This week, we are paying special attention to the state of world trade. In a new report from the International Monetary Fund (the three parts of which we will be covering in our summaries over the next three weeks) highlights the slowdown in globalization and the strains on multilateralism that are transforming the world trade system. To expand on this same idea, we review two articles from the Financial Times and Wall Street Journal that argue the supply chain issues that have evolved from the pandemic and the Russian invasion of Ukraine, as well as rising geopolitical tensions, are ushering in a new era of world trade. Also this week, we examine the recent trend of security development among China’s neighbors in the Pacific, and we explore the debt issues hampering Wall Street’s most important lenders.

Geoeconomic Fragmentation and the Future of Multilateralism:

Part I: The Current State of Global Economic Integration

International Monetary Fund

Read the full report here

Globalization – the process of increasing the free movement of people, money, goods, services, and ideas across borders – is embattled. While trade has risen in the past two decades and the internet has connected people around the world like never before, geopolitical events have demonstrated the fragility of the vastly interconnected global economy. As countries have specialized in critical commodity production for efficiency, that production has become highly concentrated, making global supply chains fragile to disruption. Globalization, which has slowed since the financial crisis, has begun to be a point of contention across the world. The perceived effects of globalization, such as surging inequality and the decline in the labor share of income, have driven discontent, fueling populist policies that raise barriers to free trade. The COVID-19 pandemic and the war in Ukraine have further weakened the global economic order, spurring governments to enact protectionist policies that are designed to support and provide subsidies to domestic industries. These policies often strengthen domestic industry at the expense of foreign producers. This global economic uncertainty has convinced firms to focus on strengthening their supply chains by reshoring to reduce their exposure to risk.

A New Era of World Trade

Companies race to work around choke points in world trade

Andrew Edgecliffe-Johnson, Financial Times

Who Is Going to Police the New World Trading System?

Greg Ip, Wall Street Journal

Supply chain risk has become a critical issue for businesses to manage. Starting with Covid-19 and continuing with the fallout from the war in Ukraine and the rise of autocratic China, businesses have begun to look at the potential of reshoring or “friendshoring” their supply chains so as to avoid significant geopolitical disruptions moving forwards. This is especially poignant as governments, like the US, increasingly move towards the reshoring of critical industries, such as semiconductor manufacturing, on the grounds of national security which is in direct contravention of World Trade Organization (WTO) rules. The world, then, is moving away from the WTO world of open and free-trade, adjudicated through legally binding, internationally recognized dispute resolution, and increasingly towards the pre-WTO era where unilateral actions by one nation on tariffs, restrictions, and the like against another were met in kind. This is largely a consequence of the Chinese system’s incompatibility with those of the West, particularly in private enterprise, making the adjudication of rules at the WTO level difficult. While Western governments allow free enterprise to maneuver and flourish within the confines of their nation’s laws, the Chinese need not pass laws at all, especially those in contravention of WTO norms, for instance on subsidies, given how pervasive the Chinese state is in private enterprise. This makes it difficult to bring a WTO case against the Chinese for practices that would otherwise be considered in violation of WTO norms. Not even countries friendly with one another have been spared, as the European Union threatens a WTO suit against the US for subsidizing electric vehicle manufacturing in the US via the Inflation Reduction Act. The US response is telling: rather than go to the WTO, retaliate with subsidies of your own. Ultimately, then, in the place of a single set of rules, the world will likely move towards regional pacts where countries will pick partners that align with their values and interests.

Asia, Europe Look to Collective Action to Restrain China

Alastair Gale & Chieko Tsuneoka, Wall Street Journal

Read the full article here

Democracies in Asia are contending with the reality that American security guarantees alone are insufficient as Chinese capabilities continue to improve. As a result, Beijing’s neighbors are increasingly developing regional security systems to achieve deterrence against Chinese aggression. For example, nations such as Japan, South Korea, Australia, and the Philippines have begun information sharing and defense procurement. Meanwhile, some bilateral military drills have taken place between nations, such as Japan and South Korea, and are set to take place between Japan and India. Cooperation is deepening with the West as well. On Wednesday, Japanese Prime Minister Fumio Kishida signed an agreement with the United Kingdom to facilitate more joint military exercises, following a similar deal cut with Australia. Additionally, French, German, and Dutch warships have been seen conducting drills in the Pacific region, most notably with Japan over the past year and a half. These actions, among others, have alarmed the Chinese whose top diplomat Wang Yi has accused the US of attempting to create an Asian NATO. Signals like these from Beijing have kept many Southeast Asian nations from aligning too closely with the US, given how important China is regionally and especially as a trade partner. As China’s rise continues, regional tensions will likely continue to flare, especially over democratic Taiwan. A hostile takeover of Taiwan by China could bring the US and even Australia, Japan, and the UK to come to its defense.

Wall Street’s Lucrative Leveraged-Debt Machine is Breaking Down

Lisa Lee, Claire Ruckin, & Jill R Shah, Bloomberg

Read the full article here

The high-risk, debt-fueled mergers and acquisitions (M&A) boom that has powered bankers over the past decade is weakening. The industry, largely propped up by the “Great Moderation”, a generation-long era of near-zero interest rates and high market liquidity, is now being confronted with the end of that era as the Fed continues its hawkish stance on fighting inflation. Some of the world’s largest banks have been forced to take write-downs on recent debt-fueled M&As. Bank of America, Barclays, and Morgan Stanley are among the most exposed to the fall. These systemically important lenders are dealing with about $40 billion in hung debt, tying up their capital to make new deals. Fortunately, the projected losses are minor compared to those of the financial crisis, but banks could still face industry-wide layoffs.