell by respectively 2.6 and 0.1% (from the previous quarter), wrong-footing WTO’s forecast of a substantial improvement in 2014. Why are economic forecasts from top institutions staffed with armies of bright economists almost always wrong? Silo thinking is the culprit. Considering the economy in isolation from the rest (geopolitics, society, the environment and so on) is a dead-end.
  • China entering a deflationary phase at a time of global fragility is one of today’s greatest uncertainties. China’s rise to prominence means that its slowdown will affect the word’s growth and inflation outlook for many years to come. Conflation is what matters.
  • Market participants are gripped by the debate “inflation versus deflation”, but for the moment the most entrenched problem is “lowflation”: inflation staying too low for too long. This explains why bond yields continue to confound earlier predictions. US and German 10-y yields now stand at respectively 2.5 and 1.3%, with flattening yield curves. These simply reflect policy-makers inability to push up GDP growth and fears about deflation.
  • Long-term deflationary pressures explain why interest rates and bond yields will remain subdued for much longer than anyone predicted. As we tend to suffer from short-term bias, we rarely think about their significance, but we ignore the four following deflationary headwinds at our peril: (1) Ageing; (2) Rising inequalities; (3) Chinese growth deceleration; (4) “Millenial” generation (it consumes much less).
  • No region crystallizes the danger of lowflation better than the Eurozone. Apart from the risk of circling the black hole of deflation, inflation at 0.7% combined with GDP at 0.2% make it impossible for the most indebted countries like Greece or Italy to meet their debt- reduction targets (as debt is no longer eroded by inflation). The acute phase of the Eurozone crisis has passed, but the recovery is eminently fragile. Lowflation is increasing the risk that it may yet flounder. The floor on the downside: the ECB is acutely aware of the risk and determined to head it off.
  • To a lesser extent, a lower growth / lower inflation outlook applies to the US as well. The US economy is exceptionally resilient and adaptive, but it also suffers from slack. Perceptions of an improvement are skewed by what’s happening in its labour market. Unemployment is down, but so is the labour participation rate. Furthermore, this is a “low-wage recovery”: today, there are almost 2m fewer jobs in mid-and higher-wage industries, and 1.85m more jobs in lower-wage industries, than there were before the recession took hold.
  • This month, there has been a spike in Asian geopolitical / societal shocks: the military coup in Thailand, violent anti-Chinese riots in Vietnam – reflecting simmering disputes in the East and South China seas, another Uighur terrorist attack in China, etc. All these disparate eruptions may retreat into the background, or continue to flare up in unexpected ways. Stresses on global supply chains and multinationals are the first round-effect. A lingering sentiment of insecurity among direct and portfolio investors comes next.
  • Russia’s intrusion in Eastern Ukraine and the spat between Vietnam and China over a deep-sea drilling rig are two facets of the same story: the move towards multi-polarity. In this messy new world void of a global hegemon, conflicts are no longer driven by ideology, but spurred by either (1) nationalism or (2) competition for resources. The latter means they are destined to multiply.
  • Common wisdom has it that autocracies, or “enlightened non-democracies”, are better at delivering growth. Wrong! New research shows unambiguously that democracy promotes economic development. Typically, a non-democratic country that becomes a democracy achieves 20% more GDP per capita over the course of 30 years. This suggests that long-term investors are better-off investing in democracies than in autocracies. But beware of this simple dichotomy. For some countries, the future may be neither democracy nor autocracy, but anarchy.
  • More than half a billion Indian voters just elected Narendra Modi in the hope that he can deliver more rapid growth. He will now endeavour to replicate in the rest of India the program of “minimal government and maximum governance” that he successfully implemented in the state of Gujarat. His challenge is therefore not economic (he knows what to do!) but political (he has to overcome the vested interests of state governments). A useful indicator to assess progress: the much-needed reduction in subsidies – that currently represent a full 2.4% of GDP.
  • The financial lobby is stronger than ever. Key policy- makers (like the heads of the IMF and the Bank of England) just voiced publicly concerns about banks pushing back against much-needed reforms. The financial sector is barely safer than it was prior to the crisis. In particular, the “too-big-to-fail” problem remains a major thorn in the regulators’ side.
  • The more information there is and the more analysis we have, the greater the confusion and the proliferation of “backfire effects” – situations in which people stick with ever greater vehemence to their original position when confronted with evidence that conflicts with their beliefs. Whether it’s climate change denial, warnings about imminent inflation risk, anti- vaccination activism, backfire effects are at work. They confuse policy-and decision-makers who sometimes fail to realize that facts never win arguments.
  • Start-ups such as Instacart epitomize the disruptive power of technology: they are altering the labour market and lowering the barriers for businesses and individuals to create wealth. Instacart’s decentralized business model couldn’t be simpler and leaner: it’s an online one-stop shop for groceries that doesn’t rely on expensive vans and warehouses. What then? Instead, “personal shoppers” deliver the goods with their own car, while being paid twice as much as a traditional worker in a supermarket. Good for the economy – less so for inequality.
  • The major “must-watch” issues that will affect investors’ and decision-makers’ sentiments over the next month(s) are – in no particular order: (1) the slowdown – or burst – in Chinese property prices; (2) the widening of Eurozone bond spreads; (3) the US currency risk in EM corporate debt; (4) geopolitical tensions in Asia; (5) chaos in Eastern Ukraine. For insights and real-time analysis on any of these, please contact us.
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