• The IMF meeting earlier this month was in somber mood. In the words of its managing director, Christine Lagarde, the global economic recovery is “brittle, uneven and beset by risks”. This suggests that the idea that global growth will be structurally low and uneven for years is now becoming mainstream. With the exception of the US, it’s hard to discern countries or regions that inspire economic confidence.
• Numerous headwinds currently affect the global economy. Every region seems to have its own “generic” set of risks. Ebola in Western Africa, countries in the Middle East entering a warlord era, the spectre of deflation in the Eurozone, regional tensions in Asia and around Ukraine, and so on. When considered in isolation, each of these risks gives the impression that it can be contained or mitigated. But we live in a world of “systemic connectivity” in which risks amplify each other, and in the process create cascading effects. Isolation or “containment” does not rhyme with interdependence and hyper-connectedness.
• Downside risks are mounting, but policy-makers now have fewer instruments at their disposal than before to jumpstart a recovery. As a result, the temptation in Europe and Japan to reflate via a weaker currency is irresistible. At a time when the divergence in monetary policies is set to accelerate, it’s hard to imagine what might prevent a secular appreciation of the USD.
• QE3 has ended, with the paradoxical and unexpected effect that inflation expectations in the US are now lower than they were when it started in September 2012! The dollar rally that will ensue will entail dramatic consequences for most emerging markets (EM), and notably for EM companies that are overleveraged in USD terms. As a US economist once famously said, capital flows “turn on a dime”, and when they do, they devastate the financial ecosystem of the country they flee.
• Apart from a surge in productivity driven by technological innovation (a big “if” highly disputed among techno-optimists and techno-pessimists), what could improve the situation? In the most developed economies, many advocate a substantial increase in public infrastructure investment. With interest rates set to be at zero for years to come, properly designed projects could pay for themselves. According to the IMF, a dollar of investment increases output by a factor of 3.
• There are 46 countries in which central banks target inflation. 30 of them are below target. Disinflation is occurring in most of the world, and globally, deflationaryrisksareontheincrease.Someglobal mega-trends – aging and rising inequalities in particular – that are deflationary by nature now co-exist with economic forces that amplify their downside risks. The main ones: (1) Chinese growth deceleration (see next bullet point), (2) Eurozone on the cusp of deflation, (3) the USD rising against the currencies of the major US trading partners, (4) falling commodity prices.
• Over the past 14 years, China alone has contributed one fourth of all global GDP growth! Inevitably, its sharp deceleration will impact the entire world through a disinflationary / deflationary effect. Apart from China itself, who will suffer the most? (1) China’s main commodities exporters – Australia and Brazil; (2) and the Asian nations who trade intensively with China. In terms of industries: (1) energy, (2) industrial metals and (3) luxury goods.
• Since 2009,we’ve been arguing that the integrity of the Eurozone would be maintained. We are now beginning to have our doubts… Protracted “lowflation” and outright deflation in Southern Europe exacerbate the debt burden, and will eventually render the sovereign debt situation unsustainable. (The stock of sovereign debt ceases to sustainable when the difference between interest payments and nominal growth multiplied by debt/GDP is less than the primary surplus). In short, flirting with deflation for too long will eventually lead to an implosion of the Eurozone. At this stage, only a weak euro can save it.
• Since July,oil prices have dropped by 25%. This stems from a combination of weaker global growth and an abundant supply of US oil. The surplus in oil will trump the surplus of geopolitical risks that affect oil prices. In aggregate, this is good news for the world economy. The $1 trillion transfer from producers to the consumer amounts to a gigantic tax cut for oil importing countries. It will add 0.5 percentage points to global growth and possibly more than 1% if it has an effect on “confidence” (according to the IMF). Among oil exporters, the countries hit the hardest are those with the highest fiscal breakeven oil price. Venezuela, Iran and Russia are all above USD100 per barrel.
• The wild market volatility seen in October shows how abundant liquidity can abruptly disappear in a down market. The fact that liquidity is simply not there when it is most needed is a particular concern for speculators – in the US, margin debt now amounts to 2.5% of GDP, one of the highest ratios in decades. What is behind this troubling issue of “structurally lower” liquidity? There are several reasons, herding being a prominent one. In today’s transparent world, most strategies look alike, particularly for high frequency trading. Equally, benchmarks tend to resemble each other. New banking regulations in terms of increased exposure to sovereign bonds are another source of instability.
• Most of us have barely started to grasp the extent to which technology is about to revolutionize everything in an inescapable trend. Finance is not immune. P2P (peer-to-peer) platforms are now dismantling barriers to entry and lowering costs in the process. In the investment business, new “robo- advisory” algorithms and their corresponding apps now provide advisory services and portfolio tools at a fraction of the cost: 0.5% instead of the traditional 2%.
• Over the next month(s),the major“must-watch”issues that will impact investors and decision-makers are: (1) growth deceleration in China; (2) End of QE and its “unintended” consequences – particularly for EM; (3) deflationary pressures in the Eurozone; (5) the US currency risk in EM corporate debt; (6) geo-political tensions in East Asia, in the MENA region and on Russia’s borders; (7) Ebola epidemic – its human/economic cost to Western Africa and the negative effect of the “infodemic” in the rest of the world.

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